Petition — SUNDSTRAND CORP. v. SUN CHEMICAL CORP. (No. 77-255)

Supreme Court, U. &

j FILED .

In THE

Supreme Court of The United States 3

Octoser Term, 1977

No. 997-2595 !

SUNDSTRAND CORPORATION,

Petitioner

vs.

SUN CHEMICAL CORPORATION, RAYMO]D F.

RYAN and THOMAS B. HART, JR., Executors of the

Estate of John B. Huarisa,

Respondents.

PETITION FOR A WRIT OF

CERTIORARI TO THE UNITED STATES

COURT OF APPEALS FOR THE

SEVENTH CIRCUIT

W. Donatp McSweeney

WuuiuM A. Montcomery

AuLAN HorwicH

Freperiok L. Hartmann

Peter V. BauGHER

7200 Sears Tower

233 South Wacker Drive

Chicago, Illinois 60606

Attorneys for Petitioner

Scuirr Harpin & WalrTE

Of Counsel

SR TS I aS EEE: LPI TEEN E, ° IF Ee Te A OTT

La Sallie Street Press — Chicago Printed In U.S.A.

TABLE OF CONTENTS

ENED ibe cache vt-Ué gees seccdevevcses

EEE Gn dee edese ese edecdecdeccccueces

QUESTIONS PRESENTED ......................

STATUTE AND RULE INVOLVED ..............

STATEMENT OF THE CASE ..................46.

1. Questions Concerning SKI’s Accounting Practices

-

SKI’s Grossly False Nine-Month’s Report ......

3. Merger Negotiations Between Sundstrand and

SKI and Further Misrepresentations by De-

ES hacks nde neaeeuiesesescecesswevens

4. Huarisa’s Right of First Refusal ..............

og

Sundstrand’s Survey of SKT and Still Further

Misrepresentations and Omissions ............

Termination of Merger Negotiations and Stock

PE Suds GANS Eb Cane che ie nerseceeeus.

SKI’s Massive 1968 Loss and Sundstrand’s Dis-

covery of the Misrepresentations and Omissions

The District Court’s Findings and Judgment ....

The Court of Appeals’ Opinion and Judgment ..

REASONS FOR GRANTING THE WRIT .........

I. The Causation Analysis Upon Which The Sev-

enth Circuit’s Decision Rests Is In Conflict With

This Court’s Decisions Under The Federal Secu-

rities Laws And With Decisions In Other Cir-

cuits, And Is Demonstrably Erroneous .......

A. The Decision Below Is In Conflict With This

Court’s Decision In Affiliated Ute Citizens v.

United States, 406 U.S. 128 (1972), And With

Decisions Of Other Circuits ...............

12

PAGE

B. Correct Application Of This Court’s Holding

In Mills v. Electric Auto-Lite Co., 396 U.S.

375 (1970), Demonstrates That There Was

No Exculpatory “Superseding” Cause ...... 15

II. The Decision Below Is In Conflict With Deci-

sions Of Other Circuits Interpreting This

Court’s Decision In Ernst & Ernst v. Hoch-

felder, 425 U.S. 183 (1976), As It Relates To

‘Plaintiff’s Conduct As A Defense ............ 17

III. The Court Of Appeals’ Reversal Of The Dis-

trict Court’ Based Upon The Court Of Appeals’

Independent ‘Examination Of Material Not In

The Trial Record Conflicts With Decisions Of

Other Circuits And Warrants Exercise Of This

Court’s Supervisory Power ................+. 20

CONCLUSION ..wccccccccsvevcsssvascssenesunnenen 25

iii

TABLE OF CONTENTS OF APPENDIX

PAGE

I. OPINIONS

Opinion of the Court of Appeals for the Sev-

enth Circuit, 553 F.2d 1033 (February 23,

AER dis dndwes 006000 eeccees M.App. 72*

Order of the Court of Appeals

CO ee M.App. 109*

Order of the Court of Appeals

is aed cu deueeeecsececes App. 110

Footnote 35 of Court of Appeals Opinion and

Related Text, as Amended by Order of May

EEE Ee App. 112

Memorandum Opinion of the United States Dis-

trict Court for the Northern District of Illi-

nois, Eastern Division (January 23, 1976), as

Amended by Minute Order (February 5,

LE SE ee M.App. 2*

Il. STATUTE AND RULE

Sections 10(b) and 29(b) of the Securities Ex-

change Act of 1934, 15 U.S.C. §4 78j(b) and

EE EE ee App. 113

Il. TEXT OF MATERIAL IN THE TRIAL REC-

ORD CITED IN FOOTNOTE 35 OF COURT

OF APPEALS OPINION, AS AMENDED BY

ORDER OF MAY 18, 1977**

* Several of the opinions and orders entered in this litigation have

been printed in the appendix to the petition for a writ of certiorari

filed by Henry W. Meers (cited herein as “M. App oi *

No. 77-83, and are therefore not reprinted in this appendix. The

appendix of petitioner Sundstrand Corporation, the pages of which

are numbered consecutively following those of the Meers appendix

(M.App. 1-109), begins at App. 110.

** Each page in the trial record cited by the Court of Appeals

in Footnote 35, as amended, is included in full in this appendix,

although some pages begin or end in the middle of a sentence,

question, or answer.

iv

PAGE

A. Glossary of Persons Referred to in the Rec-

ord Citations Listed in Footnote 35 of the

Court of Appeals Opinion or Contained in

. BUTE oo 60 k0 0.6508 c ctasedesis App. 115

B. Citations in the Court’s Original Footnote 35

Trial Transcript, p. 131 (James W. Ething-

SD GE. Sven vetcct contecestes bus App. 116

Trial Transcript, pp. 165-167 (James W.

pT Pee App. 116

Trial Transcript, pp. 484-487 (Carl L. Sadler

cross-examination) ..............+6. App. 119

Trial Transcript, pp. 625-631 (Ted L. Ross

cross-examination) ................. App. 122

Trial Transcript, pp. 1703-1705

(Statements of Counsel) ............ App. 128

Trial Transcript, pp. 2022-2023

(Remarks of the Court) ............ App. 130

Trial Transcript, pp. 2420-2423

(Statements of Counsel) ........... .App. 132

Trial Transcript, pp. 2516-2519

(Statements of Counsel) ............ App. 134

Trial Transcript, pp. 2620-2622

(Statements of Counsel) ............ App. 138

Trial Transcript, pp. 2624-2627

(Statements of Counsel) ............ App. 140

Trial Transcript, pp. 2635-2638

(Statements of Counsel) ............ App. 143

Deposition of John B. Huarisa,

SE 0 denen dan thavaedd dade ee< App. 146

Sun-Huarisa Exhibit 52: Plaintiff’s Answers

to First Set of Interrogatories of De-

fendants Standard Kollsman Industries,

Inc. and John B. Huarisa, Interrogatory

SUE DE avd cknciic nd codushaesdeteanecs App. 148

PAGE

IV. CITATIONS ADDED TO FOOTNOTE 35 BY

THE COURT’S ORDER OF MAY 18, 1977

Brief of Appellee Sundstrand Corporation

Fi | Oe ee App. 152

Petition for Rehearing and Suggestion of

Rehearing en Banc on Behalf -of Appellee

Sundstrand Corporation (March 29, 1977),

i Di cece etGhabenehesnehee ¢ keeeetesees App. 153

V. ADDITIONAL REFERENCES TO THE

TRIAL RECORD CITED IN PETI'LION OF

SUNDSTRAND CORPORATION

Deposition of Louis H. Schuette, pp. 330-333 App. 155

Deposition of Louis H. Schuette, pp. 336-337 App. 157

Trial Transcript, pp. 749-752

(Donald E. Miller cross-examinatien) ...App. 158

vi

TABLE OF AUTHORITIES

PAGE

Cases

Affiliated Ute Citizens v. United States, 406 U.S. 128

Seen) cach hacndaxeas cs Hakeas's6d nent eae 13, 14, 15

Bankers Life & Cas. Co. v. Bellanca Corp., 288 F.2d 784

SUG SEED sc ci chad keneee ease ne eacek kee mens 16

Barrett v. Baylor, 457 F.2d 119 (7th Cir. 1972) ...... 24

Basko vy. Sterling Drug, Inc., 416 F.2d 417 (2d Cir. 1969) 17

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

GPE kiaWttce cenkaseckeda tints Gibuck ase Soave. 12

| BR iowa rt tans au pci sr ind a Ree le 23

Clement A. Evans & Co. v. McAlpine, 434 F.2d 100 (5th

Cir. 1970), cert. denied, 402 U.S. 988 (1971) ........ 17

Communist Party v. Subversive Activities Control

OGRE, Te Wh Ee GREED bh wer cscscsadiess cies 21

Comstock v. General Motors Corp., 99 N.W.2d 627

Se: SE OE iain ode d's dasa se dneseuésusns se i6

Dupuy v. Dupuy, 551 F.2d 1005 (5th Cir. 1977) ...... 18, 19

E. I. du Pont de Nemours & Company v. Collins, 97

PE cccatebteddnstvendednneebeddaaes 23

Ernst & Ernst v. Hochfelder, 425 U.S. 183 (1976) ....

it eaten, ied tina a ee Leek eine h 66 sos 12, 17, 18, 20

F.P.C. v. Transcontinental Gas Pipe Line Corp., 423

ee EE bain ed don ehasunsees vonesieatennacs 23

Freeman v. United States, 509 F.2d 626 (6th Cir. 1975). 16

Fridrich v. Bradford, 542 F.2d 307 (6th Cir. 1976), cert.

ee EE os couindcadvctsasecedddses 13

Herzfeld v. Laventhol, Krekstein, Horwath & Horwath,

EE ob c dikes ceeniedesessns's 14

Hirsch v. duPont, 553 F.2d 750 (2d Cir. 1977) ........ 18

Holdsworth v. Strong, 545 F.2d 687 (10th Cir. 1976)

(en banc), cert. denied, 97 S.Ct. 1600 (1977) ....17, 18,19

PAGE

International Business Machines Corp. v. Edelstein, 526

PP MED cnesdccdccceuecksusceadens 21

Lyon v. Carey, 533 F.2d 649 (D.C.Cir. 1976) ......... 24

McLean v. Alexander, 420 F.Supp. 1057 (D.Del. 1976) .14, 18

McNabb v. United States, 318 J.S. 332 (1943) ........ 21

Merola v. Atlantic Richfield Company, 515 F.2d 165 (3d

Pn ¢ivcelucadesats dialnddksidesaewentee as 24

Mills v. Electric Auto-Lite Co.,396 U.S. 375 (1970) .15, 16, 17

Mitchell v. Texas Gulf Sulphur Co., 446 F.2d 90 (10th

Cir. 1971), cert. denied, 404 U.S. 1004 (1972) ....... 14

NBI Mortgage Investment Corp. v. Chemical Bank,

CCH Fed. Sec. L. Rep. 796,066 (S.D. N.Y. 1977)

Ey ME aC bee davndscncnevageesnsesune 18

Piper v. Chris-Craft Industries, Inc., 97 S.Ct. 926 (1977) 14

Rochez Bros., Inc. v. Rhoads, 491 F.2d 402 (3d Cir.1974) 14

Rommel-McF erran Co. Inc. v. Local U. No. 369 Int.Bro.

of Elec. Wkrs. 361 F.2d 658 (6th Cir. 1966) ........ 23

Sanders v. John Nuveen & Co., Inc., 524 F.2d 1064 (7th

Cir. 1975), vacated and remanded, 425 U.S. 929

(1976), on remand from Supreme Court, 554 F.2d 790

ee i os ol eet os Rececibameense 14, 20

Shapiro v. Merrill Lynch, Pierce, Fenner & Smith, Inc.,

a ee Se GE Is BFE noice ceccccsccescceecs 13

Straub v. Vaisman €& Co., Inc., 540 F.2d 591 (3d Cir.

SEE. ba RUNS 055Gs bse sen decleehebietetkkdesesees 18

Sundstrand Corp. v. Standard Kollsman Industries,

Inc., 488 F.2d 807 (7th Cir. 1973) ...............4.. 2,4

TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438

SE weelendhacdSecceswelsbevadssvactisenecatn 12

United States v. City of Brookhaven, 134 F.2d 442 (5th

EE 5 VAGUS cee nG hives scendddsPieveene ete 22

Worsham v. Duke, 220 F.2d 506 (6th Cir. 1955) ....... 22

Zenith Radio Corp. v. Hazeltine Research, Inc., 395 U.S.

SPENT) (nccsecedicccccncuvesensdteneonewases< 14

Vili

- PAGE

Statutes and Rules

Federal Rules of Appellate Procedure, Rule 10(a) .... 21

Federal Rules of Civil Procedure, Rule 52(a) ........ 20

General Rules and Regulations under the Securities Ex-

change Act of 1934,

Rule 10b-5, C.F.R. § 240.10b-5 ................ passim

Rule 14a-9, C.F.R. § 240.14a-9 ............000005s 12

Judicial Code, 28 U.S.C. §1254(1) ...............4.. 2

Rules of the Supreme Court of the United States, Rule

TR bod acadacnd dead adba teins sonetesuenadeekes 21

Securities Exchange Act of 1934,

Section 10(b), 15 U.S.C. § 78j(b) ............. 3, 4, 16

EE Tis Se Ee HED once dwasecvcctceedse 4

Section 29(b), 15 U.S.C. § 78ee(b) ............ 3, 4, 16

Other

22 Am.Jur.2d, “Damages,” § 84 at 120, §111 at 161-62

COIND vcs voy coeannnst eh Lette debates sdtesie sve 16

1 A. Bromberg, Securities Law: Fraud, Sees. 4.7(550)

OE GI, THOSE. 6 cin db renehas duveccadeceseaseseencs 13

2 Harper & James, The Law of Torts, § 20.2 at 1123

SED tebiees ¥ucddenecdodeecaressdses teeters 17

5 Jacobs, The Impact of Rule 10b-5, § 64.02 (1976) .... 13

Prosser, Law of Torts, § 44 (4th ed. 1971) ......... 16, 17

Restatement (Second) of Torts (1965)

ES us ek nndes ode TENS D4 abe be tees eA dae eeh ees 17

EES cbdce asad edeedbendds base kasesesasrees 17

DEF aiven Fasc swede ceseseeberdsieconaiean 17

CRUE utiats Wen pddedendadthetueudediassamres 16

Wheeler, “Plaintiff’s Duty of Due Care Under Rule

10b-5: An Implied Defense to an Implied Remedy,”

70 Nw.U.L.Rev. 561 (1975) ...... ccc cccccccccceces 17

In THE

‘Supreme Court of The United States

Ocroper Term, 1977

No.

SUNDSTRAND CORPORATION,

Petitioner

vs.

SUN CHEMICAL CORPORATION, RAYMOND F.

RYAN and THOMAS B. HART, JR., Executors of the

Estate of John B. Huarisa,

Respondents.

PETITION FOR A WRIT OF

CERTIORARI TO THE UNITED STATES

COURT OF APPEALS FOR THE

SEVENTH CIRCUIT

Petitioner Sundstrand Corporation respectfully prays

that a writ of certiorari issue to review the judgment of

the United States Court of Appeals for the Seventh Circuit

entered in this action on February 23, 1977 insofar as it

pertains to defendants-respondents Sun Chemical Corpora-

tion, and Raymond F. Ryan and Thomas B. Hart, Jr.,

executors of the estate of John B. Huarisa.*

* Petitioner does not seek review of the judgment below insofar as

it relates to defendant Henry W. Meers. Since respondents were far

more deeply involved in the fraudulent conduct than was Meers

during the time period upon which this petition focuses, the issues

which petitioner seeks this Court to consider are more clearly pre-

sented by limiting the petition to these respondents. Meers has filed

a petition for a writ of certiorari (Case No. 77-83) to which Sund-

strand Corporation has responded.

2

OPINIONS BELOW

The opinion of the Court of Appeals is officially reported

at 553 F.2d 1033 and is printed in the appendix to the peti-

tion for a writ of certiorari filed by Henry W. Meers in

Case No. 77-83. (M.App 72-107)* The opinion of the

United States District Court for the Northern District of

Illinois, Eastern Division, from which that appeal was

taken, is not officially reported and is printed at M.App.

2-71. A prior opinion of the Court of Appeals in this action,

not pertinent to the issues presented by this petition, is

reported sub nom. Sundstrand Corp. v. Standard Kollsman

Industries, Inc. at 488 F.2d 807 (7th Cir. 1973). All rcefer-

ences herein to the Court of Appeals’ opinion are to the

more recent opinion.

JURISDICTION

The judgment of the United States Court of Appeals for

the Seventh Circuit sought to be reviewed was entered on

February 23, 1977. (M.App. 108) A petition for rehearing

and suggestion of rehearing en bane was filed by peti-

tioner herein on March 29, 1977.** The petition for rehear-

ing was denied on May 18, 1977.*** This petition for

certiorari is filed within ninety days of that date. This

Court’s jurisdiction is invoked under 28 U.S.C. § 1254(1).

* On April 18, 1977 and May 18, 1977 the Court of Appeals en-

tered orders which provided for eertain additions to the opinion of

February 23, 1977. The opinion as officially reported reflects all such

changes. The opinion as reprinted in the appendix to the petition in

Case No. 77-83 (hereinafter “M.App.”) does not reflect those changes.

The Order of April 18, 1977 is set forth in full at M.App. 109. The

Order of May 18, 1977 is set forth in full in the appendix to this

petition (hereinafter “S.App.”) at S.App. 110-11. Footnote 35 of the

opinion of the Court of Appeals, as amended, appears at S.App. 112.

** On March 3, 1977 the Court of Appeals granted petitioner an

extension of time until March 29, 1977 within which to file a petition

for rehearing. That petition was directed only to the defendants

who are respondents herein.

*** One member of the panel which decided the appeal voted for

rehearing. One of the other Circuit Judges who considered peti-

tioner’s suggestion for rehearing en bane voted for rehearing.

(S.App. 110-11)

3

QUESTIONS PRESENTED

1. May a plaintiff-purchaser of securities who acted in

reliance on defendants’ fraudulent conduct in violation of

Securities and Exchange Commission Rule 10b-5, and who

acted without any knowledge of that fraud, be deprived of

damages resulting from that fraud because another cause

may have contributed to the purchaser’s consummation of

the transaction which resulted in the damages ?*

2. Where the defendant deliberately committed a fraud

in violation of Securities and Exchange Commission Rule

10b-5, can a plaintiff-purchaser be deprived of damages

resulting from that fraud on the ground that the purchaser

acted negligently in consummating the purchase?

3. Can a Court of Appeals make an “independent study”

of material not in the trial record in order to make findings

of fact contrary to findings made by the District Court?

STATUTE AND RULE INVOLVED

Sections 10(b) and 29(b) of the Securities Exchange Act

of 1934, 15 U.S.C. $4 78j(b) and 78ee(b), and Rule 10b-5

thereunder, 17 C.F.R. § 240.10b-5, are set forth in the ap-

pendix hereto (S.App. 113-114).

STATEMENT OF THE CASE

In August, 1969 petitioner Sundstrand Corporation

(“Sundstrand”’) filed its complaint against Standard Kolls-

* As presented by Question No. 3, petitioner contends that there

was no evidence of any cause other than petitioner’s reliance on

respondents’ fraud. For purposes of Question No. 1, however, the

existence of another cause is assumed arguendo.

4

man Industries, Ine. (“SKI”),* John B. Huarisa (“Hua-

risa”),** chief executive officer of SKI, and Henry W.

Meers (“Meers”), a director of SKI, alleging that all three

defendants had violated Section 10(b) of the Securities Ex-

change Act of 1934 (“1934 Act”), 15 U.S.C. § 78j(b), and

Rule 10b-5 promulgated thereunder by the Securities and

Exchange Commission, 17 CFR § 240.10b-5, in connection

with Sundstrand’s purchase of 223,190 shares of SKI stock

in early 1969. The District Court’s jurisdiction of the action

was predicated on Section 27 of the 1934 Act, 15 U.S.C.

§ 78aa.

At the first trial of this action, in 1971, Sundstrand’s

claim was dismissed at the close of its evidence. That ruiing

was reversed. 488 F.2d 807 (7th Cir. 1973).

At the second trial, the District Court, sitting without

a jury, found all defendants liable and entered judgment

against them in the amount of $4,434,786 plus prejudgment

interest. The Court of Appeals affirmed the judgment and

findings of liability in all respects but reduced the amount

awarded to plaintiff-petitioner to $334,785 plus _pre-

judgment interest, a reduction of 93%. one seeks re-

view of that Court of Appeals decision Ansofar as it re-

duced the amount of the District Court’s judgment against

defendants Sun and Huarisa’s executors.

- The fraudulent conduct of defendants which gave rise to

the findings of liability by the courts below involves mis-

representations and omissions concerning the financial con-

dition of SKI in late 1968 and early 1969. Sundstrand’s

involvement began in late 1968 but earlier events are per-

tinent to an understanding of the pervasive fraud.

* In December, 1972, SKI was merged into respondent Sun Chem-

ical Corporation (“Sun’’). As successor to the liabilities of SKI, Sun

was substituted for SKI as a defendant.

** In May, 1975, Huarisa died. His executors, respondents Ray-

mond F. Ryan and Thomas B. Hart, Jr., were substituted for him

as defendants.

ort —

4)

1. Questions Concerning SKI’s Accounting Practices

By year-end 1967, Kollsman Instrument Corporation

(“KIC”), SKI’s principal subsidiary, had deferred substan-

tial preproduction costs in connection with programs for

the production of certain aircraft instrumentation. In mid-

1968, after publication of SKI’s 1967 annual report reflect-

ing these deferrals, James W. Burke, a director and large

shareholder of SKI, and one of SKI’s other directors,

raised questions regarding the propriety of SKI’s account-

ing practices and the accuracy of the financial statements.

Burke formally submitted questions to the SKI board re-

garding those matters (the “Burke report’), as well as a

report critical of SKI’s accounting practices which had been

prepared by the accounting firm of Ernst & Ernst (the

“Ernst & Ernst report”), which Burke had retained. How-

ever, no changes were made in the accounting practices, and

SKI deferred substantial additional preproduction costs

throughout 1968. (Dist. Ct. at M.App. 30-32; Ct. Ap. at

M.App. 83-84, 95-97)

2. SKI’s Grossly False Nine-Month’s Report

On November 4, 1968, SKI published its quarterly report

to shareholders for the nine months ended September 30,

which stated that SKI had income before taxes of $4,350,039

for the first nine months of the year with net income after

taxes equivalent to $.86 per share. These figures were not

audited or reviewed by Price Waterhouse & Co., SKI’s

independent accountants. In fact, as the District Court

found, and as affirmed by the Court of Appeals, the reported

nine months earnings of SKI and its subsidiaries were

deliberately grossly overstated, since SKI should have re-

ported income before taxes of only $633,756 for that period,

or approximately $.12 per share after taxes. (Dist. Ct. at

M.App. 34-48; Ct. Ap. at M.App. 82 n. 8)

6

3. Merger Negotiations Between Sundstrand and SKI

and Further Misrepresentations by Defendants

In the late summer of 1968 Huarisa and SKI were search-

ing for a company suitable for a merger with SKI. In mid-

November, 1968, after publication of the third quarter

report, and pursuant to Huarisa’s authorization, Meers, an

SKI director, contacted Sundstrand to see if it was inter-

ested in a merger with SKI. Thereafter, a number of meet-

ings were held in November and December, 1968 among

representatives of Sundstrand and Huarisa and other SKI

representatives. During these meetings Huarisa repre-

sented to Sundstrand that SKI’s earnings for the first three

quarters of 1968 were $.26 per share, as reported in the

published nine months’ earnings statement. Huarisa also

told Sundstrand that SKI’s net income for all of 1968 would

be between $2,600,000 and $2,900,000, that SKI’s 1968 earn-

ings per share would be about $1.16, and that SKI’s earn-

ings for the year 1969 would be about $2.41 or even $2.50

per share. Huarisa provided a written projection to Sund-

strand which showed 1969 earnings of $2.13 per share.

Huarisa also stated that in no case would there be adjust-

ment to 1968 earnings which would reduce them below the

$.86 per share already reported. As both the District Court

and the Court of Appeals held, Huarisa and SKI knew or

were reckless in not knowing that the 1968 and 1969 earn-

ings projections were grossly inflated. (Dist. Ct. at M.App.

7-11, 28-30, 60; Ct. Ap. at M.App. 76-77, 82)

Thereafter, Sundstrand representatives commenced

merger negotiations with Huarisa and Meers which cul-

minated in an offer by Sundstrand for the assets of SKI

subject to its liabilities for Sundstrand stock equivalent to

$38.25 per SKI share. This proposal was subject to, inter

alia, Sundstrand’s conducting a survey of the business of

SKI. On January 2, 1969, the SKI board authorized Hua-

7

risa to proceed on the basis of the Sundstrand proposal.

(Dist. Ct. at M.App. 10-13; Ct. Ap. at M.App. 77)

4. Huarisa’s Right of First Refusal

Huarisa owned a block of SKI stock and a right of first

refusal on additional shares of SKI common stock owned

by the Burke family interests. On December 10, 1968

Huarisa had received from the Burke family an offer to

sell to him, at $30 per share, 223,190 shares of SKI stock

covered by Huarisa’s right of first refusal. Under that right

Huarisa had 30 days within which to exercise his right by

paying 5% of the purchase price. Otherwise, Sun, which

had made the offer to the Burkes, would have an uncondi-

tional right to purchase the stock. (Dist. Ct. at M.App. 5,

13-14; Ct. Ap. at M.App. 75)

On January 4, 1969, Huarisa first informed Sundstrand

that there was a right of first refusal which had been

triggered by an offer by a third party. At a meeting on

January 6, 1969 Huarisa advised Sundstrand that if Sun

acquired the stock from the Burkes, Sundstrand and SKI

would have to forget about the proposed merger. As both

courts below held, after receiving Huarisa’s confirmation

that SKI’s 1968 and 1969 earnings projections still looked

good, Sundstrand orally agreed to acquire Huarisa’s-right

of first refusal on 223,190 shares of SKI stock at $30 per

share. (Dist. Ct. at M.App. 13-15, 18; Ct. Ap. at M.App.

75, 85-87, 102)

Accordingly, on January 8, 1969 Huarisa exercised his

right of first refusal by delivering to the Burke family his

written election to purchase and $334,785 in cash, repre-

senting 5% of the purchase price. On January 9, 1969

Sundstrand and Huarisa entered into a written agreement

reflecting the oral agreement of January 4, 1969. (Dist. Ct.

at M.App. 15-16; Ct. Ap. at M.App. 75-76)

8

5. Sundstrand’s Survey of SKI and Still Further Mis-

representations and Omissions

Sundstrand undertook a survey of SKI to determine

whether or not the merger should be consummated. As both

the District Court and the Court of Appeals held, the fi-

nancial information regarding KIC and SKI which was

provided to Sundstrand during the survey and on which

Sundstrand relied was deliberately restricted and was mis-

leading, and Huarisa and the principal financial officers of

SKI and KIC, including Raymond Ryan, conspired to pre-

vent Sundstrand from discovering SKI’s true financial con-

dition. Indeed, Sundstrand’s questions about SKI’s financial

condition were often answered with outright lies. (Dist. Ct.

at M.App. 19-22, 48-57; Ct. Ap. at M.App. 77, 79, 82, 84

n. 10)

6. Termination of Merger Negotiations and Stock

Purchase

After Sundstrand personnel evaluated the information

provided by SKI, they concluded on January 20, 1969 that

certain aspects of the proposed transaction, including an

increase in labor costs which a merger would cause, unde-

sirable SKI labor practices and lack of the expected com-

patibility of SKI’s and Sundstrand’s products, and a belief

on the part of Sundstrand that SKI’s earnings projections

were somewhat optimistic, made the acquisition unattrac-

tive. A decision was then made to cancel the negotiations.

(Dist. Ct. at M.App. 22-23; Ct. Ap. at M.App. 77)

Despite further misrepresentations and omissions regard-

ing SKI’s financial condition by Huarisa and Ryan at meet-

ings on January 20 and 22, 1969, Sundstrand adhered to

its decision to call off the merger negotiations. However,

at the close of the January 22 meeting Sundstrand’s presi-

dent indicated that Sundstrand was going to purchase the

shares covered by the right of first refusal. On February 6,

1969 Sundstrand made its payment of $6,360,915 for the

9

223,190 shares of SKI common stock. Both Huarisa and

Ryan were aware of and participated in the consummation

of that transaction. (Dist. Ct. at M.App. 23-25, 48 et seq.;

Ct. Ap. at M.App. 78-79, 82-85)

7. SKI’s Massive 1968 Loss and Sundstrand’s Dis-

covery of the Misrepresentations and Omissions

On March 21, 1969 SKI published its 1968 annual report

which reported an after tax loss of $798,803, equivalent

to a loss of $.15 per share after taxes (M.App. 25), as con-

trasted with Huarisa’s earlier projection of a profit of

$1.16 per share. The disparity between the previously re-

ported earnings and the loss was caused by substantial

write-offs taken as of year-end 1968.

After the foregoing events, and only in pre-trial dis-

covery herein, Sundstrand learned that during January

and. early February 1969, Price Waterhouse was advising

SKI, Huarisa and other officers of SKI that substantial

year-end write-offs would have to be made on the books

of SKI, which would adversely affect SKI’s earnings for

1968 by several million dollars. Several days prior to

Sundstrand’s cash payment of $6,360,915 for the SKI stock

on February 6, 1969, Ryan, principal financial officer of

SKI, and his counterpart at KIC received a memorandum

from Price Waterhouse stating its preliminary assessment

that write-offs in the range of $3 million to $4.5 million would

have to be made on the books of SKI as of year-end 1968

and stating that it was encountering new areas of concern

almost daily. As the District Court found and the Court of

Appeals affirmed, Huarisa also knew of this assessment

before February 6, 1969. (Dist. Ct. at M.App. 48-51; Ct.

Ap. at M.App. 84-85) Yet, no one—neither Huarisa nor

Ryan nor anyone else—disclosed the Price Waterhouse

assessment to Sundstrand. The Court of Appeals held that

“(t]he memorandum should have been disclosed to Sund-

10

strand.” (M.App. 84) In large part the write-offs account-

ing for the difference between the fraudulent profit pro-

jection made to Sundstrand and the actual loss had been

outlined in the undisclosed Price Waterhouse memorandum.

In addition, only in March, 1969, after the loss for 1968

was reported, did Sundstrand learn of James Burke’s criti-

cisms of SKI’s accounting practices and of the Burke and

Ernst & Ernst reports. Those reports had criticized the

deferral of certain preproduction costs which were part of

the substantial write-offs as of year-end 1968. (Dist. Ct.

at M.App. 25-26; Ct. Ap. at M.App. 83-84, 95-97)

8. The District Court’s Findings and Judgment

After a lengthy trial the District Court held in an ex-

tensive opinion that ail of the defendants had violated Rule

10b-5 in misrepresenting material facts to Sundstrand and

failing to d .close material facts to Sundstrand through the

date of Sundstrand’s purchase of the SKI stock on Febru-

ary 6, 1969. (M.App. 60 et seq.) The District Court found

that SKI and Huarisa intentionally overstated earnings as

of September 30, 1968, recklessly projected earnings for

1968 and 1969 and deliberately withheld the Price Water-

house memorandum and the Burke and Ernst & Ernst re-

ports. The District Court also held that Sundstrand had no

knowledge of these misrepresentations and omissions prior

to the purchase. (M.App. 57)

The District Court thus concluded that Sundstrand had

been wrongfully induced to purchase the SKI stock. It ruled

that the damages were the difference between the amount

paid for the SKI stock and its actual value. The District

Court awarded damages of $4,434,786, plus prejudgment

interest at the rate of 6% per annum from February 6,

1969. (M.App. 70-71) (As of the date of this petition that

judgment would aggregate over $6,700,000.)

11 :

9. The Court of Appeals’ Opinion and Judgment

All defendants appealed from the judgment of the Dis-

trict Court. The Court vf Appeals affirmed the judgment of

liability as to all defendants in all respects. However, the

Court of Appeals held that Sundstrand was only entitled

to recover damages with respect to the initial payment for

the stock made by Sundstrand as a result of its January 9,

1969 agreement with Huarisa, namely $334,785, plus pre-

judgment interest at 6% per annum from January 9, 1969.

(M.App. 106-108) (On July 21, 1977, the amount of that

judgment was paid by Sun. By this petition Sundstrand

seeks to recover the balance of the judgment awarded by

the District Court.)

The sole rationale for the reduction in damages by over

90% was the Court of Appeals’ sua sponte finding that the

“only” or “principal” reason why Sundstrand completed the

purchase of the stock on February 6, 1969 was that Sund-

strand had relied on an erroneous opinion of counsel to the

effect that under the January 9, 1969 agreement between

Sundstrand and Huarisa, Sundstrand was obligated to com-

plete the purchase.* The District Court had made no find-

ings as to any such opinion, and the parties had not briefed

such an issue on appeal. (M.App. 103-104) This ruling

by the Court of Appeals that there was a “superseding

cause”—based upon its “independent study of the record”—

was contrary to the express findings by the District Court

that Sundstrand continued to rely upon the misrepresenta-

tions and omissions made by the defendants when Sund-

strand made its final payment for the stock in question, on

February 6, 1969, that such reliance was entirely reason-

able, and that Sundstrand did not begin to learn the truth

regarding defendants’ fraud or the horrendous financial

condition of SKI until late March, 1969. (M.App. 56-58)

* Both the District Court and the Court of Appeals had conciuded

that Sundstrand was not obligated to make any further payments

under the agreement with Huarisa after reimbursing him for the

downpayment he had made. (Dist. Ct. at M.App. 18, 25; Ct. Ap. at

M.App. 102)

12

REASONS FOR GRANTING THE WRIT

Each of the three reasons for granting the requested writ

of certiorari involves not only an erroneous ruling below

but a direct conflict between the decision below and the de-

cisions of other Courts of Appeals on significant matters

involving the federal securities laws and the scope of

appellate review. The decision below also conflicts with de-

cisions of this Court. Review by this Court is necessary to

resolve these conflicts and to correct the errors below.

I. The Causation Analysis Upon Which The Seventh

Circuit’s Decision Rests Is In Conflict With This

Court’s Decisions Under The Federal Securities Laws

And With Decisions In Other Circuits, And Is Demon-

strably Erroneous

The ruling below ignored the principles of causation

applicable to actions under Rule 10b-5 enunciated by this

Court and by other Courts of Appeals in holding that the

presence of an additional cause, i.e. a cause in addition to

plaintiff’s reliance on defendants’ misconduct, precludes

recovery in an action under Rule 10b-5 even where the

plaintiff-purchaser had no knowledge of the deliberate mis-

representations and omissions perpetrated by the defend-

ants. Review of the decision below is necessary to clarify

the applicable principles of causation and to correct this

error, just as this Court has recently resolved the three

other principal legal issues in private actions under Rule

10b-5.* This case presents a particularly favorable setting

for a definitive resolution of causation standards in such

cases. No issue of fact is presented by Question No. 1, since,

* The principal legal questions which have arisen in cases under

Rule 10b-5 are plaintiff’s standing, the culpability required on the

part of the defendant, the definition of a “material” fact and the

relevance of traditional tort concepts of causation, including re-

lianee. This Court has recently specifically addressed itself to the

first three of these issues. Blue Chip Stamps v. Manor Drug Stores,

421 U.S. 723 (1975); Ernst & Ernst v. Hochfelder, 425 U.S. 183

(1976) ; and TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438

(1976) (under SEC Rule 14a-9, 17 C.F.R. § 240.14a-9).

———e—oeoOoEoeEeEeEeEeEeEeEaESGee_—___ eee eee

13

for purposes of this issue, petitioner accepts arguendo the

Court of Appeals’ erroneous and unsupported finding that

petitioner had relied on an opinion of counsel in consum-

mating the transaction. (See pp. 21-23, infra)

Although there was some analysis of causation in actions

under Rule 10b-5 in A ffiliated Ute Citizens v. United States,

406 U.S. 128 (1972), much confusion remains surrounding

the application of traditional tort principles of causation

in such actions. For example, compare Shapiro v. Merrill

Lynch, Pierce, Fenner & Smith, Inc., 495 F.2d 228, 238-242

(2d Cir. 1974), with Fridrich v. Bradford, 542 F.2d 307,

316-320 (6th Cir. 1976), cert. dented, 97 S.Ct. 767 (1977).

See generally 1 A. Bromberg, Securities Law: Fraud, Secs.

4.7(550) et seq. (1973) ; 5 Jacobs, The Impact of Rule 10b-5,

§ 64.02 (1976). See also cases cited at pp. 17-18, infra. While

some of the cited cases involve causation issues in contexts

other than that presented by the instant case, the need for

this Court to clarify causation standards in actions under

Rule 10b-5 is apparent. Moreover, since this case involves

a single plaintiff defrauded in a face-to-face transaction

(as distinguished from, e.g., a class action or an open mar-

ket transaction), it presents more fundamental issues than

do many other cases in which causation questions arise,

and therefore is particularly suitable for consideration by

this Court.

A. The Decision Below Is In Conflict With This

Court’s Decision In Affiliated Ute Citizens v.

United States, 406 U.S. 128 (1972), And With

Decisions Of Other Circuits

The correct application of this Court’s analysis of causa-

tion in Affiliated Ute Citizens v. United States, 406 U.S. 128

(1972), to the facts of this case can be demonstrated by a

single but crucial example of an actionable non-disclosure.

Both the Court of Appeals and the District Court held that

SKI and Huarisa intentionally withheld from Sundstrand

14

the January 27, 1969 Price Waterhouse memorandum, an

obviously material document which indicated huge antici-

pated write-offs at year-end 1968 about which Sundstrand

had no knowledge. Both courts also held that Huarisa and

Ryan knew of the memorandum and knew that Sundstrand

was about to pay the balance of the purchase price for the

SKI stock which was subject to the right of first refusal.

(Dist. Ct. at M.App. 24, 49-50; Ct. Ap. at M.App. 78, 84)

“This obligation to disclose and this withholding of a ma-

terial fact established the requisite element of tort causation

in fact.” Affiliated Ute Citizens, supra, 406 U.S. at 154

(1972).* See also Piper v. Chris-Craft Industries, Inc., 97

S.Ct. 926, 953-54 (1977) (Blackmun, J., concurring in the

judgment).

Many lower federal courts have held that reliance upon

the misrepresentation or omission at issue need not be the

sole cause of plaintiff’s damage in order to sustain a cause

of action under Rule 10b-5; it need only be a substantial

factor. Herzfeld v. Laventhol, Krekstein, Horwath & Hor-

wath, 540 F.2d 27, 34 (2d Cir. 1976); Mitchell v. Texas

Gulf Sulphur Co., 446 F.2d 90, 102 (10th Cir. 1971), cert.

denied, 404 U.S. 1004 (1972); McLean vy. Alexander, 420

F.Supp. 1057, 1077 (D.Del. 1976); see also Zenith Radio

Corp. v. Hazeltine Research, Inc., 395 U.S. 100, 114 n. 9

(1969) (“It is enough that the illegality is shown to be a

material cause of the injury. .. .”; emphasis added).

Under the Affiliated Ute Citizens presumption and the

cases cited in the preceding paragraph, the conduct referred

to above, as well as respondents’ other acts in violation

of Rule 10b-5, constitutes at least a cause of Sundstrand’s J

* While proof that plaintiff had actual knowledge of the omitted

facts (Sanders v. John Nuveen & Co., Inc., 524 F.2d 1064, 1073,

(7th Cir. 1975), vacated and remanded on other grounds, 425 U.S.

929 (1976) ) or that plaintiff would have made the purchase even if

he had known the undisclosed facts (Rochez Bros., Inc. v. Rhoads,

491 F.2d 402, 410-11 (3d Cir. 1974)) might rebut the Affiliated Ute

Citizens presumption of causation, neither circumstance was present

here. (M.App. 57) See also pp. 17-20, infra.

=.

15

purchase of the SKI stock and a cause of the resulting

loss. No more need be proven. Under the cases cited in

the preceding paragraph, even if some other cause (e.g.

reliance on a legal opinion regarding Sundstrand’s obli-

gation to make the purchase) was operating at the same

time, because respondents’ conduct was an operating cause,

Sundstrand was entitled to recover from respondents.

Accordingly, the decision below (1) erred in failing to fol-

low Affiliated Ute Citizens and (2) was inconsistent with

the decisions cited in the preceding paragraph. Review by

this Court is necessary to resolve the conflict and to clarify

the holding of Affiliated Ute Citizens.

B. Correct Application Of This Court’s Holding In

Mills v. Electric Auto-Lite Co., 396 U.S. 375

(1970), Demonstrates That There Was No Excul-

patory ‘‘Superseding’’ Cause

The Court of Appeals also failed to perceive that its

finding of an exculpatory, second cause was in conflict with

still another decision of this Court, Mills v. Electric Auto-

Lite Co., 396 U.S. 375 (1970).

The Court of Appeals sua sponte raised the question

whether any reliance by Sundstrand on an opinion of coun-

sel to the effect that Sundstrand was contractually obli-

gated to complete the purchase constituted a “superseding

cause” which exonerates Sun and Huarisa.* (M.App. 105)

The concept of “superseding cause,” which in certain lim-

ited circumstances will relieve a prior wrongdoer of lia-

bility for injury to which his misconduct has made a sub-

stantial contribution, was developed in negligence cases at

common law. Even in such cases, in order to “supersede”

the initial wrongdoer’s liability, the later cause must be

* As shown at pp. 21-23, infra, not only was the Court of Ap-

peals’ finding unsupported by the evidence, but the evidence

established that there was no such opinion.

16

one not produced or set in motion by the initial wrongful

act, but rather must be of independent origin. Restatement

(Second) of Torts, §§ 440-42 (1965) ; Prosser, Law of Torts,

§ 44, at 270-71 (4th ed. 1971); Freeman v. United States,

509 F.2d 626, 633-34 (6th Cir. 1975) ; 22 Am.Jur.2d, “Dam-

ages,” § 84 at 120 and § 111 at 161-62 (1965) ; Comstock v.

General Motors Corp., 99 N.W.2d 627, 635-36 (Mich.Sup.Ct.

1959).

In the present case, any reliance on counsel was not a

“superseding cause” even as that concept has been applied

in negligence cases. Regardless of any understanding that

Sundstrand may have had concerning the interpretation of

the January 9, 1969 agreement with Huarisa, if Sundstrand

or its counsel had been informed, before February 6, 1969,

of the gross deception in violation of Section 10(b) which

had been practiced on Sundstrand by the conspiratorial

actions of SKI and Huarisa and which (as both courts held)

had induced Sundstrand to enter into the agreement in the

first instance, Sundstrand and its counsel would also have

known that the agreement with Huarisa was voidable under

Section 29(b) of the 1934 Act, 15 U.S.C. § 78ee(b) (S.App.

113), as interpreted by this Court in Mills v. Electric Auto-

Lite Co., 396 U.S. 375, 382-88 (1970), following Bankers

Life € Cas. Co. v. Bellanca Corp., 288 F.2d 784, 787 (7th

Cir. 1961). Thus, the supposed “superseding” cause of coun-

sel’s opinion found by the Court of Appeals would have

disappeared altogether had Huarisa or SKT disclosed (or

had Sundstrand otherwise learned of) the wrongful con-

duct found by both courts below. The Court of Appeals’

ruling in effect allows respondents to escape liability by

reason of a “cause” created by and,kept in effect solely by

their own continuing misconduct. Therefore, the Court of

Appeals erred in holding that there was an exculpatory

second, or superseding, cause.

At most, then, any reliance on counsel was a concurrent

cause with Sundstrand’s reliance on defendants’ misrepre-

17

sentations and omissions. Where harm results from two

concurrent, equally sufficient causes, even a negligent

wrongdoer is liable regardless of any negligence on the

part of the second actor. Restatement (Second) of Torts,

§ 432(2) (followed in Basko v. Sterling Drug, Inc., 416 F.2d

417, 429-30 (2nd Cir. 1969)) and §§ 302A, 439 and 442

(1965) ; 2 Harper & James, The Law of Torts, § 20.2 at 1123

(1956); Prosser, Law of Torts, 4 44 at 274 (4th ed. 1971):

Since such a rule embraces merely negligent wrongdoers,

a fortiori an intentional or reckless wrongdoer should not

escape liability under such circumstances.

This Court should grant a writ of certiorari here in order

to reaffirm Mills and to clarify the role (if any) of the con-

cepts of “concurrent” and “superseding” causes in actions

under Rule 10b-5.

II. The Decision Below Is In Conflict With Decisions Of

Other Circuits Interpreting This Court’s Decision In

Ernst & Ernst v. Hochfelder, 425 U.S. 183 (1976), As

It Relates To Plaintiff’s Conduct As A Defense

The decision below is also in conflict with another line of

recent appellate decisions under Rule 10b-5. Prior to this

Court’s decision in Ernst & Ernst v. Hochfelder, 425 U.S.

183 (1976), a number of courts had held that a plaintiff's

mere lack of diligence in discovering the truth was a de-

fense in an action under Rule 10b-5. E.g., Clement A. Evans

& Co. v. McAlpine, 434 F.2d 100, 103 (5th Cir. 1970), cert.

denied, 402 U.S. 988 (1971) ; see generally Wheeler, “Plain-

tiff’s Duty of Due Care Under Rule 10b-5: An Implied

Defense to an Implied Remedy,” 70 Nw.U.L.Rev. 561 (1975).

As a result of Hochfelder, which requires proof of scienter

on the part of the defendant, however, several Courts of

Appeals have reconsidered the due diligence defense.

In Holdsworth v. Strong, 545 F.2d 687 (10th Cir. 1976)

(en banc), cert. denied, 97 S.Ct. 1600 (1977), the Court of

Appeals held, “{i]f contributory fault of plaintiff is to can-

18

cel out wanton or intentional fraud, it ought to be gross

conduct somewhat comparable to that of defendants.” 545

F.2d at 693. Similarly, in Dupuy v. Dupuy, 551 F.2d 1005,

1020 (5th Cir. 1977), the court held that a Rule 10b-5 plain-

tiff will be barred only if his conduct is reckless; the issue

is whether the plaintiff “intentionally refused 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 ithighly probable that harm would follow,’” not

merely whether plaintiff acted unreasonably. 551 F.2d at

1020. Contra, Hirsch v. duPont, 553 F.2d 750, 763 (2d Cir.

1977) (plaintiff barred for “failfure] to exercise due dili-

gence”), followed in NBI Mortgage Investment Corp. v..

Chemical Bank, CCH Fed. Sec. L.Rep. ¥ 96,066, at p. 91,801

(S.D.N.Y. 1977) [Current Binder] (refused to follow Holds-

worth, holding that under Hirsch “the standard of due dili-

gence is still viable and accepted in this cireuit”); see

Straub v. Vaisman & Co., Inc., 540 F.2d 591, 596-98 (3d Cir.

1976) (the issue is whether plaintiff “acted reasonably”) ;

and McLean y. Alexander, 420 F.Supp. 1057, 1078 (D.Del.

1976) (plaintiff is “charged with a duty of due diligence

commensurate with his investor sophistication”), all after

Hochfelder.

The opinions cited above demonstrate that, depending

on the court in which he sues, a plaintiff may be barred

from recovery merely for failing to exercise diligence, or

for acting unreasonably or only for acting recklessly. This

aspect of the implications of Hochfelder is clearly ripe for,

and merits, review by this Court.

In the instant case, the Court of Appeals purported to

adopt the Holdsworth test (M.App. 100), but neither the

result nor the court’s reasoning accorded with that standard.

There is no basis for a conclusion that Sundstrand acted

recklessly or with gross conduct, and neither court below

so found. While the Court of Appeals suggested that Sund-

strand had some information contrary to defendants’ repre-

19

sentations (M.App. 82-83, 104), in fact, as the District Court

found, “[t]here is no evidence whatsoever that Sundstrand

had actual knowledge of the fraud being perpetrated upon

it,” and its reliance on defendants’ statements was “entire-

ly reasonable.” (M.App. 57, 58) Sundstrand’s difference of

opinion with SKI on the exact magnitude of SKI’s likely

earnings for 1968* does not constitute any bar to Sund-

strand’s recovery under the standard enunciated in Holds-

worth and Dupuy. Any reliance on an grroneous legal opin-

ion would also not have been gross or reckless conduct.

Contrary to the evidence, the Court of Appeals found that

Sundstrand “had learned enough to apprise it that forfei-

ture of its down payment was better than further payments”

under the agreement with Huarisa. (M.App. 104) The evi-

dence is clear that Sundstrand in fact concluded, after the

termination of merger negotiations and before the February

6 payment, that purchase of the SKI shares was “a good

investment.” (Schuette Dep. 330-33, 336-37, Miller at Trial

Tr. 749-52, S.App. 155-159, all of which was in evidence) In

addition, as the District Court found, Huarisa had advised

Sundstrand, albeit falsely, that other companies had offered

$45 per share for SKI, and the $30 per share price was far

below Sundstrand’s own $38.25 merger proposal. (M.App.

10) At most, the contrary conclusion of the Court of

Appeals reflects a difference of opinion on a matter of busi-

ness judgment, which is a patently inadequate basis under

Holdsworth and Dupuy for overturning the District Court’s

damage award.

By thus purporting to adopt a high standard of proof

to establish the defense (Holdsworth) but in fact applying

* While Sundstrand lacked confidence in Huarisa’s statement that

SKI’s 1968 earnings would be $1.16 per share, Sundstrand merely

concluded that SKI was more likely to earn $.80 to $1.00 a share

and, because that conclusion was based on the numerous false state-

ments and omissions of SKI and Huarisa which Sundstrand believed

to be true, it had no inkling that SKI would Jose $.15 per share.

(M.App. 23)

20

a low standard of proof, the Court of Appeals watered

down the “gross conduct” test so as to evade an obvious

implication of the holding in Hochfelder—an erosion no

less pernicious for its indirectness.* This Court should

resolve the conflict involving five Courts of Appeals and

determine the parameters of any defense in Rule 10b-5

actions based on plaintiff’s conduct.**

III. The Court Of Appeals’ Reversal Of The District

Court Based Upon The Court Of Appeals’ Independent

Examination of Material Not In The Trial Record Con-

flicts With Decisions Of Other Circuits And Warrants

Exercise Of This Court’s Supervisory Power.

The Court of Appeals’ ruling that Sundstrand was not

entitled to recover damages for the February 6, 1969 pay-

ment was based on that court’s finding that Sundstrand

consummated the purchase “only” because it believed, based

on an opinion of counsel, that it was legally obligated to

do so. (M.App. 103) This finding, developed from that

court’s “independent study of the record” (M.App. 103),

was in the face of the District Court’s contrary findings on

reliance and causation.*** This crucial finding of reliance on

an opinion of counsel, a finding the defendants did not

* The approach by this panel of the Court of Appeals should be

contrasted with the admonition of another panel of the same court:

{T]he definition of “reckless behavior” should not be a liberal

one lest any discernible distinction between “scienter” and

“negligence” be obliterated for these purposes. We believe

“reckless” in these circumstances comes closer to being a lesser

form of intent than merely a greater degree of ordinary negli-

gence. We perceive it to be not just a difference in degree, but

also in kind. Sanders v. John Nuveen & Co., Inc., 554 F.2d 790,

793 (7th Cir. 1977) (on remand from Supreme Court).

** Meers, petitioner in the related case, No. 77-83, presents a simi-

lar question in his Question No. 2.

#** See, e.g., M.App. 56-58. In this ruling, the Court of Appeals

also failed to adhere to the requirements of Rule 52(a), F.R.Civ.P.,

that “findings of fact shall not be set aside unless clearly erroneous,

and due regard shall be given to the opportunity of the trial court

to judge the credibility of the witnesses.”

21

seek and no party briefed on appeal, was expressly, indeed

blatantly, predicated upon material not in the trial record

and thus not within the Court of Appeals’ scope of review.

The Court of Appeals’ express ruling that it can inde-

pendently consult evidentiary material not in the trial ree-

ord and make its own findings of fact based thereon (S.App.

111) is in square conflict with decisions of other Courts of

Appeals. (See pp. 22-23, infra) Moreover, such conduct

constitutes, in the words of Supreme Court Rule 19, a “de-

part{ure] from the accepted and usual course of judicial

proceedings ... [so far] as to call for an exercise of this

Court’s power of supervision.”

This Court is charged with supervisory functions in

relation to proceedings in the federal courts. See

McNabb v. United States, 318 U.S. 332, 63 S.Ct. 608, 87

L.Ed. 819. Therefore, fastidious regard for the honor

of the administration of justice requires the Court to

make certain that the doing of justice be made so

manifest that only irrational or perverse claims of its

disregard can be asserted. (Communist Party v. Sub-

verswe Activities Control Board, 351 U.S. 115, 124

(1956).)

This Court should exercise its supervisory powers in order

to prevent the conduct by the Court of Appeals herein from

becoming a pernicious precedent for appellate review of

findings of fact.

The court below cited numerous references to the record

on appeal* to support the result of its “independent study

of the record.” (M.App. 104 n. 35 and S.App. 112) But of

the twenty-five citations therein to transcript or deposition

pages, only five were to trial testimony or to depositions

in evidence. (The texts of the twelve passages of the twenty-

five which are in the trial record are set forth in the

* Pursuant to Rule 10(a), F.R.App.P., the record on appeal in-

cluded all papers filed in the District Court since this case was com-

menced in 1969. International Business Machines Corp. v. Edelstein,

526 F.2d 37, 45 (2d Cir. 1975).

22

appendix to this petition at S.App. 116-147) The Court of

Appeals’ only citations to evidence in the trial record were

Trial Tr. 131, 165-67, 484-87 and 625-31 and Huarisa Dep.

229-30. (S.App. 116-128, 146-147) Only two of these five pas-

sages in evidence so much as refer to an opinion of counsel.

Neither of the two supports the Court of Appeals’ finding

that the “only” or “principal reason” Sundstrand com-

pleted the purchase was “because counsel had wrongly

advised Sundstrand officials that it was legally obligated”

to make the purchase.* (M.App. 103) There is no other

evidence in the trial record bearing on any opinion of coun-

sel. The remaining citations to the trial transcript in orig-

ina! footnote 35 of the Court of Appeals opinion are to

argument of counsel or to colloquy. (S.App. 128-146) The

other thirteen citations are to deposition passages not ad-

mitted or even offered into evidence at trial.

Other Courts of Appeals have consistently held that they

cannot consider evidentiary material not in the actual trial

record in appraising the District Court’s findings, much

less to formulate their own findings of fast. United States

v. City of Brookhaven, 134 F.2d 442, 446-47 (5th Cir. 1943)

(depositions not in evidence could not be considered by

reviewing court even though they were included in the rece-

ord on appeal); Worsham v. Duke, 220 F.2d 506, 509 (6th

* During cross-examination of Sadler, a Sundstrand officer, coun-

sel for Sun and Huarisa read a passage of Sadler’s deposition to

refresh his recollection. Sadler had testified at the deposition that

Ethington, another Sundstrand officer, told Sadler that counsel felt

Sundstrand was obligated to buy the stock. Sadler’s recollection

was not refreshed. (Tr. 484-87, S.App. 119-122) During cross-

examination of Ross, counsel for Sun and Huarisa sought indirectly

to impeach Ethington by having Ross, a Sundstrand officer, identify

Sundstrand’s interrogatory answer (Sun-Huarisa Ex. 52, set forth

in full in the appendix to this petition at S.App. 148-151), in which

Sundstrand DENIED that it had received an opinion of counsel in

this regard. (Tr. 625-31, S.App. 122-128) These two references pro-

vide no basis for rejecting the District Court's findings of reliance

and causation. Indeed, such evidence established that there was no

relianee on any such opinion because there was no opinion.

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23

Cir. 1955). See also Rommel-McFerran Co. Inc. v. Local U.

No. 369 Int. Bro. of Elec. Wkrs., 361 F.2d 658, 661-62 (6th

Cir. 1966). On a previous occasion even the Court of Ap-

peals which decided the instant case recognized this funda-

mental principle of appellate review. Charles v. Judge &

Dolph, Ltd., 263 F.2d 864, 867 (7th Cir. 1959).

This Court has recently criticized Courts of Appeals for

relying on material not developed in the record before an

administrative agency when reviewing a determination by

the agency. E. 1. du Pont de Nemours & Company v. Collins,

97 S.Ct. 2229, 2235 (1977) (court erred in retaining pro-

fessor after oral argument to prepare reports which “had

not been examined and tested by the traditional methods

of the adversary process”) ; F.P.C. v. Transcontinental Gas

Pipe Line Corp., 423 U.S. 326, 331-32 (1976).

The unfairness of the approach by the Court of Appeals

here is manifest, since Sundstrand never needed, and there-

fore made no effort, to rebut or to explain the material not

in evidence. In any event, the evidence in the trial record,

introduced by defendants, established that no legal opinion

was sought or received by Sundstrand, and none was relied

on.

When the Court of Appeals denied Sundstrand’s petition

for rehearing en banc on May 18, 1977 by a divided vote

both of the members of the pan | which decided the case

and of other Circuit Judges, the court expanded its foot-

note 35 by citing cases which purportedly justify such an

excursion beyond the trial record and by citing two in-

stances where Sundstrand referred in briefs to material not

in evidence.* (S.App. 111-112) The court’s effort to justify

its impermissible approach lacks any persuasive force.

* The two cited instances when Sundstrand referred to filings not

in evidence were references to an interrogatory answer and to a

brief in the trial court. (These excerpts are set forth in the appen-

dix to this petition at S.App. 152-154) These were cited to show con-

tentions made in the District Court. In neither instance did Sund-

strand even purport to rely on those portions of the record on

appeal as evidence to prove an evidentiary fact in issue.

24

The opinion in Lyon v. Carey, 533 F.2d 649, 652 (D.C.

Cir. 1976), does not indicate what use the District Court

made of the deposition which was referred to by the Court

of Appeals, but it appears that the portion of the deposi-

tion on which the Court of Appeals relied pertained to facts

not in dispute on appeal. In Merola v. Atlantic Richfield

Company, 515 F.2d 165, 170-71 (3d Cir. 1975), the Court

of Appeals made reference to depositions in order to pro-

vide the District Court with some guidance in connection

with proceedings upon remand. (In the instant case the

Court of Appeals made a final determination on a factual

issue without ordering a remand.) Moreover, in that case

(unlike this ease) it was not clear what had been and had

not been included in the trial record. Finally, in Barrett v.

Baylor, 457 F.2d 119, 124 n. 2 (7th Cir. 1972), the Court of

Appeals considered pleadings—not depositions—in an ac-

tion in a related state case which, the court noted, were

properly the subject of judicial notice in any event. In

short, nothing in the expanded footnote 35 excuses the

Court of Appeals’ egregious departure from the confines

of the trial record.

This Court should grant this petition in the exercise of

its supervisory powers over lower federal courts and

reverse the judgment below.

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25

af CONCLUSION

For the reasons given, petitioner Sundstrand Corpora-

tion prays that a writ of certiorari be granted to review

the judgment and opinion below.

Respectfully submitted,

W. DONALD McSWEENEY

WILLIAM A. MONTGOMERY

ALLAN HORWICH

FREDERICK L. HARTMANN

PETER V. BAUGHER

7200 Sears Tower

233 South Wacker Drive

- Chicago, Illinois 60606

Attorneys for petitioner

Sundstrand Corporation

Schiff Hardin & Waite

Of Counsel