Petition — Clarence O. Dupuy, Jr. v. Milton E. Dupuy

Supreme Court brief1977

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IN THE

Supreme Court of the United States

OCTOBER TERM, 1977

i aa “1866

CLARENCE O. DUPUY, IR..

Reiator,

versus

ON E. DUPUY,

Respondent.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

MILTON E. BRENER

1304 F.N.B.C. Building

New Orleans, Louisiana 70112

ARTHUR L. BALLIN

1121 Carondelet Bldg.

New Orleans, Louisiana 70130

ATTORNEYS FOR RELATOR

SCOFIELDS' QUALITY PRINTERS. Y O BOX 53096. N O. LA. 70153 - 504/822-1611

| BEST COPY AVAILABLE

INDEX

Page

Dee Gl „ cc cctcncecucnceeen ii

J (hh, Catia Sees ccddccde codes seaee 2

e ee aethvseeeeae 2

QUESTIONS PRESENTED ............ccccccccccees 3

I. Diligence on the Part of Plaintiff .......... 3

II. Scienter on the Part of Defendant .......... 5

III. Remand on Limited Issue .................. 6

STATUTORY PROVISIONS INVOLVED ......... 7

STATEMENT OF THE CASE ..................0.. 8

. 12

J r 21

Rr . onc cc ccc cescccccccss 23

REASONS FOR GRANTING WRITS ............. 24

I. Conflicts Among the Circuit Courts

, ⁵ ⅛ A beeches es res 24

II. Need to Settle Important Question of

Federal Law ( Recklessnes ............ 45

III. Departure by the Circuit Court from

the Accepted and Usual Course of

Judicial Proceedings to such an Ex-

tent as to Call for an Exercise of this

Court’s Power of Supervision

eg RE te 51

, ween vebscnncdvecsdsess 55

INDEX (Continued)

Page

APPENDIX

A. Trial Court Motion for Judgment

Notwithstanding the Verdict and fora

New Trial, March 11, 1976 ................. la

B. Transcript of Trial Judge’s Oral

Reasons for Judgment, Issued from

, A 1. 3a

C. Trial Court Judgment Notwithstand-

ing the Verdict and for New Trial, June

rennen — a. 7a

D. Judgment of Court of Appeals, May 9,

EO . 950000000 WV ²˙— th ttebas sxe 9a

E. Opinion of Court of Appeals, May 9.

— ̃ y , ĩ -. 10a

F. Notice of Order Denying Rehearing.

e 56a

TABLE OF AUTHORITIES

CASES:

Affiliated Ute Citizens of Utah v. U.S., 406 U.S.

ee a ee ee 24-25,44

Arber v. Essex Wire Corp., 490 F. 2d 414 (6th

e ceueler eles Goackd: 27-28,33

Azalea Meats, Inc. v. Muscat, 386 F. 2d 579

,,, 5 dp ihe ee ee begetbedeses 31

Bird v. Ferry, 497 F.2d 112 (5th Cir. 1974) ......... 34

Blue Chip Stamps v. Manor Drug Stores, 421

U.S. 723. 95 S. Ct. 1917, 44 L.Ed. 2d 539 (1975) 4.34.

35.45.55

iii

TABLE OF AUTHORITIES (Continued)

Page

Boeing Co. v. Shipman, 411 F.2d 365 (5th Cir.

777 aA ³⁰˙¹u˙ rr 40

Carroll v. First National Bank of Lin-

colnwood, 413 F. 2d 353 (7th Cir. 1969) .......... 28

City National Bank of Fort Smith Arkansas v.

Vanderboom, 422 F.2d 221 (8th Cir. 1970) ... 29,31

Clement A. Evans & Co. v. McAlpine, 434 F. 2d

r ͤ » -- 11.31.37

Commercial National Bank in Shreveport v.

Parsons, 144 F. 2d 231 (5th Cir. 1944) ........... 50

Dupuy v. Dupuy, 375 F. Supp. 730 (E.D. La.

1975), reversed and remanded 511 F.2d 641

(5th Cir. 1975), on remand reversed in part,

affirmed in part and remanded 551 F.2d 1005

0 ͤͥ! —U—T—I— K , 2.3.30

Edwards v. Sears, Roebuck & Co., 512 F. 2d

, ᷑ AA.. ˙ * 54

Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96

S. Ct. 1375, 47 L. Ed. 2d 668 (1976) 4,5,9,24,30,

33,45,47

Ford Motor Co. v. Mahone, 205 F. 2d 267 (4th

r, obs cbetecoberebelsee oun 54

Frigitemp Corp. v. Financial Dynamics

Fund, 524 F. 2d 275 (2d Cir. 1975) ............... 26

Gasoline Products v. Champlin Refining Co.,

293 U.S. 494, 51 S. Ct. 513, 75 L. Ed. 1188 ........ 53

Grimm v. Calif. Spray-Chemical Corp., 264

IL 54

Hirsch v. DuPont, 553 F. 2d 750 (1977) ............. 36

TABLE OF AUTHORITIES (Continued)

Page

Holdsworth v. Strong, 545 F. 2d 687 (10th Cir.

.o, chdneeeee 30,48

Howell v. Marnpegso Compagnia Naviera,

S36 F’. Od 10GB G Cir. 0 54

Hudak v. Economic Research Analyst, Inc.,

499 F. 2d 996 (Sth Cir. 197 4c)ͥꝓ4h;źvꝓ ee eees 31

J. I. Case Co. v. Borak, 377 U.S. 426, 84 S. Ct.

%.. 24

Johnson v. Wiggs, 443 F. 2d 803 (5th Cir.

...en eens 11.32.39

Kohler v. Kohler Co., 319 F. 2d 634 (7th Cir.

„nen 28.39

Metro-Goldwyn Mayer, Inc. v. Ross, 509 F. 2d

L dies isviteéncw ares, 25

Minneapolis, St. Paul & S.S.M.R. Co. v. Mo-

quin, 283 U.S.520,51S. Ct. 501. 75 L. Ed.1243 ..... 54

Myzel v. Fields, 386 F. 2d 718 (8th Cir. 1967) 28

Perry v. Cedar Falls, 98 Iowa 315, 54 N. W. 225. 36

Rochez Bros., Inc. v. Rhoades, 491 F. 2d 402

(3d Cir. 1974), cert. denied 425 U.S. 993 27,36

Rogen v. Illikon Corp., 361 F. 2d 260 (ist Cir.

ccc 25

Royal Air Properties, Inc. v. Smith, 333 F. 2d

oe re ee 25

Sargent v. Genesco, Inc., 492 F. 2d 750 (5th Cir.

c 31

TABLE OF AUTHORITIES (Continued)

Page

S. E. C. v. Texas Gulf Sulphur, 401 F. 2d 833 (2d

ee ee eer abocnsednceenecoecseccscore 32

Shappirio v. Goldberg, 192 U.S. 232 33

Smallwood v. Pearl Brewing Co., 489 F. 2d 579

D 666666 31

Still v. Smith, 473 F. 2d 1205 (5th Cir. 1973) 33

Straub v. Vais man & Co., Inc., 540 F. 2d 591 (3d

D ÜOJ een ! 52˙ͤ„„„6 26

Titan Group v. Faggan, 513 F.2d 234 (2d Cir.

1974), cert. denied 423 U.S. 84e 36

U.S. v. Am. R. Express Co., 265 U.S. 425, 44

r os cccccccnepevccceceess 50

White v. Abrams, 495 F. 2d 724 (9th Cir. 1974 29

STATUTES, RULES, CONSTITUTIONS:

Federal Rules of Civil Procedure

r tea. „ 4 11.22.23

Securities and Exchange Act of 1934, § 10(b),

e 1.3.4.7. 8.9.24. 33.34.

35.36. 44.47.49

Securities and Exchange Commission Rule

10b-5, 17 C. F. R. 240. 10-5 3.4.5.8. 9.26.27.

29. 31.32.34. 44.45. 46.47

United States Constitution, Fifth Amendment 7

United States Code, Title 28, Section 1254(1) ...... 2

TABLE OF AUTHORITIES (Continued)

Page IN THE

SUPREME COURT OF THE UNITED STATES

MISCELLANEOUS: OCTOBER TERM, 1977

Black’s Law Dictionary, 4th ed. (West

R AA 35

Bromberg, “Plaintiff's Due Care Under Rule No.

10b-5,"" 70 N. W. U. L. Rev. 511. 33

2A Bromberg Securities Law: Fraud (19717 26

: CLARENCE O. DUPUY, IR..

Comment, “Negligent Misrepresentations Relator,

Under Rule 10(b)-5” 32 U. Chi. L. Rev. 824 versus

GR eh Pie BOs Rey Sa 5b hak dhe w 29

MILTON E. DUPUY,

Respondent.

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

The petitioner, Clarence O. Dupuy, Jr., respectfully

prays that a writ of certiorari issue to review the judg-

ment and opinion of the United States Court of

Appeals for the Fifth Circuit entered May 9, 1977,

rehearing denied June 6, 1977, reversing a judgment

notwithstanding the verdict and alternative new trial

entered by the trial judge in favor of Relator, and

remanding the case for retrial limited to the issue of

damages. This case involves questions of far-

reaching importance in the field of federal securities

laws, particularly Section 10(b) of the Security and

Exchange Act of 1934, 15 U.S.C. §78j(b).

OPINIONS BELOW

The opinion of the United States Court of Appeals

for the Fifth Circuit in Proceedings No. 76-2667 of that

Court, entitled “Dupuy v. Dupuy” is reported at 551

F.2d 1005; copies of the Court of Appeals judgment,

opinion, and notice of denial of rehearing are append-

ed. The Federal District Court for the Eastern District

of Louisiana issued no written opinion in support of

its judgment, a copy of which is appended; Relator has

appended a copy of atranscript of the trial judge’s oral

reasons for judgment, issued from the bench, June 9,

1976.

Shortly after the filing of the initial petition by

respondent, the District Court dismissed on Relator's

Motion for Summary Judgment for Lack of Federal

Jurisdiction; the District Court’s opinion regarding

the granting of summary judgment is reported at 375

F. Supp. 730 (E.D.La. 1975). The United States Court of

Appeals for the Fifth Circuit reversed said granting

and remanded for trial; the Court of Appeals opinion

regarding the reversal of summary judgment is

reported at 511 F. 2d 641 (5th Cir. 1975). The issue that

is the subject of these two opinions is not involved in

tis application.

JURISDICTION

This Court has jurisdiction pursuant to United

States Code Title 28, Section 1254(1), authorizing

review of cases in the Court of Appeals by this Court

by writ of certiorari before or after the rendition of

judgment or decree. The judgment sought to be

reviewed is that contained in the decision of the Unit-

ed States Court of Appeals for the Fifth Circuit,

entered May 9, 1977, in the matter entitled “Dupuy v.

Dupuy’, No. 76-2677 on the docket of that Court,

rehearing of which was denied on June 6, 1977.

Federal jurisdiction was invoked by the plaintiff,

respondent herein, pursuant to the provisions of the

Securities and Exchange Act of 1934, as amended, Sec-

tion 10(b), 15 U.S.C.A. §78j(b) (1970), and under

Securities and Exchange Commission Rule 10b-5, 17

C.F.R. 240.10b-5 (1976), prohibiting manipulative or

deceptive practices, through use of a means or in-

strumentality of interstate commerce, or of the mails,

in connection with purchase or sale of any security.

On motion for summary judgment, the trial court dis-

missed the complaint on the basis that intrastate use

of the telephone was insufficient to meet the statutory

requirement of use of a means or an instrumentality of

interstate commerce. As above stated, the United

States Court of Appeals for the Fifth Circuit reversed

and remanded for trial and this decision was not the

subject of further appeal.

QUESTIONS PRESENTED

Due Diligence On The Part Of Plaintiff

1. Whether plaintiff must prove, for the protection

of his own interests and as a requisite for the

maintenance of the judicially-created private right of

action under Section 10(b) of the Securities Exchange

Act and Rule 10b-5, minimum standards of diligence,

and, if so, to what degree must diligence be exhibited

and by what rule is the conduct of plaintiff to be

measured.

2. Whether a Section 10(b) action is available toa

plaintiff upon a mere showing that he did not act with

intentional or reckless disregard of known facts in

failing to investigate the factors affecting the value of

stock sold by him or whether, in a face-to-face transac-

tion, a seller, who is a director and president of a

closely-held corporation, who has realistic and

meaningful access to information that would have dis-

closed the state of facts affecting value but who was

only exerting pressure for an immediate sale, must

additionally show that he acted as a “reasonable in-

vestor exercising due care in light of all the facts.“

3. Whether the standard of recklessness as

described in 2, above — that is, the intentional or

reckless disregard of known factors, as defined by

the United States Court of Appeals for the Fifth Circuit

in the decision complained of herein — is the correct

standard to be applied to plaintiff in private actions

under Section 10(b) of the Securities Exchange Act

and Rule 10b-5, considering that previous and

different standards of conduct have heretofore been

imposed, and further considering that the imposition

of said new standards will have the inevitable effect of

an “inexorable broadening of the class of plaintiffs”

in 19b-5 actions, declared to be a matter of concern by

this Court as tending to “ultimately result in more

harm than good. in Blue Chip Stamps v. Manor Drug

Stores, 421 U.S. at 747-748, 95 S. Ct. at 1931,44L. Ed. 2d

at 556 (1975). and in Ernst & Ernst v. Hochfelder, 425

U.S. 185. 96 S. Ct. 1375, 47 L. Ed. 2d 668 (1976).

—

4. Whether, if said newly imposed standard is cor-

rec, the United States Court of Appeals for the Fifth

Circuit erred in holding that the trial judge abused his

discretion in holding that the jury had no reasonable

basis for finding even a minimal standard of due

diligence.

Scienter On The Part Of Defendant

5. Whether “recklessness” on the part of a defen-

dant, in a Rule 10b-5 action, is sufficient to supply the

required element of scienter in accordance with the

decision of this Court in Ernst & Ernst, supra.

6. Whether the Trial Court correctly instructed

the jury as to the criteria for liability by charging in

the following language:

“To complete his proof that the defendant

acted in an unlawful manner, the plaintiff

must show that the misrepresentations

and/or omissions were done knowingly, or

that such acts were done recklessly.”

(Emphasis supplied.)

7. Whether the Trial Court instructed the jury cor-

rectly as to the requirement of scienter to impose

liability when it instructed the jury on the term

“reckless” in the following language:

“An act is done recklessly when done in con-

scious disregard of, or with indifference to, the

risk that the plaintiff would be misled. If a per-

songnakes a misrepresentation without know-

ing whether it is true or not, or makes it

without regard to its truth or falsity, or to its

possible consequences, he may be found to

have made the representation recklessly...”

8. Whether the issue of the sufficiency of the trial

judge’s charge on scienter was properly presented to

the Circuit Court of Appeals for review whe. the issue

was briefed and argued by Relator (Appellee below) as

an additional ground on which anew trial should have

been granted, although no cross-appeal was taken by

Relator from the District Court following that Court’s

granting of judgment notwithstanding the verdict and

conditional new trial in favor of Relator, which con-

ditional new trial was granted on grounds other than

the error in the jury instructions pertaining to

scienter.

Remand On Limited Issue

9. Whether the Court of Appeals properly limited

the issue on remand solely to the subject of quantum of

damages in view of the trial court’s ordering a new

trial without limitation of issue in the following

language:

“It is further ordered, adjudged and decreed

that the alternative motion for a new trial

made by Clarence O. Dupuy, Jr., the defendant

herein, be and the same is hereby granted.”

upon the ostensible grounds that the trial court

ordered a new trial on damages only.

10. Whether the action of the Court of Appeals in

limiting the remand only to the issue of the quantum of

damages was proper in view of the finding of the trial

court that the jury verdict for plaintiff (Respondent) in

the amount of $905,000.00 shocked the conscience of

the court and was the result of passion and prejudice,

and in view of the fact that issues of the value of the

stock sold are so closely intertwined with issues per-

taining to liability that to limit the new trial on re-

mand would deprive Relator of his constitutional

rights to due process and fair trial under the Fifth

Amendment of the United States Constitution.

STATUTORY PROVISIONS INVOLVED

Section 10(b), of the Securities and Exchange Act of

1934, as amended, 15 U.S.C. Section 78j(b) (1970)

provides:

“It shall be unlawful for any person, directly

or indirectly, by the use of any means or in-

strumentality of interstate commerce or of the

mails...

b) To use oremploy, in connection with the

purchase or sale of any security registered on

a national exchange or any security not so

registered, any manipulative or deceptive

device or contrivance in contravention of such

rules and regulations as the Commission may

prescribe as necessary or appropriate in the

public interest or for the protection of in-

vestors.“

Securities and Exchange Commission Rule 10b-5, 17

C.F.R. 240.10b-5, provides:

“It shall be unlawful for any person, directly

or indirectly, by the use of any means or in-

strumentality of interstate commerce, or of

the mails...

(1) Toemploy any device, scheme or artifice

to defraud,

(2) To make an untrue statement of a

material fact or to omit to state a material fact

necessary in order to make the statements

made, in 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

Presented for review and determination are two

legal issues, the resolution of which will be of

profound and far reaching significance to the vast

body of litigation, under Title 15 U.S.C. Section 78j(b)

and S.E.C. Rule 10(b)-5, dealing with securities fraud.

The first question concerns that of the degree of

diligence which must be exercised by a plaintiff in

protection of his own interests. Despite conflicting

decisions from nine of ten circuits, this Court has

never addressed itself to this issue.

The second question concerns the sufficiency of

“recklessness” to satisfy the scienter' requirement

in actions under Securities Exchange Act Section

10(b) and S.E.C. Rule 10b-5. Determination of this

issue was specifically reserved by this Court in Ernst

& Ernst v. Hochfelder, 96 S.Ct. 1375 at N. 12, p. 1381.A

third question concerns the propriety of remanding

this case for re-trial on a limited issue of damages

only. The factual setting in this case not only presents

these legal issues in sharp delineation, but also

dramatically illustrates the stark injustice inherent in

permitting recovery by one who has shown such

monumental disinterest in his own investment by ad-

mittedly, utterly and completely failing to investigate

the condition of the Corporation of which he was the

president and a director. The conduct of Respondent-

plaintiff in this case evidenced only an iron-willed

determination to sell his shares.

Milton Dupuy, respondent (sometimes hereinafter

referred to as Milton“), filed a complaint against his

brother Clarence Dupuy, (sometimes hereinafter

referred to as Clarence“), under Section 10(b), of the

Securities Exchange Act of 1934, as amended, 15 U.S.

§17j(b) (1970), and S. E. C. Rule 10b-5, 17C.F.R. 240. 10b-5

(1976). on September 7. 1973. He claimed to have been

defrauded in connection with the purchase by

Clarence of Milton's stock in Lori Corporation, a

closely held family corporation. owned 47% by each

brother and 6% by their mother, Mrs. Florence Dupuy.

They each lived in different apartments in the same

apartment complex. The corporation had been formed

in November, 1971, for the purpose of building a hotel

in the New Orleans French Quarter. Each brother at

that time paid $1880.00 for his stock. Milton made no

further cash investment. At all pertinent times, Milton

was allegedly President of the corporation and a

member of the Board of Directors.

The transfer of the stock from Milton to Clarence and

execution of the transfer document was on August 29,

1972. The essence of the complaint was an alleged

wrongful withholding by Clarence of information

concerning the execution on July 71, 1972, of a

partnership agreement by him with one William

Monteleone, the contribution by Monteleone of $600,-

000.00, cash as a limited partner to be used in construc-

tion of the proposed hotel and the assignment by

Clarence to the partnership of a real estate lease in the

name of the corporation, all on the same date of July

31, 1972.

Clarence, the Relator, defended on the grounds that

the transfer of stock on August 29th, was pursuant to

an oral agreement between the two brothers almost

two months prior to the partnership agreement in the

early part of June, 1972, confected in the apartment of

their mother and in the presence of their mother upon

the insistence of Milton, the Respondent, and that

Milton knew of Clarence’s negotiations with

Monteleone and the imminent completion of the

partnership as he had been told of it repeatedly, but

wanted, and insisted, on withdrawing completely

from the hotel venture. Clarence further defended on

the ground that the amount paid for the stock was fair

value at the time of the transfer considering that con-

struction had not yet begun, that many risks remained

to be faced, and that each brother would be required to

personally sign a $5,000,000.00, note for the construc-

tion loan and for the permanent financing, which en-

dorsement Milton feared to execute.

The case was tried before a jury and resulted in a

verdict in favor of complainant in the sum of $905.-

000.00. A motion for directed verdict, the ruling on

which had been deferred by the court, was re-urged

post trial as a motion for judgment notwithstanding

the verdict and was granted on the specified ground

that there was “. no evidence from which a finder of

facts might have inferred any diligence on the part of

the plaintiff.” In so ruling, the trial judge relied upon

the latest pronouncements of the Fifth Circuit Court of

Appeals in Johnson v. Wiggs, 443 F.2d 803 (1971), and

Clement A. Evans & Co. v. McAlpine, 434 F.2d 100

(1971), to the effect that the plaintiff must show that he

had not. ready access to the information involved

..., Or that he was“... a reasonable investor exer-

cising due care in the light of all facts... .” In addi-

tion, the court granted a conditional new trial under

the provisions of Rule 50(c)(1) Federal Rules of Civil

Procedure on the basis that the verdict was contrary to

the great weight of the evidence and that the amount of

the verdict under the circumstances was “shocking to

the conscience” and the result of prejudice and pas-

sion.

In order to properly understand the ruling of the

trial court, an acquaintance with the basic facts of this

case, as adduced at trial, complex though they may be,

is necessary.

Facts Adduced At Trial

When Lori Corporation was formed in November

1971, a moratorium had been declared by the City

Council upon construction of hotels in the French

Quarter and this hotel was to be the last permitted.

However, to the knowledge of both brothers, construc-

tion would have to be substantially commenced within

six months of the date of the construction permit,

which was obtained January 31, 1972.

The sole asset of the corporation was the lease on the

ground upon which the contemplated hotel would be

built. This lease obligated the corporation to pay rent

of $50,000.00, per year. Both brothers worked together

to arrange necessary financing and construction

plans until the end of March, 1972.

Together they obtained an $85,000 loan from the

Bank of New Orleans to use for initial expenses. They

dealt through Mr. Lawrence Merrigan, President of the

bank, who required that the note be personally en-

dorsed by Clarence (Relator) and Milton (Respon-

dent). As of the date of the trial in February, 1975, the

note was still unpaid.

In their attempts to secure permanent financing, the

brothers dealt with Mr. J. H. Harris of Harris Mortgage

Company, who, in turn, was endeavoring to obtain the

commitment of Colwell Mortgage Corporation for a

permanent loan in excess of $5,000,000.00.

The architect who was preparing the plans for the

proposed hotel was August Perez, President of the

largest architectural firm in Louisiana. He worked

primarily with Milton, the Respondent.

The construction financing was to be obtained

through the Bank of New Orleans, and Mr. Merrigan

testified to having met a number of times with both

brothers about this proposed $5,000,000.00 loan.

Milton maintained an office in the same suite where

his brother practiced law. The secretary to the two

brothers was Miss Claudette Walker who was privy to

many of the conversations between the two brothers.

There did not seem to have been any serious

problems between the two brothers until late March,

1972. On or about March 27th, Mr. Harris called

Clarence and Milton into his office and informed them

that the application for permanent financing could not

be submitted to the Board of Directors of Colwell

Mortgage “until they brought in someone with

stronger financial strength.” Both Clarence and

Milton were quite dejected after receiving the news

from Harris about Colwell.

Within the next few days the two brothers visited

both Lawrence Merrigan, the banker, and August

Perez, the architect, and met again with Mr. J. H.

Harris, the mortgage broker. All three men testified to

the respective conversations that occurred.

1 Note 10, of the Fifth Circuit opinion, (App. p. 22a), which

attempts to denigrate the importance of this testimony, misses the

point entirely. The fact that Milton was still in the venture and did

not state an intention to go out of it during the meeting with these

All three men, Harris, Merrigan and Perez, testified

that the name of William Monteleone was brought up

in a very positive manner as a prospective partner for

the corporation in the hotel venture. Harris testified

that if the brothers did get Monteleone that he, Harris,

could get them a commitment from Colwell Mortgage.

Perez recalled having specifically mentioned the

tremendous experience that Monteleone had in the

hotel business (he is the owner of 2 major New Orleans

hotel), and Merrigan was equally as enthusiastic,

mentioning to the brothers that, since Monteleone was

a client of the Bank of New Orleans, he knew of

Monteleone’s financial strength.

Perez also testified that both brothers assured him

that they would personally be responsible for

architectural fees already incurred in an amount of

over $123,000.00, in the event that the project failed.

men alters not to the slightest degree the fact that he was told and

knew specifically that William Monteleone was to be brought into

the venture to comply with the requirement of obtaining someone

with stronger financial strength. It is stated at the end of Note 10.

by the Fifth Circuit Decision that in other words, Harris says

Monteleone's name was mentioned on March 30, as a potential

partner for both Milton and Clarence. not for Clarence alone.” This

is exactly correct. August Perez, the architect, also testified that

both Milton and Clarence told him about bringing in Monteleone

as a partner. Although, as is stated in Note 10, Merrigan was hazy

on the time of his meeting with both Clarence and Milton, there can

be no doubt whatever but that the conversation concerning

Monteleone was in the presence of both brothers and that it could

not have occurred until after receipt of the bad news from Harris

on about March 27th. Harris, Merrigan and Perez all testified, in

essence, that Clarence stated in the presence of Milton at each

respective meeting that he intended to bring William Monteleone

into the venture as a partner and Harris further testified that it was

a we Monteleone would be obligated to contribute 8600.

00. cash.

Miss Claudette Walker, the secretary of the two

brothers, testified that throughout the early months of

1972, Clarence repeatedly told Milton that he would

like not to have to bring anyone else in the venture, but

that if the brothers did not get the loan from Colwell

Mortgage that he, Clarence, intended to ask Billy

Monteleone to go in with them.

The split between the two brothers came at the very

end of March or early April, 1972. According to

Clarence, it occurred because Milton claimed that they

were getting in too deep, that they should quit the hotel

venture and go into something else, that there was too

much risk involved and that they both stood to lose

everything. Clarence disagreed. Milton claimed that

the split came because Clarence refused to permit

Milton to continue to draw $1150.00 per month

management fee from certain partnership properties.

This fee had been drawn by Milton, who was not

employed, for living expenses though, in fact, he did

not manage these partnership properties (which were

not related to the hotel venture) and had not managed

them for a number of years.

Through April and May, there was virtually no con-

tact between the two brothers except demands

delivered by Milton to Clarence through their mother

that Clarence buy Milton’s shares of stock in Lori Cor-

poration. According to testimony of the mother of the

two boys, the three of them met in the apartment of the

mother in early June, 1972, and upon Milton’s vehe-

ment insistence, Clarence agreed to pay Milton $45,-

000.00, for his stock. Clarence advised Milton that he

would have to borrow funds to do it and that he would

expect to pay him within about two months. Accord-

ing to the mother, Mrs. Florence Dupuy, Milton told

her that Clarence was going in with William

Monteleone but that he, Milton, did not care who

Clarence went in with and, further, that Clarence

would have to pay the $85,000.00, note alone as he,

Milton, was getting out.

All of the above testimony, that of Lawrence

Merrigan, President of the Bank of New Orleans, of

August Perez, President of Perez and Associates

Architectural Firm, of J.H. Harris, President of Harris

Mortgage Corporation, of Miss Claudette Walker, the

secretary to the two brothers, and the testimony of

Mrs. Florence Dupuy, the mother of the two brothers,

was controverted by Milton, who claimed that, with

one minor exception, he never heard the name William

Monteleone mentioned in connection with the hotel

venture, that he never entered into an agreement with

Clarence to sell his stock, and that he never promised

Perez that he would be personally responsible for his

fee. Milton also testified that he never expressed any

reluctance to sign the Five Million Dollar construc-

tion loan and the note for permanent financing in like

amount. Messrs. Harris and Merrigan testified to the

contrary. Merrigan specifically recalled that he told

Milton that if Milton was reluctant to sign a construc-

tion loan, that the bank would be “very, very reluc-

tant” to make the loan.

After early June, the only record of communication

between the two brothers is a series of three letters

from Milton to Clarence dated June 11, June 25, and

July 9, 1972, respectively, each demanding in the most

abrasive terms that Clarence buy Milton’s stock im-

mediateiy and for cash. He accused Clarence of lying

to him, of trying to “con” him about offering to buy his

shares of Lori Corporation. The letters accused

Clarence of trying to steal Milton’s various proper-

ties. Said Milton, “I want my share of all properties in

the partnership and in the corporations and I want my

share promptly.” The letter of July 9th, stated that un-

less Milton got prompt satisfaction, he would.

have the lawyers to work you over good and properly

and they will be well paid to do this.” He accuses

Clarence of various acts of unethical, immoral and

criminal conduct, including theft from his own

mother. He states: “You will buy me out or either all

the properties will have to go up for sale and you will

no doubt wind up in federal prison.” The letter con-

cludes with this paragraph:

“Should you still want to continue to steal on

my half of all the properties, I am sure the

matter will end up in Court promptly and at

that time, I will summon the District Director

of the Internal Revenue Bureau to send a

represertative to his office to listen to my

testimony. I will also summon the newspaper

and television stations and Iam sure they. too,

will find what I have to say very interesting

and revealing. The District Attorney’s office

will also be notified and I feel they will be

there.”

At trial, Milton testified that he had a trusting

relationship with Clarence at this time, that his letters

were indicative that he acted “how brothers should”

act to each other and that he had no reason to question

him or to inquire as to the progress of the hotel project

from Monteleone, Merrigan, Harris, Perez or from his

brother.

Clarence was proceeding alone with his rather

tenuous negotiations with the bank, Colwell Mortgage

Company, and other parties with whom both brothers

had previously dealt together. On behalf of the cor-

poration and in light of the fact that Clarence had

agreed to buy Milton’s shares and that Milton no

longer considered himself connected with the cor-

poration but had only to collect his money, Clarence

signed the resolution necessary to complete the trans-

action with Monteleone on July 31, 1972, which in-

volved a partnership agreement between Lori Cor-

poration & Associates (40%), Clarence Dupuy, in-

dividually (40%), and the Monteleone Interest (20%).

This partnership, Lori Corporation & Associate, was

the assignee of the long term lease, per assignment ex-

ecuted by Clarence on behalf of Lori Corporation.

Monteleone contributed $600,000.00, in cash, which

was escrowed and earmarked for construction. This

was not paid to Clarence as a purchase of a portion of

his interest in the project. Clarence received nothing.

At this time. there was as yet no construction contract

signed. no permanent financing completed, and a very

real risk that construction of the hotel would not be

allowed by the City, or that a suit would be filed to stop

construction because of the passage of the deadline for

its commencement.

The sale of the stock from Milton to Clarence was ex-

ecuted August 29, 1972. According to Milton, it was

completed following demands by Milton that Clarence

buy his stock but motivated by statements of Clarence

that the hotel project was “going down hill.“ Accord-

ing to Clarence, the sale was executed upon the urg-

ing of Milton as a result of continuous pressure ex-

erted by Milton through their mother who relayed the

messages with the urgent plea that Clarence “pay

Milton out of the hotel” as Milton was constantly

demanding.

Although Milton claimed that he really would like to

have stayed in the hotel venture and that he got out

only because he was misled by Clarence, he admitted

at the trial that throughout the summer of 1972, he

1) never inquired as to the status of negotiations by

Clarence with Colwell Mortgage Corporation, Harris

Mortgage Corporation, or any other mortgage cor-

poration or lending institution concerning permanent

financing for the hotel;

2) never inquired concerning the status of an $85,-

000.00, note which had been executed by Lori Corpora-

tion in late 1971, as seed money for the hotel and per-

sonally endorsed by both Clarence and Milton;

3) never inquired as to whether the rent of $1500.00

(the rental required during the first twenty-four

months of the lease) per month on the property leased

in the French Quarter, site of the future hotel, was be-

ing paid, or if so, how it was being paid or whether the

lease still existed;

4) never inquired, despite his knowledge of the

deadline of construction, as to the status of attempts

by Clarence to find a partner who would contribute the

necessary cash. Without such a partner, to Milton's

own knowledge, the project was doomed;

5) never inquired as to the status of obligations to

August Perez in excess of $100,000.00 for plans for the

hotel. It must be stated that Milton claimed that

nothing was owed Perez, that Perez had agreed to do

the plans for nothing in the event the project fell

through. Perez, however, had testified that both Milton

and Clarence had agreed to assume personal respon-

sibility for these plans;

6) never asked to see any corporate records or

resolutions prepared in connection with the

partnership and transfer of the lease to the

partnership; and

7) never inquired of anyone else as to any of these

matters despite the ready availability of all informa-

tion to him from:

a) Lawrence Merrigan, President of the Bank of

New Orleans, who stated that at any time through

August 29th, he would have given full information;

b) J. H. Harris, who stated that at all times he would

have given Milton full information upon simple in-

quiry: and

c) August Perez who stated he would have been

glad to furnish Milton with full particulars upon in-

quiry.

Respondent at the trial and on appeal placed every

emphasis, as did the Fifth Circuit decision, on the fact

that Milton suffered from a kidney disease diagnosed

in 1965, as uncurable glomeruler nephritis, as a

justification for his failure to inquire as to any of these

matters concerning Lori Corporation. There is no

doubt that Milton was sick, and no doubt that this

kidney ailment merits sympathy, but the statement of

the Fifth Circuit (App. p. 50a), that the disease “had

worsened considerably by 1972” is without support in

the record. By Milton's own testimony, he was quite

able to use the telephone. He worked full-time from

mid-May to mid-August 1972, and prior to mid-May, he

was home using the telephone and writing letters,

again according to his own testimony. By the

testimony of his own Doctor, there was no change in

his condition observed in examinations of January 14,

1972, April 14, and August 29, 1972. These were the

only visits made by Milton to his physician that year.

He was no better or worse in April and August than he

had been when he was working with Clarence on the

hotel project in January.

Trial Court’s Action

The jury returned a verdict on special in-

terrogatories in favor of Milton, Respondent, on all

issues and against Clarence, Relator, in the sum of

$905,000.00. It must be noted here that Respondent had

paid a total of $1880.00, for his stock nine months

previously, worked for the corporation for ap-

proximately three and one-half months, made no ad-

ditional capital contributions, and, in addition to sub-

stantial cash consideration, received upon sale, was

relieved of his personal obligations on the $85,000.00

note to the bank. At the time of sale, there was no in-

terim or construction or permanent financing, there

i a i a a al

was a real risk that the building permit had expired,

and the only asset of the corporation was a lease on va-

cant land coupled with a rental obligation of $50,-

000.00/ year.

Motions filed during the trial by Relator for a

directed verdict were urged after trial as a motion for

judgment notwithstanding the verdict in favor of

Relator, Clarence, dismissing the petition, of Milton,

Respondent. In addition, Clarence filed a motion fora

conditional new trial under the provisions of Rule

50(c)(1) of the Federal Rules of Civil Procedure on

grounds that the verdict was contrary to the great

weight of the evidence and that the size of the verdict

was excessive.

The District Court granted Judgment N.O.V. with

the observation that there was no evidence that Milton

had exercised due diligence as required by law and

that the jury verdict with respect to diligence was not

only contrary to the great weight of the evidence, but

against“... all of the evidence that I have been able to

discern.” He further continued (App. p. 6a):

“TI will state for the record, although this is not

directly before me, that if it were not for the

Court’s ability to make this finding in the

fashion that I have, I would feel compelled to

grant a new trial, because I feel under all of the

circumstances of the case, the size of the ver-

dict which shocked the Court’s conscience and

also be contrary to the weight.”

He further stated that the verdict was a result of com-

passion.” Shortly thereafter, it was brought to the

attention of the Court by Respondent, with the con-

currence of Relator, that under the provisions of Rule

50(c)(1) of the Federal Rules of Civil Procedure, the

Court should rule on the motion for a new trial despite

the fact that he had granted a judgment notwithstand-

ing the verdict in favor of the mover.

The Trial Court entered no written reasons for the

judgment N.O.V.; the Court’s oral reasons were issued

from the bench. A transcript of these oral reasons are

set forth in the Appendix herein. In response to this

motion by respondent, the Court entered a judgment

which “... for reasons orally pronounced by the

Court”, ordered that the conditional motion for a new

trial. . . be and it is hereby granted.“

Circuit Court's Action

On appeal to the Fifth Circuit, as can be seen by

reference to the decision of May 9. 1977, appended

hereto, the Court of Appeals did not address itself to

the question of whether the trial judge had decided cor-

rectly or incorrectly in accordance with the law of due

diligence as it then existed. Instead, the Fifth Circuit

imposed new and far less stringent standards upon the

plaintiff and ruled that, as a matter of law, a

reasonable jury might have found that the plaintiff

was not reckless in his behavior; that is, that there was

sufficient evidence to support a holding that

Milton did not have knowledge of the risk of

Clarence’s forming the partnership with Monteleone

and obtaining financing for the hotel.” The Appellate

Court ruled that “... there was also sufficient

evidence to support a jury conclusion that Milton did

not act in intentional disregard of whether Clarence

had taken this course of action.” (App. p. 43a)

In addition, the Court ruled that the trial court did

not abuse its discretion in granting the conditional

new trial but read the language of the trial court as

granting the new trial on quantum only and remanded

the case solely for a hearing as to the amount of

damages. The ruling with regard to liability is, hence,

a final decision by the Fifth Circuit.

Certiorari is sought to review this holding of the

Fifth Circuit concerning liability, particularly with

reference to due diligence and the charge of the Court

concerning scienter on the part of defendant, and to

further review the propriety, in any event, of remand-

ing the case for trial on the issue on damages only.

REASONS FOR GRANTING WRIT

Conflict Among The Circuits (“Diligence”’)

Since J.I. Case Co. v. Borak, 377 U.S. 426, 84S.Ct. 1555

(1964), affirmed the right of Federal Courts to grant

relief to private parties under 15 U.S.C. Section 78j(b),

the various Circuit Courts of Appeal have fashioned

rules that determine the availability of this remedy.

Four elements to this cause of action have evolved:

scienter on the part of defendant; materiality of mis-

representation or omission; reliance by the plaintiff;

and due diligence on the part of the plaintiff.

Substantial harmony concerning the first three

elements has been reached among the Circuits either

through separate but parallel lines of decision or

through pronouncements by this Court, such as in

Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 Sup.Ct.

1375, pertaining to scienter, or Affiliated Ute Citizens

v. U.S., 406 U.S. 128, 92 S.Ct. 1456 (1972), pertaining to

reliance with respect to fraud by omission.

Only the fourth element, diligence on the part of

plaintiff; is now characterized by hopeless confusion

and contradiction among the circuit. The precedents

are disarray and have not been unified through any

decision by this Court. A diligent search fails to reveal

a single instance wherein this Court has spoken on the

subject. A review of the case law, circuit by circuit,

reflects the result of this absence and the need for an

authoritative pronouncement, which only this Court

can make.

First Circuit

Rogen v. Illikon Corp., 361 F.2d 260 (1966), does not

speak explicitly in terms of diligence, but sanctioned

the analysis of the facts to determine if reliance by

plaintiff on misrepresentations was reasonable or

justifiable, quoting with approval Royal Air Proper-

ties, Inc. v. Smith, 333 F.2d 568 (9th Cir. 1964), support-

ing the view that plaintiff may succeed although he

was “... exceedingly gullibl. in that he was over-

trusting,” in view of the fact that“... his professional

activities are wholly divorced from the world of

business.“

Second Circuit

In Metro- Golduyn Mayer, Inc. v. Ross, 509 F. 2d 930

(1975), the Court relied upon the contract between the

parties as well as Rule 10b-5, in holding that represen-

tation by the parties were paramount to any investiga-

tion in behalf of the parties and that the affirmative

duty to disclose prevailed despite knowledge of some

facts on the part of plaintiff contradictory to the

representations relied upon. However, in Frigitemp

Corp. v. Financial Dynamics Fund, 524 F.2d 275 (1975),

it was held that the defendants were under no duty to

disclose that which could have been determined by the

plaintiff, and the court quoted 2 A.Bromberg

Securities Law: Fraud — S.E.C. Rule 10(b)-5, to the

effect that there is wide spread agreement among the

courts that constructive knowledge of truth or omitted

information will bar plaintiff from 10(b)-5, recovery.“

Third Circuit

In Straub v. Vaisman & Co., Inc., 540 F.2d 591 (1976),

the court stated:

“Where the defendant acts intentionally, the

line should be drawn between the extremes of

making the plaintiff's lack of diligence,

regardless of degree, a complete bar or at the

other limit — completely irrelevant. (citing

cases) The latter option fails to encourage in-

vestor caution and, under the former view,

Rule 10(b)-5, would provide less assistance to

the trusting or gullible than does the common

law.“

The Third Circuit stated that the obligation of due care

must be a flexible one, dependent upon the cir-

cumstances of each case. We require only that the

plaintiff acts reasonably.”

Included among the factors determining whether

plaintiff has acted reasonably are “fiduciary

relationship, opportunity to detect the fraud,

sophistication of the plaintiff, the existence of long

standing business or personal relationships, and

access to the relevant information

In Rochez Bros., Inc. v. Rhoades, 491 F. 2d 402 (1974),

the Third Circuit had stated that:

“The cases generally hold that before an in-

sider may claim reliance on a material mis-

representation or nondisclosure, he must

fulfill a duty of due care in seeking to ascertain

for himself the facts relevant to a transaction.“

In Rochez Bros., Inc., the Court found that there was no

such opportunity as the facts were not discoverable by

plaintiff.

Fourth Circuit

No cases dealing directly with the subject of

diligence in 10(b)-5 cases have been identified from the

Fourth Circuit, and we pretermit for the moment dis-

cussion of the jurisprudence emanating from the Fifth

Circuit.

Sixth Circuit

There is no duty to disclose information in this cir-

cuit to one who reasonably should already be aware of

it. Securities and Exchange Commission v. Coffey, 493

F.2d 1304 (1974). This would negate a duty to direct the

seller's attention to all routine data that is readily

evailable to the plaintiff. Arber v. Essex Wire Corp.,

490 F.2d 414 (1974). In Arber it was held that the infor-

mation in question was readily available to plaintiffs

who, “although aware of its existence and availabili-

ty, were simply uninterested.”

Seventh Circuit

In Kohler v. Kohler Co., 319 F.2d 634 (1963), it was

held that the defendant purchaser was entitled to take

into account the actual and normal business acumen

of the seller. It was stated that:

“Here, the company could fairly deal with a

person who had had many years of intimate

acquaintance with the affairs of the corpora-

tion, who were closely related to many prin-

cipals of the corporation, who had intrinsic

sources of sound business advice, and who,

himself, was promoting a speedy sale, in a

manner that might not be fair if plaintiff had

been a novice to stock transactions or the cor-

poration’s activities.“

However, this does not apply to cases of intentional

fraud; and “contributory negligence” would be no bar

to an action under the statute based on fraud. Carroll v.

First Nat I Bank of Lincolnwood, 413 F.2d 353 (1969).

Eighth Circuit

Myzel v. Fields, 386 F.2d 718 (1967), agreed with the

Seventh Circuit that there is . . no duty to disclose

information to one who reasonably should already be

aware of it. Nor is there any necessity for one insider

to search out details for another insider in the same

sense that such a duty might exist toward others less

informed.” The test was stated to be whether the non-

disclosed fact was equally known or available to

both parties.

City National Bank of Fort Smith Arkansas v.

Vanderboom, 422 F.2d 221 (1970), quoted with approval

“Negligent Misrepresentations Under Rule 10(b)-5,”’

32 University of Chicago Law Review 824, 841-2 (1965):

“Not only should the plaintiff have to prove

that he relied on the defendant's statements,

but he must convince the trier of fact that his

reliance was reasonable under all the cir-

cumstances at the time. In this way recovery

would be denied to those who, because of their

‘business sophistication’ acumen, or ready

access to the information involved, could

reasonably be expected to exercise a higher

degree of care and investigation in their deal-

ing.“

The Court also quoted with approval language from

the same article proposing that an objective stan-

dard of a reasonable investor exercising due care in

light of all facts effectively imposes a duty of

reasonable investigation, thereby limiting the class of

investors who will be protected under 10(b)-5(2) tocon-

scientious buyers and sellers in good faith.“

Ninth Circuit

White v. Abrams, 495 F.2d 724 (1974), requires that

the duty of defendant to disclose depend on the

sophistication, status and information of the plaintiff,

as well as on the nature of the relationship between the

parties and the amount of reliance that the plaintiff

places in the defendant.

Tenth Circuit

Holdsworth v. Strong, 545 F.2d 687 (1976), is except

for the instant case, one of the few to address itself to

the diligence issue since the decision of this Court in

Ernst & Ernst. In Holdsworth v. Strong, like the in-

stant case, it was held that “if contributory fault of the

plaintiff is to cancel out wanton or intentional fraud, it

ought to be gross conduct somewhat comparable to

that of defendant.” The Court in Holdsworth v. Strong

stated that the plaintiff, considering the decision of

this court in Ernst is not.. duty bound to investigate

the truth or falsity of an intentional misrepresenta-

tion unless the misrepresentation is patently false.”

However the court emphasized that the plaintiff may

not reasonably or justifiably rely ona misrepresenta-

tion where a falsity is palpable.

Fifth Circuit

We turn, then, to an examination of the

jurisprudence from the Fifth Circuit from which this

case arises. Unlike the decision in Holdsworth v.

Strong, supra., the Dupuy case was not the initial en-

counter of the Fifth Circuit with the diligence issue.

The fact is that the decision of this Court in Ernst &

Ernst. supra, effected little, if any, change in the

scienter requirements that had previously been im-

posed by the Fifth Circuit. Unless and until this Court

ultimately holds that recklessness is not sufficient to

satisfy the scienter requirement, it is difficult to dis-

cern any change in the law of the Fifth Circuit

concerning scienter required by decisions of this

Court. The Fifth Circuit has always been of the view

that actions under Rule 10(b)-5, required proof of

something less than intent, but more than simple

negligence. Smallwood v. Pearl Brewing Co., 489 F.2d

579 (1974); Azalea Meats, Inc. v. Muscat, 386 F.2d 579

(1974); Hudak v. Economic Research Analyst, Inc., 499

F.2d 996 (1974); and Sargent v. Genesco, Inc., 492 F.2d

750 (i974).

Yet, despite the fact that simple negligence has

never been sufficient as a basis for a Rule 10(b)-5, ac-

tion in the Fifth Circuit, that circuit embraced the

diligence requirement not only of the Eighth Circuit,

but also of the Seventh Circuit, which required proof

of negligence only on the part of the defendant. In Cle-

ment A. Evans & Co. v. McAlpine, 434 F.2d 100 (1970),

the Fifth Circuit quoted with approval City National

Bank of Fort Smith v. Vanderboom, supra, of the

Eighth Circuit:

“Not only does the plaintiff have to prove that

he relied on the defendant's statements, but he

must convince the trier of fact that his reliance

was reasonable under all the circumstances at

the time.“

The Fifth Circuit went even further. In expressing ap-

proval of the above the following was stated in Cle-

ment A. Evans & Co., supra:

We are of the view that plaintiff's duty above

espoused is not altered merely because the

misrepresentations are alleged to be inten-

tional rather than negligent. Surely plaintiff

would not contend that a purchaser or seller

could justifiably rely on a fraudulent mis-

representation, no matter how willfully and

intentionally made, if the misrepresentation

would tax even the most credulous mind.

“We are cognizant, of course, that our views

have a limiting effect upon the class of in-

vestors who may recover in a Rule 10(b)-5 ac-

tion for damages. But, such limitation is con-

sistent with the views expressed in the

decisions of this and other circuits.“

Further, in Johnson v. Wiggs, 443 F.2d 803 (1971), the

Fifth Circuit stated its interpretation of the “insider

rule” to limit Rule 10(b)-5, actions to the protection of

“outsiders” against insiders who deal in securities

through the utilization of information which is and

can be known only to them because of their position as

insiders. The Fifth Circuit cited and followed S.E.C. v.

Texas Gulf Sulphur, 401 F.2d 833 (2d Cir. 1968).

Nonetheless, the appeal of the ruling of the District

Court in the instant case was the occasion fora review

and overhaul by the Fifth Circuit of its own rulings

with respect to diligence; and the decision for which

review is sought herein promulgates a completely

new standard by which to measure the conduct of the

plaintiff.

The Court of Appeal, in order to conclude that a

reasonable jury could have found that Plaintiff exer-

cised due care and thus to overrule the judgment n. o. v.

despite its acknowledgement that Plaintiff did

nothing to investigate, reaches out to establish a new

standard for due diligence“. The Court of Appeal

seizes upon the pronouncement of this Court in Ernst

& Ernst requiring “scienter’” by defendant, to es-

tablish an equally strict standard for Plaintiff's due

care“. Ernst & Ernst does not address itself to “due

care” in any shape, form or manner; but, since Ernst &

Ernst restricts a 10(b) action to intentional or

(possibly) reckless conduct, the Court of Appeals

holds that “due diligence” means nothing more than

absence of intentional or reckless conduct by plaintiff.

Such reasoning overlooks the fact that the

“scienter” requirement for defendant is based on the

very language of 10(b), whereas “due care” is a re-

quirement developed by jurisprudence. As an affir-

mative defense, the duty of due care would deny

recovery not because there has been no violation of the

rule, and not because the plaintiff has not been injured

by the defendant’s conduct, but because as a policy

matter, the law should not protect, through implied

remedies, those who do not take minimal steps to

protect themselves, Bromberg, “Plaintiff's Due Care

Under Rule 10b-5, 70 NWU L Rev. 561, 596. Just as

Congress did not intend to subject merely negligent

conduct of a defendant to an action under 10(b), Con-

gress did not intend to relieve a plaintiff from avail-

ing himself of all information that an investigation

would have disclosed.” Bromberg, supra, p. 598; Still

v. Smith, 473 F.2d 1205 (5th Cir., 1973); Shappirio v.

Goldberg, 192 U.S. 232, 241-42; Arber v. Essex Wire

Corp., 490 F.2d 414 (6th Cir., 1974) where the Court said:

When the means of knowledge are open and at

hand or furnished to the purchaser or his

agent and no effort is made to prevent the par-

ty from using them — he will not be heard to

say he has been deceived to his injury by the

misrepresentations of the vendor.”

The case law dealing with “due care” imposes greater

duties on plaintiff in face to face transactions involv-

ing stock in a closely held corporation than it imposes

in the case of an open market situation. Bird v. Ferry,

497 F.2d 112, 114 (5th Cir., 1974). Such flexible stand-

ards involves a much sounder rationale than the Fifth

Circuit Court of Appeal’s mechanical rule of equat-

ing plaintiff's standard of care with that of defendant.

When the U.S. Court of Appeals for the Ninth Circuit

in the case of Blue Chip Stamps v. Manor Drug Stores,

492 F. 2d 136, reversed the decision of the district judge,

339 F.Supp. 35, and remanded, this Court granted a

writ of certiorari and held that the Birnbaum rule bars

respondent from maintaining this suit. In so doing

this Honorable Court reasoned that:

. . virtually all lower federal courts facing

the issue in the hundreds of reported cases

presenting this question over the past quarter

century have reaffirmed Birnbaum’s conclu-

sion that the plaintiff class for purposes of

Section 10(b) and rule 10b-5, Private Damage

Actions is limited to purchasers and sellers of

securities.”

This Court further reasoned as follows:

“The long standing acceptance by the courts

coupled with Congress’ failure to reject Birn-

baum's reasonable interpretation of the word-

ing of Section 10(b), wording whichis directed

towards injuries suffered in connection with

the purchase or sale” of securities, argues

significantly in favor of acceptance of the

Birnbaum rule by this court.“

Applying the reasoning of Blue Chip Stamps with

regard to the Birnbaum rule to the Due Diligence“

rule, it is respectfully submitted that a writ should be

granted because of:

(a) The long standing judicial acceptance of

the rule requiring due diligence;

(b) Congress’ failure to reject the interpreta-

tion of Section 10(b) as requiring due

diligence, over a period of many years;

favoring adherence to the due diligence; and

(d) the recognition that litigation under rule

10b-5 presents a danger of voraciousness

different in degree and in kind from that which

accompanies litigation in general.”

The Due Diligence”, ‘Reasonable Diligence” or Due

Care” concepts, by the very significance of those

terms cannot be restricted to “intentional or reckless

behavior.” Black’s Dictionary, Fourth Edition, p. 544

defines Due Diligence” as:

“Such a measure of prudence, activity, or

assiduity, as is properly to be expected from,

and ordinarily exercised by, a reasonable and

prudent man under the particular circum-

stances; not measured by any absolute stand-

ard, but depending on the relative facts of the

special case. Perry v. Cedar Falls, 98 lowe 315,

54 N.W. 225.”

In Hirsch v. Dupont, 553 F.2d 750 (1977), the court

states:

“Securities laws were not enacted to protect

sophisticated businessmen from their own

errors of judgment, and saidinvestors must, if

they wish to recover under federal law, in-

vestigate information available to them with

care and prudence expected from people

blessed with full access to information.”

“Sorilledde’s failure to pursue this line of in-

vestigation suggested either that, despite

appearances, the knowledge he would have

discovered was immaterial, Titan Group v.

Faggan, 513 F.2d 234 (2nd Cir., 1974), cert. de-

nied 423 U.S. 840, or that Gariboldi failed to ex-

ercise due diligence to obtain important infor-

mation, see Rochez Bros. Inc. v. Rhoades, 491

F.2d 402, 409-10 (2nd Cir., 1974), cert. denied 425

U.S. 993.”

The Court of Appeal by imposing the scienter' re-

quirement upon the duty of due care utterly and com-

pletely misconceives the very nature of the same. Sec-

tion 10(b) is designed to encourage responsible

behavior in the securities markets. This imposes upon

the plaintiff the duty to use reasonably obtainable in-

formation, a duty that, conceptually, is not limited to

“intentional or reckless” behavior.

Only through an analysis of the application of these

newly promulgated judicially-created rules by the

Fifth Circuit to the facts of this case can the meaning of

the rules become clear. In essence, the grossest

behavior imaginable on the part of an investor is

deemed not to be disqualifying. The Fifth Circuit pays

lip-service to retention of the “methodology” of

McAlpine, (App. p. 29a); but the application of that so-

called methodology in this case reveals that the re-

quirement of diligence, whether termed negligence or

recklessness under the Court’s new rules, has been

torn assunder.

The Fifth Circuit recognized some obvious

problems with the plaintiff's case arising out of his

almost bizarre lack of interest in anything but sale of

his stock, now and for cash, for several months prior to

the consummation of the transfer on August 29th. The

Court stated (App. p. 47a):

“Two factors indicate that Milton intentional-

ly sold his stock in disregard of all chances for

success. First, the parties agree that the sale

occurred without any independent investiga-

tion by Milton into the affairs of Lori.

Although he knew Merrigan, Perez, and

Harris, he did not discuss the sale with them.”

A comment is necessary. Not only did Milton not dis-

cuss the sale with them; he discussed nothing at all

with them. He made not the slightest inquiry into the

progress of the hotel, irrespective of any stock sale. As

the owner of forty-seven percent of the stock, as presi-

dent and a member of the Board of Directors, one might

have found it curious, not only that Milton did not dis-

cuss with them a prospective sale of his stock, but also

that he did not once, over a period of almost five

months after his rift with his brother, and almost three

months after his verbal agreement to sell his stock to

his brother, see fit to question the banker, mortgage

broker, or architect at all; or to ask whether a possible

partner had been obtained; whether necessary financ-

ing had been obtained or if prospects for financing

were imminent; whether the rent was being paid on the

vacant ground; where the money was coming from to

pay the rent; whether the $85,000 note, which he had

personally signed, had been paid; whether Mr. Perez

was still working on the plan; or whether there were

indeed any prospects for a hotel or not.

The Fifth Circuit continues:

“Second, Milton initiated the sale negotiations

and exerted pressure for a quick agreement.”

He did indeed. He told Clarence, in writing, in the most

abrasive possible manner that he wanted cash now;

that he no longer wanted to stay in any venture in

which Clarence was participating; that Clarence was

a thief who was trying to steal from him; and that, un-

less Clarence bought all of Milton’s investments,

Clarence was going to wind up in jail.

According to the testimony of Milton’s mother, she

was continually urging Clarence to keep his promise

to buy Milton's stock. She went to Clarence every time

that Milton came to her wanting to know when

Clarence was going to buy his stock, and apparently

Milton must have come to her many times indeed for

she was in Clarence’s apartment practically every

morning during late July and August urging Clarence

to complete the sale.

The Fifth Circuit itself saw fit to note as a significant

fact in Johnson v. Wiggs, supra, that the sale was

not as a result of Wiggs’ efforts to purchase but by

the acceptance of an offer of Johnson to sell. See also

Kohler v. Kohler, supra.

To reach its conclusion that Milton did not act

recklessly, it was necessary to conclude (App. 43a)

that there was sufficient evidence in the record to sup-

port a holding that Milton did not have knowledge of

the risk of Clarence’s forming the partnership with

Monteleone and obtaining financing and that he,

Milton, did not act in intentional disregard whether

Clarence had taken this course of action.

Ignoring the fact that the corporation had been form-

ed solely for the purpose of building a hotel and that it

was uncontroverted that there could be no financing

until some partner was obtained, the Fifth Circuit

grudgingly acknowledged (App. p. 44a):

“Harris testified that he discussed with

Clarence and Milton the possibility of tapping

Monteleone as a source of financing. Merrigan

and Perez also recalled meetings at which the

brothers mentioned Monteleone as an in-

vestor. And their mother stated that Milton

himself informed her of the partnership.”

The Fifth Circuit then justifies the action of the jury in

ignoring all of this testimony by citing a case whose

very rationale it, in truth, disregards:

“Nevertheless, the Jury, as the fact finder,

assesses the credibility of these witnesses and

resolves this factual dispute. Boeing Co. v.

Shipman, (5th Cir. 1969), 411 F.2d 365, 375. If

the jury believed Milton’s testimony, then it

could have reasonably concluded that Milton

knew nothing of the risk of the partnership

having been created.” (App. p. 44a).

Indeed. For what did Milton think he was being paid

any money at all for his stock, or for what reason did

he think he was being released on an $85,000 note, if

Clarence was not pushing ahead to do the very things

he had said he was going to do and for which the cor-

poration had been originally formed?

Even more remarkable, however, is that the Fifth

Circuit, without comment on the action of the trial

judge in finding that the verdict was against the

overwhelming weight of the evidence, finds that a

reasonable jury could have disregarded the testimony

of the bank president, the mortgage broker, the

architect, and the mother of the two boys, to say

nothing of the testimony of the secretary of the two

brothers, which is not mentioned in the decision, and

to accept in lieu thereof the self-serving testimony of

Milton Dupuy. Boeing Co. v. Shipman, cited by the

Fifth Circuit in support of this methodology, stated,

however, that “a mere scintilla of evidence is insuf-

ficient to present a question for the jury” and held

further:

On motions for directed verdict and for judg-

ment notwithstanding the verdict the Court

should consider all of the evidence — not just

that evidence which supports the non-mover's

case — but in the light and with all reasonable

inferences most favorable to the party op-

posed to the motion. If the facts and inferences

point so strongly and overwhelmingly in

favor of one party that the Court believes that

reasonable men could not arrive at a contrary

verdict, granting of the motions is proper.“

However. one need not make any in depth inquiry

into the standards to be applied in determining the

question of judgment notwithstanding the verdict; the

quantity of evidence need not be examined. The un-

contested and uncontroverted facts were such that

something other than extortive demands by Milton

that Clarence buy his stock must be called for if there

is any requirement of diligence whatsoever, whether

it be freedom from negligence or freedom from

recklessness that must be proved.

Two other factors must be mentioned in connection

with the decision of the Fifth Circuit in its application

of its newly formulated rules pertaining to diligence

as applied to this case.

FIRST: The Fifth Circuit was obviously impressed

with the fact of Milton’s unfortunate illness. There is

no doubt that the affliction itself is deserving of sym-

pathy, but is not a justifiable basis for a verdict inthis

case although it obviously influenced the thinking of

both the jury and the Fifth Circuit. The Appellate

Court stated (App. p. 50a) that.. the time that Milton

could devote to any investigation was limited by his

search for employment and later by the substantial

amount of traveling required by the new job.“ The

“investigation” would have involved nothing more

than one simple telephone call to any of the parties

mentioned above: Harris, the mortgage broker; Perez,

the architect; or Merrigan, the banker, all of with

whom he had previous extensive business dealings.

He never even placed a single question to his brother

concerning the progress of the hotel. All he asked for

was money for his stock. Nowhere in the juris-

prudence is there any support for such an exception to

the rule of diligence. Milton’s illness has no bearing on

the issue. There was no testimony about extensive

traveling, only testimony about occasional trips, none

which would have prohibited a simple inquiry into the

status of the hotel.

SECONDLY: The Fifth Circuit obviously believed,

as did the jury, that Milton had sold his stock for a

small fraction of its true worth, thus not only cor-

roborating his claim that he knew nothing of the

progress of the hotel venture, but also creating a pic-

ture of a gross injustice that cried out for rectification.

The Fifth Circuit stated (App. p. 24a):

“At that time there could be no doubt that

Milton's stock was enormously valuable.”

The appellate court ignored, as did the jury, the

testimony of defendant's expert who testified that the

plaintiff's stock was worth a maximum of $25,000.00 as

of August 29, 1972. The expertise of this witness, Mr.

Carmi Gamoran, included involvement in the finan-

cial planning of approximately 30 hotels throughout

the country. including the Hyatt Hotels in Los

Angeles. Houston and Sarasota, Florida. He is a certi-

fied public accountant with many years experience

with a large New York based firm. Mr. Gamoran used

the income projection method of determining the

value of plaintiff's stock, the only truly valid basis for

such a determination.

The huge figures that were tossed about by plain-

tiff's experts in order to persuade the jury were based

upon the totally fallacious method of equating the in-

vestment of $600,000 by Mr. Monteleone who obtained

a 20% interest as a limited partner, as though it were a

sale of 20% interest in the venture by Mr. Clarence

Dupuy for which Clarence received and pocketed the

$600,000. The $600,000 was actually Monteleone’s con-

tribution to the partnership, which was created and it

was placed in escrow and earmarked for construction.

He had no further responsibility.

Monteleone was not obliged to sign a promissory

note nor to invest extra capital, nor did he have any

responsibility for planning or construction of the

hotel or for operation thereafter. He was further allow-

ed the first $500,000 in tax write-offs by the partner-

ship agreement. He was additionally limited to a max-

imum $100,000.00 profit after a period of five years.

Clarence Dupuy had the sole responsibility to per-

sonally sign the $5,000,000.00 note, to oversee and

supervise the planning and construction and the

operation of the hotel. Yet the Appellate Tribunal, no

less than a lay jury, treated this $600,000.00 as though

it were a purchase of something Clarence owned and

set a market value on it. On the date of the sale, August

29, 1972, the object of the lease was an empty lot. There

was no construction, noreven aconstruction contract.

Although permanent financing was now more likely,

there was as yet no commitment. There was the

prospect that construction of the hotel would be barred

through the lapse of time or that a suit would be filed to

stop construction once commenced. Yet plaintiff's ex-

perts treated the matter as though the hotel was stand-

ing as a completed structure with every stick of fur-

niture in place and already producing the revenues

that the optimistic brochures projected. The reason-

ing is contrary to Affiliated Ute Citizens of Utah v.

United States, 406 U.S. 128, 92 S. Ct. 1456 (1972), in that it

treats the ultimate worth of the underlying assets as a

measure of damages. The trial judge recognized the

stark invalidity of such reasoning and remarked that

such testimony was far from the mark of true market

value as he understood it, and later described the jury

verdict based on such testimony as shocking to the

conscience and the result of prejudice and passion.

Although the matter has been remanded by the Fifth

Circuit for retrial on the issue of damages, the decision

of the Fifth Circuit and the issues that are here pre-

sented to this Honorable Court, cannot be fully under-

stood without some reference to the aspect of the case

involving quantum.

The injustice in this case is not to the Respondent.

The injustice consists in awarding any sum in addi-

tion to the substantial consideration received to a

plaintiff who insisted on and succeed in selling his

stock at a large profit (he invested only $1,880 just five

months previous to the oral agreement, and eight

months prior to the consummated sale). Declining to

risk his own substantial fortune, he precipitously

withdrew from the hotel venture. Having refused to

face the risks and delays, having turned his back on

his obligations to the corporation and a deaf ear to all

that was transpiring, he now seeks profits of a

magnitude that will bankrupt his brother, or may not

accrue to his brother for a generation if ever. There can

be nothing in Section 10(b) or Rule 10(b)-5 to

countenance such a result.

Need to Settle Important Questions of Federal

Law (“Recklessness”’)

The issues presented for review not only affect the

litigants to this case, but also affect the broad spec-

trum of securities transactions throughout the nation.

The policy underlying the recent decisions of this

Court in Ernst & Ernst v. Hochfelder, supra, and in

Blue Chip Stamps v. Manor Drug Stores, 421 U. S. 723,

95 S. Ct. 1917, 44 L. Ed. 2d 539 (1975), expressing con-

cern “that the inexorable broadening of the class of

plaintiffs who may sue in this area of the law will ul-

timately do more harm than good”, emphasizes the*

need of this Court to settle the important questions of

Federal law regarding the scienter and due diligence

standards at issue herein.

The Circuit Court in this case has held that the hold-

ing of this Court in Ernst & Ernst requiring scienter on

the part of the defendant in order to impose Rule 10b-5

liability mandates a relaxation of the plaintiff's due

diligence standard, which relaxation, if allowed, will

invite all investors to throw caution to the wind,

secure in the notion that reasonable diligence is not re-

quired of them. In light of the above policy under-

lying Ernst & Ernst however, this Court should render

an authoritative decision for the benefit of all the Cir-

cuits.

The Circuit Court has additionally disregarded the

question whether recklessness on the part of the

defendant suffices for the imposition of liability un-

der S.E.C. Rule 10b-5, which question was specifically

reserved from the holding of this Court in Ernst &

Ernst. This important question of Federal law should

be authoritatively determined by this Court.

In connection with the sufficiency of recklessness to

impose liability under S.E.C. Rule 10b-5, it is respect-

fully submitted that the trial Court erred in its charge

to the jury on “proscribed conduct” where it in-

structed:’

“Third: To complete his proof that the defen-

dant acted in an unlawful manner, the plaintiff

must show that the misrepresentations

and/or omissions were done knowingly, or

that such acts were done recklessly.”

(Emphasis supplied)

The Court further instructed:

“An act is done recklessly when done in con-

scious disregard of, or with indifference to, the

risks that the plaintiff would be misled. If a

person makes a representation without know-

ing whether it is true or not, or makes it

without regard to its truth or falsity or to its

possible consequences, he may be found to

have made the representation recklessly.”

The first interrogatory propounded to the jury was

the following:

“Do you find that in regard to the sale of stock

by Milton E. Dupuy to Clarence O. Dupuy, Jr.,

that the defendant, Clarence O. Dupuy,

knowingly or recklessly misrepresented

and/or failed to disclose any material facts to

the plaintiff, Milton E. Dupuy?” (Emphasis

supplied)

The defense objected to the use of the term

“reckless” in the instruction.

Subsequent to the trial, on March 30, 1976, this Court

decided Ernst & Ernst v. Hochfelder, supra:

“We granted certiorari to resolve the question

whether a private cause of action for damages

will lie under Section 10(b) and Rule 10(b)-5 in

the absence of any allegation of ‘scienter’ — in-

tent to deceive, manipulate, or defraud. 421

U.S. 909 (1975). We conclude that it will not and

therefore we reverse.” (Emphasis supplied)

This Court held that “... an intent to deceive,

manipulate or defraud is required for civil liability

under Section 10(b) and Rule 10(b)-5. (Note 7, p.

1380).

In Note 12 of that decision, Your Honors stated:

“In certain areas of the law, recklessness is

considered to be a form of intentional conduct

for purposes of imposing liability for some

act. We need not address here the question

whether, in some circumstances, reckless

behavior is sufficient for civil liability under

Section 10(b) and Rule 10(b)-5.”

This question, the sufficiency of “recklessness” is not

only squarely presented by the jury instructions of the

Court and the formulation of the interrogatory above

quoted, but also is squarely presented by the factual

setting in which the case arises. Further, it is closely

entwined with the issue of the degree of diligence, if

any, that is to be required of plaintiff. The decisions of

the Fifth Circuit in the instant case and of the Tenth

Circuit in Holdsworth v. Strong, supra, are based upon

such comparative analysis and relative fault. It would

be difficult to imagine a more uniquely appropriate

setting for a determination of the question of: 1)

whether recklessness suffices to supply the neces-

sary scierter and 2) if so, the appropriate definition of

such recklessness.

Additionally, in this case, such rules should be

applied in light and in consideration of the behavior of

the plaintiff, and any standards applicable to his

obligation of reasonable investigation, if any such

obligation be found by this Court to exist.

The charge of the District Court in this case would

appear to be deficient in several particulars even

should this Court ultimately determine that reckless-

ness, or at least one of the various definitions of it, suf-

fices. It is noted with regard to these instructions that:

1) Recklessness was not placed before the jury in

the framework of a form of intent.

2) “Indifference to the risks that the plaintiff would

be misled” or without knowing whether it is true or

not” are not correct explanations of recklessness as

opposed to negligence, particularly in light of the re-

quirements of Ernst & Ernst.

If recklessness be deemed sufficient, this Court

should formulate the appropriate standards to be ap-

plied. The definition advanced by the District Judge is

most certainly inadequate and the matter should be

remanded for trial before a jury properly instructed.

Undoubtedly, the standard to be applied to the con-

duct of the plaintiff in a 10(b) case will ultimately be

fashioned by this Court with due regard to the

minimum standards required of the defendant.

Should this Court agree with Relator that the unique

factual setting and the legal issues in this case

warrant review by this Court, it would appear that the

alleged misconduct on the part of Relator, which at the

very most could be characterized as recklessness,

should be measured against that of Respondent, which

can hardly be characterized as anything short of

reckless.

The Fifth Circuit refused to address itself to the

scienter question raised by Clarence, Relator-

Appellee. The Fifth Circuit decision states in Note 34,

page 3032 (App. p. 56a):

“As part of his argument for a new trial, the

appellee challenges the scienter instruction of

the trial court. Because the appellee did not

cross-appeal, however, this issue is not prop-

erly before the Court and is not included in our

remand for a new trial. The District Court or-

dered a new trial only on damages.

In this, the Court of Appeal was patently incorrect.

Defendant did not cross-appeal because there was

nothing to cross-appeal from. The trial Court granted

— —

judgment notwithstanding the verdict in favor of Clar-

ence, the relator herein, and further granted him a new

trial. The new trial was not limited to the issue of dam-

ages. That misreading of the trial court's judgment by

the appellate court will be the subject of discussion

below. For the moment, however, suffice it to say that

by its very terms, the judgment granting Judgment

N.O.V. in favor of Relator and the conditional new trial

under Rule 50(c)(1) granted to defendant everything he

had requested. It has never been the rule that one could

appeal from the reasons for judgment. The judgment

which is the subject of this dispute states in pertinent

part. (App. p. 8a):

“IN THE ALTERNATIVE, AS REQUIRED BY

RULE 50(c)(1) OF THE FEDERAL RULES OF

CIVIL PROCEDURE, AND FOR THE

REASONS ORALLY ASSIGNED BY THIS

COURT,

IT IS FURTHER ORDERED, ADJUDGED

AND DECREED THAT THE ALTERNATIVE

MOTION FOR A NEW TRIAL MADE BY

CLARENCE O. DUPUY, THE DEFENDANT

HEREIN, BE AND IS HEREBY GRANTED.”

Without taking a cross-appeal, however, the

appellee is entitled to urge in support of the judgment

below in his favor any matter appearing of record,

which may constitute additional grounds for afford-

ing the relief requested and for the appellate court to

consider in affirming the grant of a new trial. U.S. v.

American Railway Express Co., 265 U.S. 425 at 435, 44

Sup.Ct. 560 at 564, 68 L.Ed. 1087; Commercial National

Bank in Shreveport v. Parsons, 144 F.2d 231 (5th Cir.

1944).

The issue was properly preserved in the only way in

which, under the existing law and rules of court, it

could be preserved for further review. That the Court

of Appeals erred in findjng that the district court

limited the grant of a re-trial to damages only will be

further discussed in connection with the issue raised

below concerning tne propriety of limiting the remand

of the case to damages only. But the question of the

trial court’s charge on scienter was squarely and

properly before the Fifth Circuit and is properly

presented to this Court.

Departure By The Circuit Court From The

Accepted And Usual Course Of Judicial Pro-

ceedings To Such An Extent As To Call For An

Exercise Of This Court’s Power Of Super-

vision (“Limited Remand”’)

It is respectfully submitted that the Circuit Court's

limited remand on the issue of the quantum of dam-

ages was improper in that it misread the trial court's

judgments, and oral reasons thereon, granting a new

trial on all issues, and in that it completely dis-

regarded the trial court’s holding that the jury verdict

shocked the conscience of the court and was the result

of prejudice and passion and completely disregarded

the fact that where, as here, the issues as to liability

and damages are so interwoven, a limited remand

works an injustice to Relator so great as to deprive

him of his constitutional rights of due process andtoa

fair trial.

The written judgment of the lower court granting the

new trial is set forth above and is appended hereto

(App. p. 7a) and, as can be seen by simple reference

thereto, is without limitation as to issue.

The oral remarks of the trial judge in open Court af -

ford no basis for concluding that the trial judge intend-

ed in any way to limit the scope of the new trial. It is

doubtful that the reasons assigned by the lower court

for the new trial were limited to questions of dam-

ages. Having found in his grant of Judgment N.O.V.

that the verdict was“. . . contrary to all of the evidence

that I have been able to discern,” the district judge

must certainly have found that it was contrary to the

overwhelming weight of the evidence so as to justify

the conditional new trial. Be that as it may, it is ap-

parent that the Court of Appeals has confused two

aspects of the lower Court’s ruling:

1) The reasons for which the new trial was grant-

ed; and

2) The scope of the new trial.

There was nothing in the lower court's oral state-

ment, or in the written judgment, which would have

permitted any reasonable inference that the Court in-

tended to limit the scope of the new trial, which it alter-

natively granted. The appellant, Respondent herein,

himself made no such inference and no such issue was

ever briefed or argued below.

The district court’s oral remarks were made in open

court after granting the Judgment N.O.V. in favor of

defendant Clarence. The Court stated (App. p. 6a):

“TI will state for the record, although this was

not directly before me, that if it were not for the

Court’s ability to make this finding in the

fashion that I have, I would feel compelled to

grant a new trial because I feel under all the

circumstances of this case, the size of the ver-

dict which shocked the Court's conscience and

also be contrary to the weight ... the court

concludes, under these circumstai.css, that

the jury must have reached this verdict only

on the basis of compassion.”

As explained in Note 32 of the decision of the Fifth

Circuit (App. p. 52a), the Appellate Court read those

remarks as limiting the remand to the issue of dam-

ages. Even if the Court correctly reads the remarks as

limiting the reasons for the remand to the question of

damages, the conclusion that the remand itself is for a

trial only on damages is untenable. Such a retrial

would be contrary to establish jurisprudence under

the circumstances of this case and contrary to the dic-

tates of this Court in Gasoline Products v. Champlin

Refining Co., 293 U.S. 494,51 Sup.Ct. 513, 75 L.Ed. 1188:

“Where the practice permits a partial new

trial, it may not properly be resorted to unless

it appears that the issue to be retried is so dis-

tinct and separable from the others that a trial

of it alone may be had without injustice

(Citing Cases). Here the question of damages

on the counterclaim is so interwoven with that

of liability that the former cannot be sub-

mitted to the jury independently of the latter

without confusion and uncertainty, which

would amount to a denial of a fair trial....

there should be a new trial of all issues raised

by the counterclaim.”

If, as the trial court concluded, the verdict on

damages was shocking to the conscience and infected

— ———ͤ ene — —

with passion and prejudice, what assurance of

fairness in its resolution of the complex issues of lia-

bility exists? In such instances a complete new trial is

required. Minneapolis, St. Paul & S.S.M.R. Co. v. Mo-

quin, 283 U.S. 520, 51 S.Ct. 501, 75 L.Ed. 1243.

The decisions among the circuits have been

remarkably uniform in their reluctance to retry on the

limited issue of damages in similar circumstances.

Howell v. Marnpegso Compagnia Naviera, 536 F.2d

1032 (5th Cir. 1976); Ford Motor Co. v. Mahone, 205 F.2d

267 (4th Cir. 1953); Edwards v. Sears, Roebuck & Co.,

512 F.2d 276 (Sth Cir. 1975); Grimm v. Calif. Spray-

Chemical Corp., 264 F.2d 145 (9th Cir. 1959).

In Grimm, supra, the Appellate Court upheld the ac-

tion of the trial court in granting a re-trial on all issues

even though a re-trial on damages only had been re-

quested:

Here the issues are interwoven to the extent

that a retrial of the damage issue alone would

be grossly unfair to the Appellee. ....

“In these circumstances, the judge was

doubtlessly persuaded that he must either

deny the relief asked by the appellant or order

a new trial on the issues of both liability and of

damages. In this unusual posture of affairs we

are satisfied that the Court did not exceed its

jurisdiction in granting a new trial on both

issues.”

It would be difficult to imagine a case in which

issues of liability and damages are more closely inter-

woven than in the case before this Court. Itis virtually

impossible to try the damage issue without pro-

ducing practically all of the evidence bearing on the

matter of liability.

Virtually every factor affecting liability is a factor

tending to negate the claim of relator that he was de-

ceived as tothe value of the stock, or that any omission

of Relator was material in nature. A determination on

the materiality of any alleged misrepresentations or

omissions is inextricably affected by the determina-

tion regarding whether Plaintiff-Appellant received

fair value upon sale of his stock.

CONCLUSION

This case presents legal issues of crucial impor-

tance and wide-spread interest to courts, com-

mentators, attorneys and investors. The issues are

presented in a framework that calls for thorough

analysis and careful formulation of complex and im-

portant rules of conduct. Above all, the writ should be

granted, so that this high tribunal may review and cor-

rect the radical, innovative and unjustified departure

by the Court of Appeals from a well established rule of

law, by imposing limitations on the due diligence”

concept which all but writes the same out of Section

10(b) actions, and run contra to the philosophy and

reasoning espoused by this Courtin Ernst & Ernst and

Blue Chips, supra. And finally, concededly of more

importance to Relator than to the Court, grant of the

writ will enable this Court to determine whether, as

Relator believes the gross injustice in this case is not

any fraud perpetrated on Respondent. The injustice is

the gross misuse of Section 10(b) to obtain huge unde-

— — —

served profits after having a deliberate choice to opt

out for immediate cash, as correctly perceived by the

trial judge.

We respectfully pray that this Court grant a Writ of

Certiorari ordering that the record be forwarded to

this Court for review and that, after due consideration,

the judgment notwithstanding the verdict of the trial

court dismissing plaintiff's case be reinstated. Alter-

natively, we pray that the entire case be remanded for

new trial on all issues with appropriate instructions

concerning the law of scienter and of the degree of

diligence required of plaintiff.

Respectfully submitted,

MILTON E. BRENER

1304 F.N.B.C. Building

New Orleans, La. 70112

Telephone 504/581-9322

ARTHUR L. BALLIN

1121 Carondelet Building

New Orleans, Louisiana 70130

Telephone 504/523-2155

ATTORNEYS FOR RELATOR

CERTIFICATE OF SERVICE

I hereby certify that three copies of the foregoing

Petition for Writ of Certiorari have been personally

served on:

C. Ellis Henican, Jr., Esq.

Suite 4440

One Shell Square

New Orleans, Louisiana 70130

this ____ day of July, 1977.

I further certify that all parties required to be served

have been served.

MILTON E. BRENER

— — —

APPENDICES

A. Trial Court Motion For Judgment Notwithstand-

ing The Verdict And For New Trial, March 11,

1976.

UNITED STATES DISTRICT COURT

EASTERN DISTRICT OF LOUISIANA

MILTON E. DUPUY

Civil Action

versus No. 73-2370

Section I

CLARENCE O. DUPUY, JR.

MOTION FOR JUDGMENT NOTWITHSTANDING

THE VERDICT AND FOR A NEW TRIAL

Pursuant to Civil Procedure Rules 50 and 59, defen-

dant, CLARENCE O. DUPUY, JR., hereby moves this

Court to set aside the verdict of March 3, 1976, and the

judgment of Marvwh 5th rendered thereon and to enter

judgment in his favor dismissing plaintiff's suit

notwithstanding the said verdict and further moves

that a new trial be granted. The verdict is contrary to

the law and the evidence in the following particulars:

There is no evidence in the record of damages suf-

fered by the defendant by any legally acceptable

criteria.

— —— — eR — —

— ae

—— oe aed

ee ae

——Ä— — — Be ea T—— — 4 so

There is no evidence that the plaintiff exercised due

diligence as required by law.

There is no evidence to justify suspension of the run-

ning of the statute of limitations beyond the date of the

transaction complained of, August 29, 1972.

The weight of the evidence is that the plaintiff did

not rely on misrepresentations or omissions of the

defendant, but demanded and insisted that defendant

buy his stock for cash without regard to success or

failure of the hotel venture.

There is no evidence of any misrepresentation and

no evidence that any failure to disclose information

was knowing or reckless.

WHEREFORE, defendant prays that the verdici of

March 3, 1976, and the judgment of this Court of March

5, 1976, be set aside and that this Court render judg-

ment notwithstanding the verdict dismissing the

plaintiff's suit at his cost and that a new trial be

granted.

2 GARON, BRENER & McNEELY

1304 First National Bank of

Commerce Building

New Orleans, Louisiana 70112

581-9322

/s/ MILTON E. BRENER

MILTON E. BRENER

/s/ ARTHUR BALLIN

ARTHUR BALLIN

Suite 1121

Carondelet Building

226 Carondelet Street

New Orleans, Louisiana 70130

B.. Transcript of Trial Judge’s Oral Reasons For

Judgment Issued From Bench June 9, 1976.

THE COURT:

Gentlemen, I have, I guess I’ve studied, worried

about this case as much as anything I ever had,

because I realize it means a great deal to the parties

because of the result by the jury.

After deliberation, I have concluded that I have no

alternative, under the applicabie standard, but to

grant a Judgment Notwithstanding The Verdict on the

basis that the Plaintiff did not exercise due diligence,

as required by the law and as the Court instructed the

jury and that the jury’s finding to the contrary, was not

only against the great weight of the evidence, but

against all of the evidence that I have been able to dis-

cern.

You have a situation where the evidence is clear that

the Plaintiff, at least, until May, of 1972, is fully con-

versant and very active in the promotion of a hotel

venture that he had issued financial statements show-

ing his value as being almost half a million dollars,

that he took active part in the negotiations with

bankers, architects, financial consultants, seeking to

obtain financing, long-term financing and that he was

— ————

—— kk ͤ SEäüm— —-—: 2 —

— —— Ʒ21G — —ñ—

President of the corporation and Director of the cor-

poration.

Subsequent to May, of 1972, there is a completely

divergent version of the story as to what happened

between the Plaintiff and the Defendant. To put it

bluntly, either the Plaintiff or, the Defendant is lying.

Obviously, the jury made its decision on issues of

credibility. The jury is entitled to great weight.

I don't, however, need to get to issues of credibility in

reaching the decision that I have reached in this mat-

ter, because taking all of the evidence in the case that

is, by the Plaintiff, by witnesses produced by the Plain-

tiff and by the Defendant, there is no evidence from

which a finder of fact might have inferred any

diligence on the part of the Plaintiff.

Plaintiff has introduced letters that he wrote to his

brother, the Defendant, in which he, in very abrasive,

crude language, accused him of every type of con-

ceivable fraud and the desire to do the Plaintiff out of

his interest in all of their ventures, apartment build-

ings, that they owned jointly, business properties.

There was, to put it bluntly, and to put it mildly, an

utter distrust by the Plaintiff in the Defendant.

Yet, regardless of which version of facts around the

sale of this stock is accepted, there was absolutely no

effort on the part of Plaintiff to verify or, take any

steps to verify any information that might have been

given him by the Defendant when such information

could have been available over the telephone.

We have testimony by the banker, Mr. Merrigan, by

Mr. Harris, the mortgage broker, by the architect, that

they would have informed the Plaintiff. He had dealt

with them before, a telephone call would easily have

disclosed the true situation.

There is no reason to believe that even if the Defen-

dant were involved in some effort to defraud the Plain-

tiff, there is absolutely no evidence to indicate that

these people, reputable men in the community, would

have participated.

In short, for the Plaintiff feeling as he did, as ex-

pressed by the evidence which he introduced, by his

complete inability to put any trust in his brother, the

Defendant, in this Court’s opinion, cannot justify his

actions and in effect, putting his head in the sand or,

attempting to have the finder believe that he can put

his head in the sand and make no inquiries con-

cerning the stock of the corporation of which he, ifyou

accept his version, had no reason to believe that he

was anything other than the President and Director,

until the consummation of the transaction.

Now, the Plaintiff has argued totally that the Court

should infer due diligence from actions on the part of

the Defendant, that the finder of fact might have in-

ferred it from actions on the part of the Defendant.

I think this is circuitous logic, it is certainly true

that the degree of artifice which the Defendant in this

case might have used, might bear upon the standard of

due diligence required of the Plaintiff.

But, in this case, the Plaintiff exercised no due

diligence in a situation where, by his own testimony

and by his own evidence, he should have exercised the

greatest of diligence for his own protection.

Therefore, I have no hesitation and no difficulty, af-

ter viewing all of the evidence and particularly after

having counsel for the Plaintiff verify the rectitude of

my conclusions concerning the evidence, the actual

direct and circumstantial evidence, in granting a

Judgment Notwithstanding The Verdict purely on the

basis of failure of the Plaintiff to prove that his

reliance was reasonable under the circumstances at

the time and that the jury’s findings is completely

against and contrary to the great weight of the

evidence.

If it were not for this fact, the Court would be faced

with a much more difficult decision and that is,

whether to grant a new trial.

I will state for the record, although this is not direct-

ly before me, that if it were not for the Court’s ability to

make this finding in the fashion that I have, I would

feel compelled to grant a new trial, because I feel un-

der all of the circumstances of the case, the size of the

verdict which shocked the Court’s conscience and also

be contrary to the weight. I would grant a new trial

rather than a remittitur, because I feel that it would be

unfair to both sides for the Court to substitute its own

judgment.

You have here a situation where the jury heard

evidence for almost two weeks, heard very complex

instructions as to the law, went out and deliberated for

less than an hour-and-a-half, including sending the

Court a question.

The Court concludes, under these circumstances,

that the jury must have reached its verdict only on the

basis of compassion and not a considered verdict, as

required.

Thank you very much.

MR. BRENER:

Your Honor, may I ask one point of clarification?

Under the Federal Rules, as I understand it, when the

Court rules on a judgment N.O.V., I don’t know

whether Your Honor has overruled a motion for new

trial, considered it moot or, what. But, as I under-

stand, the Court should also either rule on the new trial

or, hold it in abeyance in the event, which we hope

doesn’t happen, the —

THE COURT:

Well, I will hold it in abeyance.

I have stated my reasons for the benefit of the par-

ties.

MR. BRENER:

Okay, I understand.

THE COURT:

I am informed, gentlemen, by the Clerk, that there is

also a motion by the Plaintiff to amend the verdict,

which I presume is moot, in light of the Court's ruling.

C. Trial Court’s Judgment Notwithstanding The Ver-

dict And For New Trial, June 18, 1976.

UNITED STATES DISTRICT COURT

EASTERN DISTRICT OF LOUISIANA

MILTON E. DUPUY

Civil Action

versus No. 73-2370

Section I

CLARENCE O. DUPUY, JR.

JUDGMENT

The Court having previously granted the motion of

defendant for Judgment Notwithstanding the Verdict;

ee eee

accordingly for reasons orally pronounced by the

Court,

IT IS ORDERED, ADJUDGED AND DECREED that

there be judgment in favor of defendant, Clarence O.

Dupuy, Jr., and against plaintiff, Milton E. Dupuy, dis-

missing said plaintiff's suit, ai plaintiffs costs.

In the alternative as required by Rule 50(c)(1) of the

Federal Rules of Civil Procedure, and for the reasons

orally assigned by this Court,

IT IS FURTHER ORDERED, ADJUDGED AND

DECREED that the alternative motion for a new trial

made by Clarence O. Dupuy, the defendant herein, be

and is hereby GRANTED.

Dated at New Orleans, Louisiana, this — day of

June, 1976.

/s/ NELSON B. JONES

NELSON B. JONES,

CLERK

APPROVED AS TO FORM:

/s/ [ILLEGIBLE]

UNITED STATES DISTRICT

JUDGE

D. Judgment Of Court Of Appeals, May 9, 1977.

UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

No. 76-2667

D. C. Docket No. CA 73-2370 “I”

MILTON E. DUPUY,

Plaintiff-Appellant,

versus

CLARENCE O. DUPUY, IR..

Defendant-Appellee.

Appeal from the United States District Court for the

Eastern District of Louisiana

Before JONES, WISDOM and GODBOLD, Circuit

Judges.

JUDGMENT

This cause came on to be heard on the transcript of

the record from the United States District Court for the

Eastern District of Louisiana, and was argued by

counsel;

10a

ON CONSIDERATION WHEREOF, It is now here

ordered and adjudged by this Court that the judgment

of the said District Court in this cause be, and the same

is hereby, affirmed in part and reversed in part; and

that this cause be, and the same is hereby remanded to

the said District Court in accordance with the opinion

of this Court;

It is further ordered that defendant-appellee pay to

plaintiff-appellant, the costs on appeal to be taxed by

the Clerk of this Court.

May 9, 1977

Issued as Mandate:

E. Opinion of Court of Appeals, May 9, 1977

Milton E. DUPUY, Plaintiff-Appellant,

Clarence O. DUPUY, IR., Defendant-Appellee.

No. 76-2667.

United States Court of Appeals.

Fifth Circuit.

May 9. 1977.

Appeal from the United States District Court for the

Eastern District of Louisiana.

Before JONES, WISDOM and GODBOLD, Circuit

Judges.

11a

WISDOM. Circuit Judge:

In this brother-against- brother case, a purchaser of

stock, to depress the price, misrepresented and failed

to disclose material facts regarding the value of the

stock. The question presented is whether the seller of

the stock will be denied recovery against the

purchaser under Securities and Exchange Commis-

sion Rule 10b-5! because the seller, who could have

ferreted out the facts, failed to do so until after the sale.

The case turns on the degree of diligence required of

the plaintiff, Milton Dupuy, under Rule 10b-5 when the

defendant, his brother Clarence, intentionally com-

mitted acts of fraud that significantly affected the

plaintiff's decision to sell the stock at a price con-

siderably below its value. This is primarily a question

1 17 C.F.R. 240.10b-5 (1976) states in part:

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

ly, by the use of any means or instrumentality of interstate

commercz, or of the mails,

{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

statements made, in 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.

The Rule is promulgated under section 10-b of the Securities and

Exchange Act of 1934, 15 U.S.C. § 78j(b) (1970):

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

ly, by the use of any means or instrumentality of interstate

commerce or of the mails

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

or sale of any security registered on a national exchange

or any security not so registered, any manipulative or

deceptive device or contrivance in contravention of such

rules and regulations as the Commission may prescribe as

necessary or appropriate in the public interest or for the

protection of investors.

12a

for the jury to decide. Here, on interrogatories sub-

mitted to the jury, the jury decided that the plaintiff

had “exercised due diligence for his protection in con-

nection with [the] sale of the stock’’, and awarded

Milton damages of $905,000.

The trial judge granted the defendant’s motion fora

judgment notwithstanding the verdict. He held that

there was “no evidence from which a finder of fact

might have inferred any diligence on the part of the

plaintiff’. Alternatively, the trial judge stated that “if

it were not for the Court's ability to make this finding

2 This is language of the district court's fourth interrogatory.

The court's question and the jury’s answers included the follow-

ing:

1. Do you find that in connection with, and prior to the

sale of stock by Milton E. Dupuy to Clarence O. Dupuy, Jr.

that the defendant, Clarence O. Dupuy, either knowingly

or recklessly misrepresented or knowingly or recklessly

failed to disclose any material fact(s) to the plaintiff,

Milton E. Dupuy?

Answer “Yes” or “No”

Answer: Yes X No

2. Did Milton E. Dupuy rely on the misre presentations of

the defendant or would he have attached importance to the

information withheld from him in connection with and

prior to the sale of the stock?

Answer: Yes X No ——

4. Do you find that Milton E. Dupuy exercised due

diligence” for his protection in connection with this sale of

stock?

Answer: Yes X No

5. On what date do you find Milton E. Dupuy discovered,

or should have discovered, through the exercise of

reasonabie diligence, the misrepresentations or

omissions referred to in Interrogatory No. 1?

Answer by checking one:

Before September 7, 1972

On or after September 7,1972 X

6. What amount do you feel will adequately compensate

the plaintiff for the damages he has sustained?

Answer by means of a numerical figure.

Answer: $905,000

3 Fed. R. Civ. P. 50(b).

13a

in the fashion I have, I would feel compelled to granta

new trial, because I feel under all the circumstances of

the case, the size of the verdict. . . shocks the Court's

conscience and also [is] contrary to the weight [of the

evidence]’’.4

We reverse the judgment n. o. v., but remand the case

for a new trial on damages.5

The Facts

Clarence and Milton Dupuy were raised in poverty

in a poor section of New Orleans. They worked as

children and as youths and always on a share and

share alike basis. Until the dispute arose that

generated this litigation the two brothers worked har-

moniously for many years on real estate ventures. By

1971 they had accumulated certain valuable proper-

ties held by Les Freres Corporation, Argonne Cor-

poration, Dupuy and Dupuy, a partnership, and

Dupuy Construction Company, a partnership. The

stock and the partnerships were divided equally

between Clarence and Milton. Clarence was the older

brother and dominated their personal relationships.

He was an attorney, a successful politician, and an

4 Fed.R.Civ.P. 50(c). The court added:

I would grant a new trial rather than a remittur.

because I feel that it would be unfair to both sides for the

Court to substitute its own judgment.

5 This is the second appeal of this case. Shortly after the suit was

filed, Clarence moved for summary jue gment on the ground of

lack of federal jurisdiction. The district court granted the motion.

Dupuy v. Dupuy, E.D.La.1974, 375 F.Supp. 730. This Court re-

see and remanded for trial, Dupuy v. Dupuy, 5 Cir. 1975,511 F. ad

41.

l4a

elected member of the New Orleans City Council.

Milton did not finish college, but acquired firsthand

knowledge of the construction business and real es-

tate development. At one time he was appointed and

served as President of the Orleans Parish Levee

Board.

In late 1971 the Dupuys organized the Lori Corpora-

tion to acquire a valuable long-term lease on land

bounded by Toulouse, Burgundy, Rampart, and St.

Peter streets in the City of New Orleans. This property

is within but on the edge of the French Quarter. The

value of the land was enhanced when, prior to the

Dupuys’ acquisition of the lease, the City Council of

New Orleans declared a moratorium on construction

of hotels in the French Quarter, but excepted from the

ban the premises just described.

To form Lori Corporation, each brother contributed

$1,880 to the enterprise and received 47 percent of the

company’s stock.“ Milton was president, Clarence

Secretary-treasurer, and Mrs. Dupuy, their mother,

vice-president. During 1971 and early 1972 Milton

supervised the day-to-day development of this ven-

ture.“ He signed the lease with the landowner, met fre-

quently with the architect, August Perez, and

assembled statistics for the necessary financing. He

and Clarence met with the president of the Bank of

6 Their mother, Mrs. Florence Dupuy, received the remaining six

percent of the stock.

7 The brothers managed Lori as they had managed several other

properties owned jointly, including apartments and a parking lot.

Milton supervised the development of the projects and managed

them after construction. Clarence provided legal services and

financing.

15a

New Orleans, Lawrence Merrigan, and a mortgage

banker, J. H. Harris, (representing Colwell Mortgage

Trust), to discuss financing the project. As compensa-

tion for these duties and his management of other

jointly held properties, Milton received a monthly fee

of $1,150.

At Harris’s suggestion, Milton obtained an ap-

praisal from a Mr. John Bird. in whom Colwell had

confidence. Bird valued the project initially at $7,340,-

000 and the market value of the lease at $986,500,000.

Because of changes in the plans, he reduced these

figures respectively to $7,100,000 and $962,330,000.

All went well until March 30, 1972, when Clarence

abruptly cut off Milton’s management fee. Clarence

had always controlled the checkbook. Clarence says

that Milton turned his back on the project. At the time,

however, Milton’s monthly fees were his sole source of

income; he had no substantial savings; Milton had

serious kidney trouble causing increasing medical

expenses; and he was supporting his present wife and

child and his former wife and children. He could not

borrow on his interest in the Les Freres and Argonne

corporations, because he had no means of paying the

debt. Milton asked Clarence to buy his interest, but

Clarence offered him only a note. Milton’s financial

crisis forced him to find other employment. He ob-

tained a job with Norman Brothers, real estate de-

velopers, but the work required travel to Clearwater,

Florida, and to Algiers (across the Mississippi River

from New Orleans). After three months, his health was

so bad that he had to give up this job. He had worked

for Norman Brothers from May 15 to August 18, 1972.

16a

After his management was terminated and having

no personal contacts with the development of the Lori

property, Milton had to rely on Clarence for informa-

tion as to what was happening to the financing of the

projected hotel. Milton testified that whenever he

spoke to Clarence over the telephone Clarence told

him that the Lori Hotel “was having a rough time...

everything is going downhill”; that “it’s just prac-

tically worthless”.

Shortly after Clarence cut off Milton’s income,

Clarence began negotiations with William

Monteleone, owner of a well-known and long-

successful French Quarter hotel. Earlier, Clarence

and Milton had discussed but had never pursued the

possibility of interesting Monteleone in the venture.

Milton testified that Monteleone’s name came up just

once and then as a possible purchaser of some of

Milton’s stock. The banks and mortgage brokers had

conditioned financing of the construction of the

Dupuy hotel on the participation of someone having

larger financial resources than Clarence and Milton

possessed.

Clarence’s negotiations with Monteleone and his

representatives were extensive. A letter to the New

Monteleone Hotel from Arthur L. Ballin, an attorney

who represented Monteleone, shows that instead of

“everything going downhill”, prospects were

favorable. As early as April 21, Ballin had a four-hour

conference with Monteleone and Clarenve to review

the “proposition of joint venture and partnership in

commendum”’.8 On April 24 there was a two-hour con-

8 The events referred to in this paragraph are taken from a letter

by Arthur J. Ballin to the New Hotel Monteleone, Inc., dated July 6,

1972. (App. 47)

17a

ference by Ballin and Clarence to prepare a draft of the

partnership. At that time, Monteleone was prepared to

put up the necessary financing. On April 28 there was

a two-hour conference by Ballin with Clarence and

Monteleone, who expressed doubts about the joint

venture. These doubts were later dissipated. Ballin

talked with Clarence on May 1 and arranged for a

meeting the next day. May 2 Ballin met with Clarence.

They were in agreement as to the partnership, but

Clarence wanted and obtained an option to repur-

chase Monteleone’s interest. May 5 Ballin had several

telephone conferences and a meeting with Clarence.

On May 8 Ballin again met with Monteleone and

Clarence. On that day Monteleone instructed Ballin to

prepare papers to complete the transaction. There

followed meetings by Ballin with Clarence on May

12,to discuss provisions of the partnership agreement;

on May 13, to re-draft the partnership agreement; on

May 15, with Monteleone as well as Clarence, to revise

the agreement; on May 17, a meeting with Clarence,

after Ballin had studied the tax effects of the agree-

ment; on May 19, a long telephone conversation to dis-

cuss the tax effects; on May 22, a meeting by Ballin

with Clarence and accountants to discuss tax effects of

the partnership. June 2 Ballin met with Clarence to

review the revised agreement. June 6 Ballin met for

three hours with Clarence and accountants to review

the revised partnership agreement and tax questions.

Finally, on June 7, 1972, Ballin met with Clarence and

reviewed the final form of the partnership and Clar-

ence’s option. The partnership agreement called for

Monteleone to put up, individually, $180,000 in cash,

for which he would receive a6 percent interest, and the

New Hotel Monteleone, Inc., to put up $420,000 in cash

1... ⁵—˙D]J. K—?))) K

18a

for a 14 percent interest. The Lori Corporation would

receive a 40 percent interest, for its lease to the land on

which the hotel was to be built. Clarence would receive

a 40 percent interest. Thus, for two months before

Clarence bought Milton’s stock and for one month

before the putative directors’ meeting approving the

partnership with Monteleone, Clarence knew that the

Lori stock was worth a small fortune. But not Milton,

although he lived in the same apartment complex with

Clarence and they shared a patio.

The partnership agreement was executed on July 31,

1972, before Arthur L. Ballin, in his capacity as Notary

Public. Clarence Dupuy appeared individually and as

Secretary-Treasurer of Lori Corporation. William A.

Monteleone appeared individually. The New Hotel

Monteleone appeared through its duly authorized Ex-

ecutive President.

On that same day, July 31, 1972, Clarence signed a

certificate as Secretary of Lori Corporation certifying

as true and correct a resolution, adopted by the Board

of Directors of the Corporation, authorizing Clarence

to execute on behalf cf Lori Corporation the

partnership with Clarence Dupuy, William A.

Monteleone, and New Hotel Monteleone, under the

name of Lori Corporation and Associate The con-

tribution of the corporation was to be the assignment

of the Lori lease to the partnership. Also, on that same

day Clarence certified as true and correct a resolution

authorizing an option in favor of Clarence and Lori

Corporation, for five years, to repurchase the interests

of William A. Monteleone and the New Hotel

Monteleone for $700,000.

19a

On ¢ oss-examination, Clarence admitted that he

had not notified Milton of any meeting of the Board of

Directors and that no meeting had been held. Indeed,

so he said, no meeting of the Board had ever been held

for the Lori Corporation or for any other of their cor-

porations. This loose practice might be understan-

dable when the two brothers had harmonious

relations. But a jury would find it hard to understand

why it did not put Clarence under the unshakable duty

to disclose the facts to Milton, when the effect of the

meeting that did not exist was to make effective the

partnership with Monteleone resulting in the

successful financing of the hotel and the assignment

of Lori’s sole asset to the partnership.

Because of Monteleone’s participation, the

partnership received a construction loan of $5,000,000

from Colwell Mortgage Trust. Clarence accepted

Colwell's offer on July 25, subject to certain changes.

Colwell approved the changes on July 27.

Clarence revealed none of these facts to Milton. In-

deed, during the time he was negotiating with Ballin

and Monteleone he assured Milton that the develop-

ment of the hotel had been stalled by a failure to obtain

financing. Not knowing of Clarence’s bright future for

the hotel, never having been informed of the need for a

bona fide or non-existent directors’ meeting, and hard

pressed financially, Milton urged Clarence to buy his

stock. ~

Milton, more and more apprehensive about his in-

vestment, wrote letters to Clarence June 19, June 25,

20a

and July 9, 1972.9 These letters clearly show that

Milton mistrusted his brother. By that time, however,

Clarence had closed his agreement with Monteleone,

except for executing final papers. He gave no inkling

of this to Milton.

In early June 1972 Clarence sent Milton a statement

from G. E. Conroy, their accountant, for $375, and ask-

ed him to co-sign a check of Lori Corporation for that

amount, payable to Conroy. The statement did not

show the nature of the services performed. The record

shows that they were to consider the tax aspects of

Clarence’s proposed transactions with Monteleone.

Milton asked for a full report on what Conroy had done

to earn the $375. Clarence did not reply to this request.

9 After writing letters of June 11 and June 25, Milton sent the third

on July 9, a letter that demonstrates that as of that date Milton had

no ment to sell his stock to Clarence:

larence,

I have had plenty of time to review your past actions and it

is quite clear and can be proven tha you have

systematically stolen from me. In addition, You are aow

trying to steal something that is rightfully mine, my share

of all the property.

You have lied and tried to con me about offering to buy my

share of the Lori Corporation....

I do not want to be part of any business venture or partner-

ship or corporation arrangement whereby you may have

an interest. I want my share of ALL the properties in the

partnership and in the corporations and I want my share

promptly. ...

I want only my share that belongs to me and! want it now.

And unless I get it I will have the lawyers to work you over

good and properly and they will be paid well to do this.

Any offer that you may want to submit you must do so in

writing only. ...

The letter of June 25 states, in part: “You deliberately wanted me

out of the corporation and this is the reason you abruptly cut off

my income from our partnership and forced me to seek employ-

ment elsewhere on a full time basis. Clarence testified that he

construed this langu as consistent with his having entered into

an agreement with Milton on June 22 by which he purchased

— stock. A jury could reasonably have reached the opposite

conclusion.

21a

The jury could have inferred that a reply would have

disclosed to Milton his negotiations with Monteleone.

In August, still thinking that the hotel venture was

in deep trouble, Milton agreed to sell his 47 percent in-

terest in Lori for $10,000. On August 29 Milton signed

the agreement of sale. He did so without consulting the

bankers, the architect, or any lawyers. He explains

that he relied on Clarence's representations because,

in spite of his mistrust, Clarence was his brother on

whom, in spite of everything, he had always relied.

Moreover, his kidney disease prevented an indepen-

dent investigation. His kidney disease, diagnosed in

1965 as incurable glomeruler nephritis, had worsened

considerably by 1972. It had forced Milton to quit is

job on August 18, at which time, he said, he was flat on

his back. The Social Security office set the date of his

complete employment disability as April 1972.

Milton argues that the true value of his 47 percent in-

terest in Lori was at least $500,000 and perhaps 81.200.

000. On January 28, 1972, Clarence had estjmated the

value of his 47 percent at $493,250.00. A preconstruc-

tion appraisal valued the lease alone at $1,000,000. In

February 1972 the equity value of the proposed hotel

was estimated at $1,810,000. And the Monteleone

transaction appears to have been based on a total

value of $3,000,000.

Clarence tells a different story. As noted, he con-

tends that the termination of Milton’s income resulted

from Milton’s voluntary withdrawal from the hotel

venture. Discussions with the Bank of New Orleans

and the mortgage broker had revealed that both

brothers would have to sign the note for the construc-

tion loan. According to Clarence, Milton did not want

to risk his entire fortune on the hotel; he was insistent

that Clarence buy his interest in the project.

Clarence asserts that during the financial meetings

with Merrigan and Harris, Milton discussed with them

the prospect of a partnership with Monteleone. The

topic also arose in a meeting with the architect, Perez,

according to both Clarence and Perez. The mother of

the men testified that Milton told her in June that

10 Clarence overstates the supportive value of the testimony of

Merrigan, Perez, and Harris.

Merrigan said that to say whether Milton was present at the

meeting where Monteleone's name came up, he would have to rely

on his memory. which he could not do. (Tr. XVII, 23) In fact, he

could say only that he felt he may have met with Milton in January

or February 1972. (Tr. XVII, 23). Merrigan testified that his ap-

pointment book listed only Clarence as having had an appoint-

ment on March 27, 1972; that Monteleone’s name came up only as a

hypothetical possibility. (Tr. XVII, 26).

Perez's testimony is inconsistent with Clarence’s basic conten-

tion that Milton's salary was cut off because Milton turned his

back on the project. Perez testified to a meeting with Clarence and

Milton on March 28, 1972, (Tr. X VIII, 6) and it was his recollection

that both Clarence and Milton had attended. According to Perez,

both Clarence and Milton said on this date that the two brothers

were considering the possibility of bringing Monteleone into the

hotel project, (Tr. XVIII, 8) and both of them would guarantee

Perez's fees (Tr. XVIII, 8). Milton and Clarence told him to keep

working. Clearly, Milton was not disheartened about the project at

this March 28, 1972 meeting (Tr. XVIII, 19), two days before

Milton's monthly fee terminated. About a month later, Clarence

told Perez Milton was out of the deal. He did not see Milton after

March 28, 1972.

Harris did testify that Monteleone’s name had come up in a meet-

attended by Milton on March 30, 1972. That was the date on

which Milton's management fee was terminated. According to

Harris, there was no evidence that Milton was withdrawing from

the project. The first he beard of that was when Clarence told him

so on May 22, 1972. (First Supp. Record, 145) In other words, Harris

says Monteleone’s name was mentioned on March 30 as a potential

partner for both Milton and Clarence, not for Clarence alone. (First

Supp. Record, 126)

Monteleone was to be Clarence's partner. During this

conversation, Milton reportedly reaffirmed his desire

to sell his interest in the hotel. Clarence testified that

not only had Milton reason to believe in the prospect of

the Monteleone partnership, but he knew of its actual

formation.

The brothers have different versions of the terms of

the sale of the Lori stock. According to Clarence,

Milton first suggested the sale and frequently pres-

sured him through their mother for a speedy agree-

ment on the terms. Clarence denies any direct contact

with Milton except for a June meeting at which they

agreed on a price of $45,000, $10,000 to be paid by check

and $35,000 to be paid in cash; Clarence was to assume

the corporation's note of $85,000 for interim financing.

The payment on August 29, 1972, was witnessed by

Milton's wife and mother. The mother testified that

Clarence carried the cash to Milton’s apartment in a

large cardboard box. Milton denies both the June meet-

ing and the payment of any cash, a denial corroborated

by his wife.

Even though Clarence says that he paid $45,000 for

Milton's interest in Lori, he insists that the stock was

absolutely worthless at the time and that Milton could

not have suffered any damages from the sale. Dis-

regarding the successful financing, he argues that in

August Lori owned only a lease that required annual

rent payments of $50,000. There was no hotel, no in-

come. Even if the hotel were built, substantial busi-

ness risks precluded any guarantee of success. And

the inherent lack of marketability of close corporation

stock detracted further from the value of Milton's in-

24a

vestment. Considering that Milton had contributed

only $1,880 to the venture in 1971, Clarence argues that

$45,000 was more than an adequate return in 1972.

Clarence’s return consisted of the value of 94 percent

of Lori stock plus a 40 percent interest in the

partnership.

Summarizing, Clarence bought Milton’s 47 percent

stock interest on August 29, 1972. A month before, July

31, Monteleone had paid $600,000 for a 20 percent in-

terest in the partnership. By August 29 a $5,000,000

construction loan had been obtained. Two months

before, on June 31, Clarence certified a resolution, on

its face adopted by the Board of Directors approving

the partnership and assignment of Lori's lease. At that

time there could be no doubt that Milton’s stock was

enormously valuable.

Clarence is here represented by Ballin. Ballin, here

arguing that on August 29 Milton’s 47 percent stock in-

terest was virtually worthless, embraced a transac-

tion in June and July requiring Monteleone to put up

$600,000 for a 20 percent interest in Lori Corporation

and Associate. The same transaction gave Lori Cor-

poration a 40 percent interest. Clarence received a 40

percent interest and, of course, had a 94 percent in-

terest in Lori after buying out Milton. On the record

before it, the jury could fairly infer that Clarence in-

tentionally misrepresented to Milton the financial

prospect for the Maison Dupuy Hotel and that he con-

cealed material facts from his brother to depress the

price of the stock.

The more difficult question is the extent to which

fraud under Rule 10-bis vitiated by the victim's lack of

diligence in protecting his interests.

II.

DUE DILIGENCE

a. Judgment Notwithstanding the Verdict.

The trial judge overturned the jury verdict because

he found that the record showed no evidence that

Milton had exercised due diligence to protect his own

interests.

This Court, in Boeing Co. v. Shipman, 5 Cir. 1969, 411

F.2d 365 (en banc), limited our inquiry in this type of

case to the question whether the district court im-

properly substituted its judgment for that ofthe jury:

[Tjhe Court should consider all of the evidence

— not just that evidence which supports the

non-mover’s case — but in the light and with

all reasonable inferences most favorable to

the party opposed to the motion... . [I]f there

is substantial evidence opposed to the

motions, that is, evidence of such quality and

weight that reasonable and fair-minded men

in the exercise of impartial judgment might

reach different conclusions, the motions

should be denied, and the case submitted to the

jury. ... There must be a conflict in substan-

tial evidence to create a jury question.

However, it is the function of the jury as the

traditional finder of the facts, and not the

Court to weigh conflicting evidence and in-

-—

ferences, and determine the credibility of

witnesses.

Id. at 374-75. We need not resolve the swearing match.

We need decide only whether a reasonable jury could

have found from the evidence that Milton exercised

due diligence under Section 10b-5, in the circum-

stances of this case, to protect his interests before he

sold his stock to Clarence

b. The Law of Due Diligence.

1. Background and Approach

The Securities and Exchange Act of 1934 did not

provide expressly for a private cause of action to en-

force Section 10-(b). Neither the Act nor its legislative

history supply the elements of such an action.! ! When

the SEC promulgated Rule 10b-5, apparently it intend-

ed to exercise its broad enforcement powers, rather

than to establish a mechanism for investor compen-

sation. 2 Consequently, the Commission also failed to

announce the prerequisites for recovery of damages

by victims of stock fraud. Not until J. I. Case Co. v.

Borak, 1964, 377 U.S. 426, 84 S.Ct. 1555, 12 L.Ed.2d 423,

did the Supreme Court recognize a private cause of ac-

tion arising from the Acts. The burden has fallen upon

the courts to define the requirements for private en-

forcement of the securities laws.

11 See Wheeler, Plaintiff's Duty of Due Care Under Rule 10b-5; An

Implied Defense to an Implied Remedy, 70 Nw.U.L.Rev. 561, 564-68

(1976); Comment, Reliance Under Rule 10b-5: Is the Reasonable In-

vestor “Reasonable”? 72 Colum.L.Rev. 562, 563 (1972).

12 Id.

27a

The courts have established that with regard to

private recovery for the violation of Rule 10b-5, a

properly stated cause of action must establish the

scienter of the defendant. is the materiality of any mis-

representation or omission by the defendant,'4 the ex-

tent of actual reliance by the plaintiff on the defen-

dant’s statements,'5 and the justifiability of the

reliance, frequently translated into a requirement of

due diligence by the plaintiff. is Treatment of the last of

these elements has varied substantially among the

circuits. This Court established due diligence” as a

separate element in 10b-5 cases, apart from questions

of materiality, reliance, or defenfants’ duties. Clement

A. Evans & Co. v. McAlpine, 5 Cir. 1970, 434 F.2d 100,

cert. denied, 1971, 402 U.S. 988, 91 S.Ct. 1660, 29 L.Ed.2d

153, rehearing denied, 404 U.S. 874, 92 S.Ct. 26, 30

L.Ed.2d 120; accord Bird v. Ferry, 5 Cir. 1974, 497 F.2d

13 Ernst & Ernst v. Hochfelder, 1976, 425 U.S. 185, 96 S.Ct. 1375, 47

L.Ed.2d 668.

14 Schlick v. Penn-Dixie Cement Corp., 2 Cir. 1974, 507 F. 2d 374,

cert. denied, 1975, 421 U.S. 976,95 S.Ct. 1976, 44 L.Ed.2d 467; Arber v.

Essex Wire Corp., 6 Cir. 1974, 490 F.2d 414, cert. denied, 419 U.S. 830,

te Ng 42 L.Ed.2d 56; Rogen v. Ilikon Corp., 1 Cir. 1966, 361 F. 2d

15 Holdsworth v. Strong, 10 Cir. 1976, 545 F.2d 687; Titan Group,

Inc. v. Faggen, 2 Cir. 1975, 513 F.2d 234; cert. denied, 423 U.S. 840, 96

S.Ct. 70, 46 L.Ed.2d 59; Rochez Bros. v. Rhoades, 3 Cir. 1974, 491 F. 2d

402. The Supreme Court has held that proof of actual reliance is not

required when defendants have omitted information rather than

misrepresenting it. Affiliated Ute Citizens v. United States, 1972,

406 U.S. 128, 92 S.Ct. 1456, 31 L.Ed.2d 741. Reliance on the omission

generally is presumed if the omission is material. See, e.g., Com-

petitive Associates v. Laventhal, Krekstein, Horwath & Horwath,

2 Cir. 1975, 516 F.2d 811.

16 Holdsworth v. Strong, 10 Cir. 1976, 545 F.2d 687; Straub v.

Vaisman & Co., 3 Cir. 1976, 540 F.2d 591; Vohs v. Dickson, 5 Cir.

1974, 495 F.2d 607; Rochez Bros v. Rhoades, 3 Cir. 1974, 491 F.2d 402;

Clement A. Evans & Co. v. McAlpine, 5 Cir. 1970, 434 F.2d 100, cert.

denied, 1971, 402 U.S. 988, 91 S.Ct. 1660, 29 L.Ed.2d 153, rehearing de-

nied, 404 U.S. 874, 92 S.Ct. 26, 30 L.Ed.2d 120.

—

28a

112, rehearing denied, 5 Cir., 503 F.2d 567; Vohs v.

Dickson, 5 Cir. 1974, 495 F.2d 607.17 By considering in-

dependently whether the carelessness of a plaintiff

should preclude his recovery, the Court promotes two

policies. First, general principles of equity suggest

that only those who have pursued their own interests

with care and good faith should qualify for the

judicially created private 10b-5 remedies. See Clement

A. Evans & Co. v. McAlpine, 5 Cir. 1970, 434 F.2d 100,

104; City National Bank v. Vanderboom, 8 Cir. 1970, 422

F.2d 221, 230 n.10, cert. denied, 399 U.S. 905, 90 S.Ct.

2196, 26 L.Ed.2d 560; Wheeler, Plaintiff's Duty of Due

Care Under Rule 10b-5: An Implied Defense to an Im-

plied Remedy, 70 Nw.U.L.Rev. 561, 564-68 (1976)

(hereinafter cited Wheeler). Second, by requiring

plaintiffs to invest carefully, the Court promotes the

anti-fraud policies of the Acts and engenders stability

in the markets. Wheeler, 70 Nw.U.L. Rev. at 585; Note,

The Due Diligence Requirement for Plaintiffs Under

Rule 10b-5, 1975 Duke L.J. 753, 760-61.

17 But see Stier v. Smith, 5 Cir. 1973, 473 F.2d 1205, which did not

examine the diligence of a plaintiff who had been induced to

purchase stock from a corporate insider. The Court said:

We should always be wary of holding that a purchaser of

securities, who deals with the corporate insider, could

have found out omitted material facts, by examining the

corporate books or undertaking other extensive in-

vestigations. To do so is to allow the insider to present

prospective purchasers with a mountain of information

which they cannot possibly digest and excuse themselves

from liability on the basis that they did not provide the

right answers because they were not asked the right

questions. Id. at 1208.

Rather than concluding that the plaintiff had fulfilled the limited

requirements of due care imposed on an outsider, see Bird v. Ferry,

5 Cin 1974, 497 F.2d 112, the Court merely held that Stier “was enti-

tled to judgment as a matter of law because sophisticated in-

vestors, like all others, are entitled to the truth”. 473 F. ad at 1207.

Some other circuits used different approaches in

evaluating the conduct of plaintiffs. Several courts

have made the duty of defendants to disclose depend

on the sophistication, status, and information of the

plaintiff. White v. Abrams, 9 Cir. 1974, 495 F.2d 724:

Arber v. Essex Wire Corp., 6 Cir. 1974, 490 F.2d 414,

cert. denied, 419 U.S. 830, 95 S.Ct. 53, 42 L.Ed.2d 56;

Kohler v. Kohler, 7 Cir. 1963, 319 F. 2d 634. The First and

Tenth Circuits have analyzed the facts to determine

whether reliance by plaintiffs on misrepresentations

was reasonable or justifiable. Holdsworth v. Strong,

10 Cir. 1976, 545 F.2d 687; Rogen v. Ilikon Corp., 1 Cir.

1966, 361 F. 2d 260. One panel in the Second Circuit has

abandoned altogether the requirements of reliance in

fact and justifiable reliance in cases involving inten-

tional misrepresentations. In Metro-Goldwyn- Mayer,

Inc. v. Ross, 2 Cir. 1975, 509 F.2d 930, the court held that

the duty of the defendant to correct his misrepre-

sentation is absolute, regardless of the defendant's

knowledge of the misrepresentation. Accord, Com-

petitive Associates, Inc. v. Laventhol, Krekstein,

Horwath & Horwath, 2 Cir. 1975, 516 F.2d 811. But see

Titan Group, Inc. v. Faggen, 2 Cir. 1975, 513 F.2d 234,

cert. denied, 423 U.S. 840, 96 S.Ct. 70, 46 L.Ed.2d 59. See

generally, Comment, Securities Regulation — Two

Different Standards of Reliance Applied in Individual

Private Damage Actions Under SEC Rule 10b-5 by the

Second Circuit, 49 Temple L.Rev. 182 (1975).

These alternative approaches to the due diligence

determination present several analytical problems,

which cause us to retain the methodology of

McAIpine.

30a

First, inconsistent standards of conduct for defen-

dants arise from analyses that vary the duty to dis-

close with the status of the plaintiff. Because the

private 10b-5 cause of action derives from a

prohibitory SEC rule, the standard of conduct for

defendants logically should be the same whether the

SEC or a private litigant enforces the duty. In an SEC

enforcement proceeding, the due care of the victim

generally does not receive consideration. SEC v.

Dolnick, 7 Cir. 1974, 501 F.2d 1279, 1283 (disregarding

whether the victim was a knowledgable investor);

Hanly v. SEC, 2 Cir. 1967, 415 F.2d 589, 596 (disregard-

ing the sophistication of the victims, as well as their

previous relationships with the defendants). But see

SEC v. Coffey, 6 Cir. 1974, 493 F.2d 1304, 1312-13, cert.

denied, 1975, 420 U.S. 908, 95 S.Ct. 826, 42 L.Ed.2d 837

(on the peculiar facts of this case the defendant

violated no duty because the victims possessed suf-

ficient knowledge about a representation to avoid be-

ing misled by it). The dispositive element in these

cases is that the defendant owes a duty of full and fair

disclosure to the public, not to any particular investor.

Whether a private plaintiff might be precluded from

recovery, then, need not alter the distinct considera-

tion whether a defendant has violated duties imposed

by the Act. With a flexible duty approach, however, the

defendant owes different duties depending on the

status of the victim and the type of legal action. This

could lead both to unnecessary confusion between

public and private enforcement proceedings and to

gamesmanship by defendants. See Wheeler, 70 Nw.

U.L.Rev. at 591.

Second, the materiality-reliance approach of the

First and Tenth Circuits also faces a problem of con-

sistency of application. In Affiliated Ute Citizens v.

United States, 1972, 406 U.S. 128, 92 S. Ct. 1456, 31

L.Ed.2d 741, rehearing denied, 407 U.S. 916, 92 S.Ct.

2430, 32 L.Ed.2d 692 and 408 U.S. 931, 92 S.Ct. 2478, 33

L.Ed.2d 345, the Supreme Court held that in a 10b-5

case involving a material omission “positive proof of

reliance is not a prerequisite to recovery“. Id. 406 U.S.

at 153, 92 S.Ct. at 1472. By eliminating positive proof of

reliance when materiality is established, the Court re-

lieved the plaintiffs from an almost impossible burden

of proof. See Holdsworth v. Strong, 10 Cir. 1976, 545

F. 2d 687, 695; Jackson v. Oppenheim, S.D.N.Y. 1974, 411

F.Supp. 659. Ute Citizens creates a distinction between

affirmative misrepresentation cases, in which plain-

tiffs must demonstrate reliance on the assertions of

defendants, and omission cases, in which such proof is

not required. When due care is discussed in terms of

reliance, then, the misrepresentation-omission dis-

tinction couid remove from plaintiffs the responsibili-

ty of exercising due care to protect their interests in

omission cases. If reliance never becomes an issue, in

other words, a court will have no basis to assess the

justifiability of that reliance.

The purposes of examining the diligence of a 10b-5

plaintiff, however, do not justify distinguishing

between misrepresentations and omissions. As we

have suggested, courts have used due diligence to

limit, as a matter of equitable discretion, recoveries to

those parties who have purchased securities with care

and good faith. Courts have also viewed the due

diligence requirement as a method to promote stat-

utory policies encouraging investor diligence in the

interest of the efficiency and stability of the securities

markets. These purposes for the due diligence re-

32a

quirement, whatever its form, do not vanish in

omissions cases. As diligence can reveal misrepre-

sentations, it can also reveal omissions. After Ute

Citizens, then, tying the diligence analysis to reliance

can generate an improper distinction between the mis-

representation and omission causes of action.

Third, to abandon completely the consideration of

reliance in fact and reasonable reliance ignores not

only the above policies of due diligence but also the

need for a causal link between the misrepresentation

or omission and the injury suffered by the private

plaintiff. The cause of action would no longer provide

compensation for losses occasioned by the violation

of the Act because a plaintiff could sue without relying

on the fraud. This would transform the action into an

enforcement mechanism. We reject this approach

because of the Supreme Court’s recognition of a 10b-5

private action as a device to compensate victims of

stock fraud and thereby to promote the public objec-

tions of the Act. J. I. Case Co. v. Borak, 377 U.S. at 432-

35, 84 S.Ct. 1555.

As we see it, the McAlpine approach of treating due

diligence as a separate element in private 10b-5 cases

best supports the policies of the Acts and ensures

proper exercise of the Court’s equity powers.

2. The Subjective Elements of the Due

Diligence Consideration.

The diligence of the plaintiff in 10b-5 cases is judged

subjectively. Straub v. Vaisman & Co., 3 Cir. 1976, 540

F.2d 591, 598; Clement A. Evans & Co. v. McAlpine, 5

33a

Cir. 1970, 434 F.2d 100, 102. The role model for a plain-

tiff, then, is an investor with the attributes of the plain-

tiff, rather than the average investor. For example,

McAlpine approved a jury instruction that imposed a

duty of due diligence “solely under the peculiar cir-

cumstances of each case, including existence of a

fiduciary relationship,'* concealment of the fraud.“

opportunity to detect it,2° position in the in-

dustry,®! sophistication and expertise in the financial

community,?2 and knowledge of related pro-

ceedings”. Several courts have also considered

whether the plaintiff initiated the stock transaction or

pressured for a speedy resolution. White v. Abrams, 9

Cir. 1974, 495 F.2d 724; Hafner v. Forest Laboratories,

Inc., 2 Cir. 1965, 345 F.2d 167; Kohler v. Kohler Co., 7

Cir. 1963, 319 F.2d 634.

18 Accord, e. g., Holdsworth v. Strong, 10 Cir. 1976, 545 F.2d 687;

Straub v. Vaisman & Co., 3 Cir. 1976, 540 F.2d 591; Bird v. Ferry, 5

Cir. 1974, 497 F.2d 112; rehearing denied, 503 F.2d 567; Rogen v. II-

ikon Corp., 1 Cir. 1966, 361 F.2d 260.

19 Accord, e. g. Myzel v. Fields, 8 Cir. 1967, 386 F.2d 718, cert. de-

nied, 1968, 390 U.S. 951, 88 S.Ct. 1043, 19 L.Ed.2d 1143.

20 Most courts analyze whether the plaintiff has effective access

to information about the fraud. E. g., Holdsworth v. Strong, 10 Cir.

1976, 545 F.2d 687; Straub v. Vaisman & Co., 3 Cir., 1976, 540 F.2d 591;

Rochez Bros. v. Rhoades, 3 Cir. 1974, 491 F.2d 402; Kohler v. Kohler

Co., 7 Cir. 1963, 319 F.2d 634.

21 Most courts give weight to the plaintiff's being a corporate in-

sider. E. g.. Holdsworth v. Strong, 10 Cir. 1976, 545 F.2d 687; Bird v.

Ferry. 5 Cir. 1974, 497 F.2d 112; Myzel v. Fields, 8 Cir. 1967, 386 F. 2d

718.

22 Accord. e. g. Holdsworth v. Strong, 10 Cir. 1976, 545 F.2d 687;

Straub v. Vaisman & Co., 3 Cir. 1976, 540 F. 2d 591; Myzel v. Fields, 8

Cir. 1967, 386 F.2d 718; Rogen v. Ilikon Corp., 1 Cir. 1966, 361 F. 2d

260.

34a

3. The Standard of Care.

This Court has announced a due diligence test that

measures the plaintiff's conduct against that of a

reasonable investor with the attributes of the plaintiff.

It is, in effect, a negligence standard. Clement A.

Evans & Co. v. McAlpine, 5 Cir. 1970, 434 F.2d 100, 103,

quoted with approval the test employed by the Eighth

Circuit:

With regard to misrepresentations, the ques-

tion is whether a reasonable investor, in light

of the facts existing at the time of the mis-

representation and in the exercise of due care,

would have been entitled to rely upon the mis-

representation

Mo Alpine answered that question in the negative and

affirmed a jury finding that the plaintiff lacked

“reasonable diligence”. Accord, Bird v. Ferry, 5 Cir.

1974, 497 F.2d 112; Vohs v. Dickson, 5 Cir. 1974, 495 F.2d

607.

Recently, however, an important reexamination has

begun of the appropriateness of applying a negli-

gence standard to the conduct of plaintiffs when the

Supreme Court has forbidden a similar standard to be

applied to the conduct of defendants. In Ernst & Ernst

v. Hochfelder, 1976, 425 U.S. 185, 96 S.Ct. 1375, 47

L.Ed.2d 668, the Court reversed an imposition of 10b-5

liability without proof of scienter — intent to deceive,

manipulate, or defraud”. Id. at 193, 96 S.Ct. at 1381.

Ernst & Erns® an accounting firm, had not inten-

tionally defrauded the plaintiffs. The firm had con-

tracted to audit a brokerage house, the president of

35a

which had perpetrated an intentional fraud. During

the audit Ernst & Ernst failed to test adequately the in-

ternal control system of the company and thereby

breached a common law and statutory duty to do so.

Nevertheless, the Court refused to impose 10b-5

liability on the accountants because they had not act-

ed with scienter, which the text of the opinion equated

with intent. A footnote qualified the Court's holding:

In this opinion the term “scienter” refers to a

mental state embracing intent to deceive,

manipulate or defraud. In certain areas of the

law recklessness is considered to be a form of

intentional conduct for the purposes of im-

posing liability for some act. We need not ad-

dress here the question whether, in some cir-

cumstances, reckless behavior is sufficient

for civil liability under § 10(b) and Rule 10b-5.

Id. at 194 n. 12, 96 S.Ct. at 1381.23

Two circuits have reevaluated their due diligence

standards in light of Ernst. In Holdsworth v. Strong, 10

Cir. 1976, 545 F.2d 687, the plaintiff, Holdsworth, sold

his stock in a close corporation to Strong. Although

Holdsworth was a sophisticated insider with access to

company books, he relied on several intentional

misrepresentations by Strong about the financial

health of the company. Citing McAlpine and Rochez

Bros. v. Rhoades, 3 Cir. 1974, 491 F.2d 402, the court

23 At least one commentator has argued after Ernst that the

scienter standard should and will include recklessness. Bucklo,

The Supreme Court Attempts to Define Scienter Under Rule 10b-5:

Ernst & Ernst v. Hochfelder, 29 Stan.L.Rev. 213, 227 n. 99, 235-36,

239-40 (1977).

recognized that the traditional due diligence require-

ment imposed a standard of negligence on plaintiffs.

But it decided that Ernst called for a change:

If the negligence standard were being applied

it might be appropriate to allow due diligence

to be exacted from the victim, but where

liability of the defendant requires proof of in-

tentional misconduct, the exaction of a due

diligence standard from the plaintiff becomes

irrational and unrelated.

545 F.2d at 692. Consequently, the Court held that con-

tributory fault would bar recovery only when plaintiff

exhibited “gross conduct somewhat comparable to

that of defendant”. Id. at 693.

In Straub v. Vaisman & Co., 3 Cir. 1976, 540 F.2d 591,

the Court responded to Ernst by reversing the burden

of proof on the due diligence issue. The plaintiff, the

European manager of a portfolio management com-

pany, executed an unsuccessful stock purchase on the

defendant’s advice. In assessing the manager's

diligence, the Court noted several arguments for cir-

cumscribing the due care requirement. But it balanc-

ed the effect of Ernst against the general SEC policy of

encouraging diligence in stock transactions. As a

result, it continued to require that plaintiffs act rea-

sonably, and it made the due care question an affirma-

tive defense. On the facts, the American defendant did

not carry his burden of proof primarily because the

Europeans lacked access to information concerning

the abuse of their trust.

24 See text at note 25 infra.

37a

These cases and commentary have developed

several reasons for changing the due diligence stand-

ard after Ernst. They first draw analogies to tort

theory. Holdsworth v. Strong, 10 Cir. 1976, 545 F.2d 687,

693-95; Straub v. Vaisman & Co., 3 Cir. 1976, 540 F.2d

591, 597; Wheeler, 70 Nw. U. L. Rev. at 575. This is not an

innovative approach, although a justifiable one for

courts attempting to define the scope of judicially

created remedies. See, e. g., Blue Chip Stamps v.

Manor Drug Stores, 1975, 421 U.S. 723, 95 S.Ct. 1917, 44

L.Ed.2d 539; List v. Fashion Park, Inc., 2 Cir. 1965, 340

F. 2d 457, cert. denied sub nom.; List v. Lerner, 382 U.S.

811.86 S. Ct. 23, 15 L.Ed.2d 60, rehearing denied, 382 U.S.

933, 86 S.Ct. 305, 15 L.Ed.2d 60; 3 L. Loss Securities

Regulation, 1759-1763; 6 L. Loss, 3880 et seq.; Com-

ment, Negligent Misrepresentations Under Rule 10-b,

32 U. Chi.L.Rev. 824, 828-33 (1965). Tort law distin-

guishes between intentional misrepresentations and

negligent ones. Contributory negligence may bar

recovery for the latter, but not for the former:

[Wihere there is an intent to mislead, [barring

recovery] is clearly inconsistent with the

general rule that mere negligence of the plain-

tiff is not a defense to an intentional tort. The

better reasoned cases have rejected con-

tributc ry negligence as a defense applicable

to inteational deceit.

W. Prosser, Handbook of the Law of Torts § 10 at 716

(4th ed. 1971) (hereinafter cited W. Prosser). The

Restatement of Torts agrees:

The recipient in a business transaction of a

fraudulent misrepresentation of fact is

justified in relying on its truth, although he

might have ascertained the falsity of the

representation had he made an investigation.

Restatement of Torts § 540 (1938). The American Law

Institute rejected any change in this rule when it con-

sidered the Restatement Second. See 42 ALI Pro-

ceedings 331 (1965), rejecting Restatement (Second) of

Torts § 540 (Tent. Draft No. 11, 1965).

Two theories support the tort law dichotomy. First,

the policy of deterring intentional misconduct out-

weighs that of deterring negligent behavior. This con-

stitutes a change in tort philosophy from the period

dominated by the concept of caveat emptor. W.

Prosser, § 108 at 717. “The recognition of a new stan-

dard of business ethics, demanding that statements of

fact be at least honestly and carefully made, and in

many cases that they be warranted to be true, has led to

an almost complete shift in this point of view.” Id. Sec-

ond, comparative culpability influences the deter-

mination of who should bear any given loss. When

both parties are negligent, there may be no reason for

the judicial system to shift the loss from the victim.

See id. at § 65. When one inflicts a loss intentionally on

a negligent victim, however:

[s]uch conduct difiers from negligence not

only in degree but in kind, and in the social

condemnation attached to it. . It is in reali-

ty a rule of comparative fault which is being

applied, and the court is refusing to set up the

lesser fault against the greater.

39a

Id. at § 65 at 426. Of course, other factors, such as the

comparative abilities of the parties to spread losses

fairly also influence the allocation decision. Such fac-

tors have led to increasing dissatisfaction with the

concept of contributory negligence. See James, Con-

tributory Negligence, 1953, 62 Yale L.J. 691; W.

Prosser, § 64 at 418. .

The strength of the tort law analogy is enhanced by

the similarity of policy arguments derived from the

Securities Acts. Just as principles of tort law are in-

tended to deter intentional misconduct, one of the prin-

ipal policies behind the Acts is to protect investors

. Jainst fraud and, through the imposition of specified

civil liabilities, to promote ethical standards of

honesty and fair dealing”. Ernst & Ernst v.

Hochfelder, 1976, 425 U.S. 185, 195, 96 S.Ct. 1375, 1382,

47 L.Ed.2d 668, citing H. R. Rep. No. 85, 73d Cong., ist

Sess., 1-5 (1933). Regarding Section 10b-5 specifically,

the Ernst opinion, besides limiting the bases on which

liability may be imposed, also demonstrates the

strength of congressional intent to “prevent

‘manipulative and deceptive practices which ...

fulfill no useful function’ "’. 425 U.S. at 206, 96 S.Ct. at

1387, citing S.Rep. No. 792, 73d Cong., 2d Sess., 12-13

(1934); H.R. Rep. No. 1383, 73d Cong., 2d Sess., 10-11, 20-

21 (1934). The prospect of unreasonable behavior by

investors apparently did not generate such concern; at

least the legislative history does not speak of it. It is

therefore fair to say that the federal policy of deterring

intentional misconduct in securities dealings out-

weighs the policy of deterring negligent behavior by

investors.

40a

This argument leads to the conclusion that nothing

in the Act requires disregard for the comparative

equities of the parties. If it is fairer for a judicially

allocated loss to fall upon the more culpable actor un-

der tort law, the judicially created remedial! system for

the Securities Acts can respond to similar notions of

equity without disrupting the legislative scheme.*

Still another reason to adhere to this approach is

that Ernst diminished substantially the need to limit

the scope of the 10b-5 remedy. Before Ernst, tremen-

dous liability could result from the negligent

behavior of any person connected with a stock sale or

purchase. For accountants, lawyers, brokers, dealers.

and underwriters who handled these transactions, this

potential liability posed a substantial risk to their

professional existence. The principle of due diligence

and other elements of the private cause of action

provide mechanisms for limiting potential liability.

See Clement A. Evans & Co. v. McAlpine, 5 Cir. 1970,

434 F.2d 100, 104. With the scienter requirement.

liability will be imposed only upon reckless or inten-

tional wrongdoers, reducing substantially the risk on

most actors in securities transactions. The need, then,

for further limitation by the reasonable diligence re-

quirement becomes questionable. Indeed, the Tenth

Circuit has argued that requiring proof of both the

scienter of the defendant and the reasonable diligence

of the plaintiff would impermissibly limit 10b-5

recoveries to the “extraordinary” cases. Holdsworth

v. Strong, 10 Cir. 1976, 545 F.2d 687, 693.

25 But see Wheeler, 70 Nw.U.L.Rev. at 586.

4ia

The final argument for relaxing the reasonable

diligence standard after Ernst is that most 10b-5 cases,

when limited to their facts, are consistent with the dis-

tinction between intentional and negligent mis-

representation. In Carroll v. First National Bank, 7

Cir. 1969, 413 F.2d 353, cert. denied, 1970, 396 U.S. 1003,

90 S.Ct. 552, 24 L.Ed.2d 494, forexample, the Court said:

whatever the relevance of plaintiffs’

negligence might be to the issues at a trial on

the merits, it does not support the dismissal of

the amended complaint which is based on

fraud rather than negligence.

Id. at 358. Other cases that required plaintiffs to

act reasonably did not require proof of intentional

misconduct by defendants. E. g., White v. Abrams, 9

Cir. 1974, 495 F.2d 724; Vohs v. Dickson, 5 Cir. 1974, 495

F. 2d 607; Arber v. Essex Wire Corp., 6 Cir. 1974, 490 F.2d

414; City National Bank v. Vanderboom, 8 Cir. 1970, 422

F.2d 221; Rogen v. Likon Corp., 1 Cir. 1966, 361 F.2d

260; Jackson v. Oppenheim, S.D.N.Y.1974, 411 F.Supp.

659. See A. Bromberg, Securities Law-Fraud SEC Rule

10b-5 § 8.4(652) (1971). Indeed, because most cases

before Ernst did not require scienter, they can be read

consistently with the distinction between intentional

and negligent misrepresentation cases. 26

26 The clearest exception to this general proposition in

McAlpine:

While the commentator quoted by the court couched his

language in the context of negligent misrepresentations,

we are of the view that plaintiff's duty above espoused is

not altered merely because the misrepresentations are

alleged to be intentional rather than negligent.

434 F.2d at 104. After Ernst, however, we view the due diligence

rule from a different perspective. To begin with, the above policy

i —

42a

We consider that Ernst & Ernst v. Hochfelder

prompts a change in the law of due diligence, as it is

applicable in 10b-5 cases. Both tort law and federal

securities policy support imposing on the plaintiff

only a standard of care not exceeding that imposed on

the defendant. Although the “scienter” requirement

may still be unsettled, the Supreme Court has impos-

ed on defendants a standard not stricter than

recklessness. In this case, then, the question should

not be whether Milton acted unreasonably by failing to

investigate the condition of Lori Corporation. Instead,

the Court should ask whether Milton intentionally

efused to investigate “in disregard of a risk known to

him or so obvious that he must be taken to have been

aware of it, and so great as to make it highly probable

that harm would follow.” W. Prosser, § 34 at 185 (1971).

4. The Due Diligence of Milton.

After reviewing the voluminous trial record, we

hold that a reasonable jury could find that Milton did

not act recklessly when he sold his stock.

The district court's instructions were, as we view

arguments, not discussed at all in McAlpine, provide substantial

support for a change. Furthermore, the McAlpine opinion does not

indicate whether the plaintiff proved that the defendants had

perpetrated an intentiona! fraud. From the Court's brief factual

discussion, McAlpine probably intended the deception. But his co-

defendants, another stock broker and his firm, may have only

acted negligently. Thus the facts of the case are somewhat dis-

tinguishable from Dupuy, where the district court expressly con-

ditioned liability on proof of intentional or reckless behavior.

43a

them, more favorable to Clarence than to Milton. 27 The

district court instructed the jury that to recover

Milton must prove that he acted reasonably, an in-

struction consistent with previous holdings of this

Court. The jury found that Milton had met this burden

of proof — that he had acted reasonably; “with due

diligence” (the language of the court’s interrogatory).

After Ernst, the jury did not have to decide whether

Milton acted negligently, but oniy that he did not act

recklessly. We reinstate the jury’s verdict, then,

because there is sufficient evidence in the record to

support a holding that Milton did not have knowledge

of the risk of Clarence’s forming the partnership with

Monteleone and obtaining financing for the hotel.

There is also sufficient evidence to support a jury con-

clusion that Milton did not act in intentional disregard

of whether Clarence had taken this course of action.

Whether Milton knew of the risk of Clarence’s hav-

ing formed a partnership with Monteleone poses a

jury question. Milton testified that Monteleone’s name

arose only once as a possible purchaser of some of

Milton’s stock. He denies that he ever discussed

Monteleone with Harris or Merrigan or Perez. And he

insists that

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