Petition — Fleschner v. Abrahamson
Supreme Court brief1978
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Supreme Court, U. S.
FILED
No. 77- ] 2 : MAR 14 1978
IN THE MICHAEL RODAK, JR.,
Supreme Court of the United States
October Term, 1977
al
MALCOLM K. FLESCHNER, WILLIAM J. BECKER,
HAROLD B. EHRLICH and FLESCHNER
BECKER ASSOCIATES,
Petitioners,
v.
ROBERT ABRAHAMSON and
MARJORIE ABRAHAMSON,
Respondents.
PETITION FOR A WRIT OF CERTIORARI
TO THE UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
. RICHARD E, CARLTON
125 Broad Street
New York, New York 10004
Counsel for Petitioners
Fleschner, Becker and
Fleschner Becker Associates
Davip M. OLASOV
ROBERT D. OWEN
SULLIVAN & CROMWELL
Of Counsel
MARK M. JAFFE
One World Trade Center
New York, New York 10048
Counsel for Petitioner Ehrlich
ALLAN J. GRAF
Hi__, Betts & NAsH
Of Counsel
March 14, 1978
INDEX
PAGE
ITE ETD Ie ITS A ot SRN am RS 1
EE SR Ree ea Coe aA
I a a 2
RR ER EIR al are ce tage Oe an ae 3
a ee lealinscnewans 3
Reasons for Granting the Writ ..................0..00..000... 7
a a eae 21
BI So hiiarcchetisessithiabapdasnidavebhs dlakdehobsinn<ickestetcdacs Al
CITATIONS
Cases:
Angelakis v. Churchill Management Corp.,
[1975-1976 Transfer Binder] Fep. Ssc. L.
Rep. (CCH) § 95,285 (N.D. Cal. 1975) ...... 8
Blue Chip Stamps v. Manor Drug Stores, 421
GR HE CID Schcebinscdec. cee ccttiaces 4, 6, 7, 8, 9, 10, 16
Bolger v. Laventhol, Krekstein, Horwath & Hor-
wath, 381 F. Supp. 260 (S.D.N.Y. 1974) ...... 8
Botany Mills v. United States, 278 U.S. 282
I at a i adele 15
Byrnes V. Faulkner, Dawkins & Sullivan, 550 F.
> ff. .. & . , Serer aee 5 20
ii
Chris-Craft Industries, Inc. v. Piper Aircraft
Corp., 480 F.2d 341 (2d Cir. 1973), rev'd,
Piper v. Chris-Craft Industries, Inc., 430 U.S.
RARER a eareealind oS penne nein me vers
PAGE
15
Cort v. Ash, 422 U.S. 66 (1975) «0.000000... 10, 16, 17
Courtland v. Walston & Co., Inc., 340 F. Supp.
I SII: disivcvnnasinetiansacoscenneneniil
Ernst & Ernst v. Hochfelder, 425 U.S. 185
(1976) ........... Men OA St tig NAD aOR eR Gh
Esplin v. Hirschi, 402 F.2d 94 (10th Cir. 1968),
cert. denied, 394 U.S. 928 (1969) .........00000....
Estate Counseling Service, Inc. v. Merrill Lynch,
Pierce, Fenner & Smith, Inc., 303 F.2d 527
SUI, TIE 1. cdesnsaccccussedennetanennieiodbahen
Ferschtman v. Schectman, 450 F.2d 1357 (2d
ee ee ahaa ieaneeige
Gammage Vv. Roberts, Scott & Co., [1974-1975
Transfer Binder] Fep. Sec. L. Rep. (CCH)
bo 8 2 | | ReenrEEnerr
Garnatz V. Stifel, Nicolaus & Co., 559 F.2d 1357
ar OL AEE aReae ae ee
Greenspan v. del Toro, [1975-1976 Transfer
Binder] Fep. Sec. L. Rep. (CCH) 4 95,488
(S.D. Fla.) appeal dismissed for want of prose-
cution, No. 74-2943 (Sth Cir. 1974) ..............
Harris v. American Investment Company, 523 F.
2d 220 (8th Cir. 1975), cert. denied, 423
IRE SIRES Tei ioran ie a Rae
Herpich v. Wallace, 430 F.2d 792 (Sth Cir.
SIT .c:.scpihiases uch taceadinnddenehadesdudmanaiannenendiaietios
Hull v. Newman, Kennedy & Co., No. 118-283
I acai tiene as
19
20
13
~~ a ———
wie 0 cnet hee see tee one Ks.
iii
PAGE
In the Matter of Donner Estates, Inc., Investment
Advisers Act Release No. 21 (November 3,
1941), 10 S.E.C. 400, [1941-1944 Transfer
Binder] Feb. Sec. L. Rep. (CCH) 4 75,216 .... 18
In the Matter of Loring, Investment Advisers Act
Release No. 33 (July 22, 1942), 11 S.E.C.
885, [1941-1944 Transfer Binder] Feb. Src.
S FF os i Gk A ee 18
In the Matter of the Pitcairn Company, Invest-
ment Advisers Act Release No. 52 (March 7,
1949), 29 S.E.C. 186, [1948-1952 Transfer
Binder] Feb. Sec. L. Rep. (CCH) 4 75,990 ... 18
In the Matter of Roosevelt & Son, Investment Ad-
visers Release No. 54 (September 2, 1949), 29
S.E.C. 879, [1948-1952 Transfer Binder] Fep.
Sec. L. Rep. (CCH) 4 76,016
Janigan v. Taylor, 344 F.2d 781 (1st Cir.), cert.
denied, 382 U.S. 879 (1965) 2.000000. 19
Kohler v. Kohler Co., 208 F. Supp. 808 (E.D.
Wisc. 1962), affd, 319 F.2d 634 (7th Cir.
RRR EE SY oe a Opa Wet ee ee 19
Levine v. Seilon, 439 F.2d 328 (2d Cir. 1971) .... 19, 20
Lewis v. Transamerica Corp., No. C 73-2180
(N.D. Cal. 1974), appeal argued, No. 75-1285
! , , TR eran 8
National Railroad Passenger Corp. v. National
Ass'n of Railroad Passengers, 414 U.S. 453
SUE Do oer ee inl Se a eo 15
Piper v. Chris-Craft Industries, Inc., 430 U.S. 1
Ub eit ee Ah ea Ean a 16, 17
Richardson v. MacArthur, 451 F.2d 35 (10th
BRE RIE 1 ae Ce nT eo 20
iv
PAGE
Santa Fe Industries, Inc. v. Green, 430 U.S. 462
Perea cee 16
Schaefer v. First National Bank, 326 F. Supp.
1186 (N.D. Ill. 1970), appeal dismissed, 465
iw we Te, |e S| eee ee 20
Scripps-Howard Radio v. FCC, 316 US. 4
C BGBD cn iicvevesssissececssssseenconeucasaeenaneeeeee 17
Securities Investor Protection Corp. v. Barbour,
421 UB, 413 CIGTE) «..<cecesccscisescs eee 16
Selzer v. Bank of Bermuda Ltd., 385 F. Supp.
413 (SB BDILY. FED scccinnudceeeeeeee 18
Sullivan v. Chase Investment Services of Boston,
434 F. Supp. 171 (N.D. Cal. 1977) ............... 8
Wilson v. First Houston Investment Corp., 566
F.2d 1235 (Sth Cir., Feb. 2, 1978) ................ 7
Wolf v. Frank, 477 F.2d 467 (Sth Cir.), cert.
denied, 414 U.S. 975 (1973) ............00.00000.2... 19, 20
Statutes and Rules:
Section 22 of the Securities Act of 1933, 15
U8 tot hs Nn 10
Securities Exchange Act of 1934:
Section 10(b), 15 U.S.C. § 78j(b) .................. 4,6
Section 27, 1S UAC. © FERED ancsevssccsensesssannneen 10
Section 25 of the Public Utility Holding Company
Act of 1935, 15 U.S.C. § 79y .........0000. — F
Section 322 of the Trust Indenture Act of 1939,
BS US. BT FCO ooccccccssccccecsasssuseeee 10
Investment Company Act of 1940:
Section 36(b), 15 U.S.C. § 80a-35(b) 13, 14
Section 44, 15 U.S.C. § 808-43 oooo.o.ccccccesceeeee 10
ee o
Vv
PAGE
Investment Advisers Act of 1940:
Section 202, 15 U.S.C. § 80b-2 000... 5
Section 206, 15 U.S.C. § 80b-6.................... passim
Section 214, 15 U.S.C. § 80b-14 .....3, 5, 10, 13, 14
ccc ensernsuceneessreerces ees 2
Rule 10b-5 under the Securities Exchange Act of
1934, 17 C.F.R. § 240.10b-5 2... 4, 6,7,8
Rule 206(4)-1 under the Investment Advisers
Act of 1940, 17 C.F.R. § 275.206(4)-1 ........ 9
Legislative Materials:
S. Rep. No. 1775, 76th Cong., 3d Sess. (1940)... 12
H.R. Rep. No. 2639, 76th Cong., 3d Sess.
es enapvasoesecenes 17
S. Rep. No. 1760, 86th Cong., 2d Sess. (1960)... 13
Investment Trusts and Investment Companies:
Hearings on S. 3580 Before a Subcomm. of the
Senate Comm. on Banking and Currency, 76th
EL 11, 12
Investment Trusts and Investment Companies:
Hearings on H.R. 10065 Before a Subcomm.
of the House Comm. on Interstate and Foreign
Commerce, 76th Cong., 3d Sess. (1940) ........ 11,12
Investment Advisers Act Amendments: Hearings
on S. 2849 Before the Subcomm. on Securities
of the Senate Comm. on Banking, Housing and
Urban Affairs, 94th Cong., 2d Sess. (1976) .... 14
Investment Advisers Act Amendments: Hearings
on H.R. 13737 Before the Subcomm. on Con-
sumer Protection and Finance of the House
Committee on Interstate and Foreign Com-
merce, 94th Cong., 2d Sess. (1976) ................ 14
vi
Is I eae
S. 3580, 76th Cong., 3d Sess. (introduced by Sen.
Wagner on March 14, 1940) 2.000.000...
H.R. 8935, 76th Cong., 3d Sess. (introduced by
Cong. Lea on March 14, 1940) ........00000000......
STAFF OF SENATE COMM. ON BANKING AND CuR-
RENCY, 76TH CONG., 3D Sess., S. 3580
(Comm. Print, May 24, 1940) .........000000.......
Miscellaneous:
Investment Advisers Act Release No. 491 (De-
cember 15, 1975), [1975-1976 Transfer
Binder] Fep. Sec. L. Rep. (CCH) 4 80,341 ....
D. Rogers, A Brief History of the Investment
Counsel Association (April 1975) (unpub-
lished draft at Investment Counsel Association,
127 East 59th Street, New York, New York)
12
12
14
12
en ee ee ee
SF teh oe
Beco epi: Tana Nate) Sim 8 dae oe ote
Pee ee | a a
IN THE
Supreme Court of the United States
October Term, 1977
No. 77-
MALCOLM K. FLESCHNER, WILLIAM J. BECKER,
HAROLD B. EHRLICH and FLESCHNER
BECKER ASSOCIATES,
Petitioners,
Vv.
ROBERT ABRAHAMSON and
MARJORIE ABRAHAMSON,
Respondents.
PETITION FOR A WRIT OF CERTIORARI
TO THE UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
Petitioners Malcolm K. Fleschner, William J. Becker,
Harold B. Ehrlich and Fleschner Becker Associates’ re-
spectfully pray that a writ of certiorari issue to review the
judgment and opinion of the United States Court of Ap-
peals for the Second Circuit entered on February 25, 1977,
and modified on rehearing on January 6, 1978.
Opinions Below
The opinion of the Court of Appeals (A3-49)? is un-
officially reported at [1976-1977 Transfer Binder] Fep.
1 These petitioners and Harry Goodkin & Co. were defendants in
“ District Court.
oy below are reproduced in the appendix to this peti-
on and —” page references are to that appendix.
2
Sec. L. Rep. (CCH) § 95,889. The Order of the Court of
Appeals modifying that opinion (A50-52) is not reported.
The opinion of the District Court (A54-74) is reported at
392 F. Supp. 740.
The interim opinion of the Court of Appeals (A75-78),
which requested the parties and the Securities and Ex-
change Commission as amicus curiae to file supplemental
briefs in view of “the importance and novelty of the issues”
(A78) raised under the Investment Advisers Act of 1940,
is reported at 537 F.2d 27.
Jurisdiction
The judgment of the Court of Appeals was entered on
February 25, 1977, and an order granting in part a timely
petition for rehearing was entered on January 6, 1978.
This Court’s jurisdiction is invoked under 28 U.S.C.
§ 1254(1).
Questions Presented
Respondents, former limited partners of a privately held
investment partnership, seek damages from the limited
partnership, its general partners and accountants under
the Investment Advisers Act of 1940 on the claim, sup-
ported only by respondents’ uncorroborated oral testimony,
that had petitioners not omitted to disclose that the partner-
ship’s investments included unregistered securities, respon-
dents “would have” withdrawn from the partnership sooner
and as a result would have increased by another $1,254,800
their net profit of $289,000 on an investment of $599,000.
Two important questions are presented:
1. May a private right of action for damages be implied
under the Investment Advisers Act of 1940 to permit
former limited partners of a closely held, predominantly
dnt Ct a Ne nl
Sete anes
family investment partnership to sue the general partners
as purported investment advisers, even though (i) the Act
contains no express provision for any damage actions and
confers no jurisdiction on the federal courts to hear actions
at law and (ii) the legislative history evidences a clear con-
gressional intention not to create private rights of action and
Congress has consistently declined opportunities to do so?
2. If such a right of action is implied, may respondents
recover damages merely on the claim that they “would
have” liquidated their partnership interests at a larger profit
if they had withdrawn earlier, even though they realized a
substantial profit on their investment, sustained no “out-of-
pocket” loss, and do not allege that the petitioners were
unjustly enriched by the respondents’ failure to withdraw?
Statutes Involved
Sections 206 of the Investment Advisers Act of 1940, 54
Stat. 852, as amended, 74 Stat. 887, 15 U.S.C. § 80b-6,
and Section 214 of that Act, 54 Stat. 856, 15 U.S.C. § 80b-
14, are set forth in the appendix to this petition (A1-2).
Statement of the Case
This case arises out of the respondents’ participation in
The Fleschner Company, now Fleschner Becker Associates
(“FBA”), a private investment partnership organized in
1965 by their former friend Fleschner to invest collec-
tively his and his family’s capital. Respondents remained
limited partners through September 1970. On withdrawal
respondents realized a profit of $289,000 on their invest-
ment of $599,000, a return of 48%.
This action was commenced in January 1971 against
certain general partners of FBA (the petitioners here) and
4
the firm of accountants that prepared FBA’s financial state-
ments for the years 1966, 1967 and 1968. Respondents
claim (i) that petitioners omitted disclosure of the fact that
FBA’s investments had, since January 1967, included un-
registered securities, and (ii) that had they known of such
investments they would have withdrawn from FBA in Sep-
tember 1968, when their proportional share of FBA’s assets
reached peak value. Respondents claim they would have
thus realized an additional net profit of $1,254,800. Re-
spondents sued under § 10(b) of the Securiticts Exchange
Act of 1934 and § 206 of the Investment Advisers Act of
1940, seeking as damages the difference between what they
realized on withdrawal in 1970 and what they would have
realized had they withdrawn in 1968.*
The District Court granted petitioners’ motions for sum-
mary judgment on the ground that respondents had sus-
tained no damages (A65-74).
On appeal, the Court of Appeals unanimously affirmed
the dismissal of respondents’ claim under § 10(b) and Rule
10b-5, not because of failure to allege compensable dam-
ages, but because of failure to allege fraud in connection
with the purchase or sale of a security (A12):
“(T]he requirement of fraud in connection with the
purchase or sale of a security is not satisfied by an
allegation that plaintiffs were induced fraudulently
not to sell their securities. Blue Chip Stamps v.
Manor Drug Stores, 421 U.S. 723, 737-38 (1975).”
Nonetheless, the Court of Appeals (2-1; Gurfein, J., dis-
senting on this point) held that respondents had an implied
right of action for damages under § 206 of the Advisers
8 Jurisdiction was allegedly based on 15 U.S.C. §78aa and 15
U.S.C. § 80b-14.
ee Peer e
;
;
:
2
sf
:
5
Act, the first Court of Appeals to do so. The majority,
ignoring the characteristics of this closely held, predomi-
nantly family investment partnership, further held that the
general partners were “investment advisers” * to the limited
partners, because they “managed the funds of others for
compensation” (A15). Finally, the majority disregarded
respondents’ enormous profits and the absence of any out-
of-pocket loss and fashioned an ad hoc measure of damages
to be applied by the District Court on remand (A32-33).
In a vigorous dissent (A34-49), Judge Gurfein pointed
out that the legislative history of the Advisers Act reveals
that the Act “ ‘represented a compromise between the SEC
and the investment advisory industry’” (A35) and in no
manner supports implication of a private action for dam-
ages:
“The legislative history of the Advisers Act in-
dicates that it was a tentative attempt to effect a
‘compulsory census’ of investment advisers by re-
quiring registration rather than to provide a full
regulatory scheme.” (A35)
* * *
“The attempted withholding of jurisdiction over
actions at law in the Advisers Act [by Congress’
deletion of any reference to ‘actions at law’ in § 214,
the jurisdictional section] indicates that Congress
was not intending to provide for any liability beyond
injunctive relief.” (A37) (footnote omitted )
* * >
“(The fact that, in contrast to each of the other
securities acts, Congress did not] provide for any
express civil liability in damages . . . indicates
rather that, in its cautious approach to the regula-
4“Investment adviser” is defined by § 202(a)(11) of the Advisers
Act, 15 U.S.C. § 80b-2(a) (11).
6
tion of investment advisers, Congress was not yet
ready to impose any civil liability for damages.”
(A38-39)
The dissent also voiced concern that the court was creating
a “claim for relief by judicial legislation, without the ability
to define the outer limits of such a claim” (A44). The
absence of such limits, the dissent stated, creates a
“distinct danger that, by implying an open-ended
private right of action, the court is giving the clients
of investment advisers carte blanche to convert them-
selves from victims to defrauders.” (A45)
* * *
“Implying a claim for relief without limitation will
encourage actions against investment advisers for
poor judgment, disguised by pleadings subtly im-
plying fraud and deceit.” (A48)
Finally, noting that the majority was affirming the dismissal
of respondents’ claim under § 10(b) of the 1934 Act be-
cause of their failure to satisfy the “purchase or sale”
requirement reaffirmed by Blue Chip Stamps, the dissent
urged that the Court
“ought instead to leave the issue to Congress. To
create an analogue to Section 10(b) without the re-
quirement that the ‘fraud’ be ‘in connection with
the purchase or sale’ of a security hardly gives
broad effect to the policy considerations so clearly
expressed in the majority opinion of the Supreme
Court in Blue Chip Stamps and in Mr. Justice
Powell’s concurring opinion... . The majority
specifies no limits to the civil liability under § 206
which it is in the process of creating over this dis-
sent. Yet, it is simply extending 10b-5 by resort to
a different statute.” (A47)
Petitions for rehearing, with suggestions for rehearing in
banc, were filed on three issues: (1) the implication of a
bein + a oemneit td
7
private right of action under § 206, (2) the holding that
FBA’s general partners were investment advisers, and (3)
the measure of “damages.” Rehearing was granted in part
to allow further supplemental briefs from the parties and
the SEC only on the second issue. After receiving the
additional briefs the majority adhered to its holding that
the general partners are “investment advisers” but withdrew
its earlier conclusion that they were advisers “to the limited
partners” rather than the partnership itself (A51). In all
other respects the petitions for rehearing were denied.
Reasons for Granting the Writ
This case, which has been in the federal courts since
1971, raises questions that the lower federal courts, the
SEC, and the investment community have all recognized
to be novel and important. The issue of an implied right
of action under § 206 has now been considered by sharply
divided panels of two Courts of Appeals,° is awaiting decision
5 Eight entities in addition to the SEC filed briefs amicus curiae,
either contemporaneously with the petitions for rehearing or the sup-
plemental briefs on rehearing, or both: (1) Investment Asso-
ciation (the industry organization whose counsel had drafted the bill
enacted as the Advisers Act in 1940), in opposition to the implication
of a private right of action under the Advisers Act; and (2) Stein-
hardt, Berkowitz & Co.; (3) A.W. Jones & Associates; (4) A.W.
Jones Company; (5) Avalon; (6) Euclid Partners; (7) Goodnow,
Gray & Co.; and (8) Jubilee, all in opposition to the holding that
general partners of investment partnerships are investment advisers.
After rehearing was ted another entity, National Venture
Capital Association, t to file a brief amicus curiae on the latter
point, but was refused permission.
* The Fifth Circuit, relying on the decision below, recently deter-
mined, again over a vigorous dissent, that although Blue Chip Stamps
barred plaintiff's 10b-§ claim, he nonetheless had an implied right of
action for damages under § 206. Wilson v. First Houston Investment
Corp., 566 F.2d 1235 (Sth Cir., Feb. 2, 1978).
after argument in a third,’ and seems likely to trouble the
federal courts for years, unless resolved now by this Court.*
The decision below implied a right of action in dis-
regard of the Act’s distinctive legislative history and the
policy considerations enunciated by this Court in Blue
Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975).
In doing so, the court created an open-ended cause of action
for damages against “investment advisers,” expansively
construed by the court to include even investors managing
their own funds in a common pool with the property of
family and friends. The majority opinion vests rights to
sue in a large and extremely ill-defined class of plaintiffs,
creates corresponding liabilities in a broadly defined class
of defendants, and leaves open many central questions the
resolution of which, even if possible, would burden the
federal courts for decades.’
7 Lewis v. Transamerica Corp., No. 75-1285 (9th Cir., docketed
1975) (argued May 12, 1977).
8 The district courts have divided on the issue: Sullivan v. Chase
Investment Services of Boston, 434 F.Supp. 171 (N.D.Cal. 1977)
(cause of action implied after dismissal of 10b-5 claim) ; Angelakis v.
Churchill Management Corp., [1975-1976 Transfer Binder] Fen.
Sec. L. Rep. (CCH) {95,285 (N.D.Cal. 1975) (cause of action
implied) ; Lewis v. Transamerica Corp., No. C 73-2180 (N.D.Cal.
1974) (“no Federal jurisdiction” and no right of action ; oral decision
by District Court, see transcript of argument held Sept. 27, 1974 at
10), appeal argued, No. 75-1285 (9th Cir., May 12, 1977) ; Bolger v.
Laventhol, Krekstein, Horwath & Horwath, 381 F.Supp. 260 (S.D.
N.Y. 1974) (cause of action implied) ; Greenspan v. del Toro, [1975-
1976 Transfer Binder] Fep. Sec. L. Rep. (CCH) § 95,488 (S.D.
Fla.) (no right of action), appeal dismissed for want of prosecution,
No. 74-2943 (5th Cir. 1974); Gammage v. Roberts, Scott & Co.,
[1974-1975 Transfer —— Fep. Sec. L. Rep. (CCH) { 94,760
(S.D.Cal. 1974) (no right of action).
® In addition to the lack of a “purchase or sale” limitation in actions
under § 206, and the overbroad construction of the defendant class,
the majority’s decision forbodes other areas of difficulty :
(footnote continued on following page)
9
The result is, as the dissent below noted, “a claim for
relief without limitation” (A44). This new claim is indeed
broader than any other right of action, express or implied,
under the federal securities laws. With or without judicial
definition, it will necessarily result in an “inexorable broad-
ening of the class of plaintiffs who may sue.” Blue Chip
Stamps, supra at 747-48. The full measure of this extension
of federal jurisdiction into an area of law traditionally
governed by state partnership and contract law cannot now
be known, but, according to the SEC, even this case—in
which respondents received a huge profit on their invest-
ment and allege no fraud in connection with the purchase
or sale of a security—“is not one that would test the outer
limits of the cause of action created by the antifraud pro-
visions of the federal securities laws” (SEC Br. 30 n.34).
The apparent expectation of the SEC is that this right of
action, like the right of action under Rule 10b-5 so aptly
(footnote continued from preceding page)
Virtually Boundless Plaintiff Class. Section 206 applies not
only to clients of investment advisers but also to “prospective
clients,” an undefined and as yet unconstrued term. Moreover,
by excising from its opinion the statement that the general
partners were investment advisers “to the limited partners”
ae modifying Al9 n.16), the majority appears to hold
i) that the partnership, not the limited partners thereof, was
the “client,” and (ii) that the class of plaintiffs extends to
non-client individuals with some interest in an advised “client”
who sue, not derivatively, but in their own right.
_ Overbroad Construction of Advisers’ Duty. Although § 206
imposes a duty on investment advisers to refrain from “fraudu-
lent, deceptive or manipulative” conduct, the majority below has
created a right of action under § 206 in which nondisclosure is
the gravamen of the complaint.
Recovery for Negligent Misstatement. Likewise, claimants
under § 206 may not be required to prove sciénter ; Rule 206(4)-
1(a) ( ), 17 C.F.R. § 275.206(4)-1(a)(5), appears to define
any “untrue statement” in any “advertisement” (a broadly de-
fined term, see Rule 206(4)-1(b)) to be, whether or not inten-
tional, a “fraudulent, deceptive, or manipulative act, practice or
course of business... .”
10
described by this Court, may someday become “a judicial
oak which has grown from little more than a legislative
acorn.” Blue Chip Stamps, supra at 737.
“The starting point in every case involving construction
of a statute is the language itself.” Blue Chip Stamps, supra
at 756 (Powell, J., concurring). In the case of the Advisers
Act, the unmistakably distinctive language of the jurisdic-
tional section, § 214, especially when read against the back-
ground of the Act’s legislative history, demonstrates a clear
Congressional intent to deny implied actions for damages
under the Act. See generally Cort v. Ash, 422 U.S. 66, 78
(1975).
Section 214 of the bill finally enacted by Congress in
1940, unlike the earlier drafts submitted by the SEC and
others, and unlike every other federal securities act,’® does
not confer jurisdiction on the district courts to hear “actions
at law brought to enforce any liability or duty created by”
the Act. The district courts are granted only jurisdiction to
hear criminal prosecutions and “suits in equity to enjoin
any violation of this subchapter.” The deliberate omission
of the words “actions at law” and the use of the word “vio-
lation” rather than “liability” can only be construed as
limiting the jurisdiction of the federal courts under § 206
to criminal prosecutions and SEC enforcement proceedings.
Since 1940, Congress has foregone at least three oppor-
tunities to include a provision for civil liability. As recently
10 Securities Act of 1933, Section 22, 15 U.S.C. §77v; Securities
Exchange Act of 1934, Section 27, 15 U.S.C. § 78aa; Public Utility
Holding Company Act of 1935, Section 25, U.S.C. §79y; Trust
Indenture Act of 1939, Section 322, 15 U.S.C. § 77vvv; and Invest-
ment Company Act of 1940, Section 44, 15 U.S.C. § 80a-43.
se
11
as 1975, Congress declined to act on a recommendation by
the SEC that it reinsert the “actions at law” language deleted
from the early drafts in 1940. Congressional intent has
rarely been clearer.
A. 1940
The legislative record demonstrates Congress’ recognition
that in 1940 it knew very little about the “investment coun-
sel” profession, even after a brief study by the SEC and
Congress." The “basic approach” of the Act was, in the
words of the chief counsel to the SEC study, a “compulsory
census” designed only to reveal the identity, number and
general activities of those who receive compensation for
advising others concerning securities transactions.” The
11 The majority below refers to “exhaustive studies” and “extensive
reports” (A15) by the SEC that preceded enactment of the Invest-
ment Company Act and Investment Advisers Act, which were passed
as Titles I and II of the same bill, but fails to note that only 70 of
5,335 pages of SEC reports, and only 72 of 1,276 pages of testimony
before Congressional committees concerned Title II, the Advisers
Act. (Compilation of reports appears at Investment Trusts and
Investment Companies: Hearings on S. 3580 Before a Subcomm. of
the Senate Comm. on Banking and Currency, 76th Cong., 3d Sess.
(1940) [hereinafter “Senate Hearings’’| at 307; Advisers Act testi-
mony appears at Investment Trusts and Investment Companies:
Hearings on H.R. 10065 Before a Subcomm. of the House Comm. on
Interstate and Foreign Commerce, 76th Cong., 3d Sess. (1940)
[hereinafter “House Hearings” at 86-93, and Senate Hearings at
47-51, 318-21, 711-64, 1124)
12 David Schenker, chief counsel to the SEC’s study of investment
trusts and investment companies, testified in the Senate hearings:
“Therefore, our fundamental approach to this problem is in
the first instance, before we could intelligently make an a
praisal of the economic function or of the abuses which might
exist in that type of organization, to see if we could not get
something which approximated a compulsory census. Funda-
mentally that is the basic approach of title 2 [the Advisers
Act]. We first would like to find out how many people are
engaged in this business, what their connections are, what is
the extent of their authority, what is their background, who
they are, and how they handle the people’s funds?” Senate
Hearings at 48 (emphasis added).
12
SEC was given customary enforcement powers, and a gen-
eral antifraud provision, § 206, was included, but in con-
trast to every other federal securities statute the Advisers
Act was enacted without any provision for civil liability.
The original draft bill would have conferred district
court jurisdiction over “actions at law”; early drafts and
committee prints incorporated by reference the jurisdictional
section (§ 25) of the Public Utility Holding Company Act
of 1935, which includes the “actions at law” language.”
However, the industry voiced strong opposition to the early
drafts and, after a three-week hiatus in the hearings during
which SEC and industry representatives met and negotiated,
the industry submitted a draft of its own. That draft,“* which
was accepted by the SEC and enacted by Congress,” for
18 See, e.g., S. 3580, 76th Cong., 3d Sess 98 (introduced by Sen.
Wagner on March 14, 1940) ; H.R. 8935, 76th Cong., 3d Sess. 98
(introduced by Cong. Lea on March 14, 1940).
14 The industry draft was incorporated into a committee print:
STAFF OF SENATE COMM. ON BANKING AND CuRRENCY, 76TH
Conc., 3p Sess., S. 3580 at 135-36 (Comm. Print, May 24, 1940).
15 Although the industry had cooperated with the SEC throughout
the SEC study (Senate Hearings at 41), there was no agreement on
the first draft bill submitted by the SEC to Congress (id. at 41-42,
175, 345) ; there was, in fact, vehement industry sition (House
Hearings at 88-90, 92; Senate Hearings at 712-23, 737-54). ring
a three-week period (86 Conc. Rec. 10069 (remarks of Senator
Wagner) ) following the April hearings, representatives of industry
negotiated changes in the proposed bill (House Hearings at 88-90,
92; S. Rep. No. 1775, 76th Cong., 3d Sess. 21 (1940).
Finally, it was the industry draft of Title II, the Advisers Act,
that Congress enacted. The chief counsel to the SEC study testified
at the conclusion of the Senate Hearings:
“In connection with the investment advisers, I think that
Robert Page who represented Scudder, Stevens & Clark .. .
submitted a draft of the bill to us, which is the draft that is
included in this new bill.” Senate Hearings at 1124.
See D. Rogers, A Brief History of the Investment Counsel Associa-
tion ( ty 1975) (unpublished draft at Investment Counsel Associa-
tion, 127 East 59th Street, New York, New York).
a °
13
the first time omitted the critical language conferring on
the district courts jurisdiction to hear “actions at law
brought to enforce any liability or duty created by” the Act.
B. 1960
After consideration of “[e]xtensive proposals” submitted
by the SEC in 1960,"* Congress amended the Advisers Act,
but only to strengthen the Commission’s enforcement
powers. No change was proposed or effected in § 214.”
C. 1970
Again in 1970, while amending the Advisers Act and
while adding to the Investment Company Act a strictly
limited, express right of action against investment advisers
to mutual funds (§ 36(b) ), Congress refrained from adding
a right of action under the Advisers Act against other invest-
ment advisers generally.
D. 1975
Finally, in 1975, just three weeks after the Court of
Appeals requested the parties to this case, and the SEC as
16S. Rep. No. 1760, 86th Cong., 2d Sess. 2 (1960). The amend-
ments to the Advisers Act effected 19 changes in 11 of the Act’s 21
sections.
The Senate report emphasized once again the extremely limited
scope of the Advisers Act:
“The Investment Advisers Act of 1940 was passed as title II
of the bill of which title I was the Investment Company Act.
Unlike other Federal securities statutes, it has few substantive
or regulatory provisions. Modeled somewhat on the broker-
dealer registration provisions of the Securities Exchange Act
of 1934, it resembles a continuing census of the Nation’s in-
(1900). advisers.” S. Rep. No. 1760, 86th Cong., 2d Sess. 2
17 Even though the question of jurisdiction had been raised in 1957
in an action in which the SEC had filed an amicus brief supporting
recognition of private actions. Hu/! v. Newman, Kennedy & Co.,
- (1988). (S.D.N.Y. 1957) (settled) ; see 24 SEC Ann. Rep.
14
amicus, to file briefs on the Advisers Act questions raised
in this action (A75-78), the SEC proposed to Congress
that it reinsert the very words, “actions at law brought to
enforce any liability or duty created by”, that were deleted
from early drafts of the bill in 1940. Investment Advisers
Act Release No. 491 (December 15, 1975), [1975-1976
Transfer Binder] Fep. Sec. L. Rep. (CCH) 4 80,341. Al-
though hearings were held on the SEC’s proposals, and
testimony was received on the proposed amendment to
§ 214,"* Congress failed to act on the proposals. The
proposals have not been resubmitted by the SEC.
* * *
The majority below attempted to explain the deletion
from § 214 as follows:
“Appellees argue that the omission of any refer-
ence to ‘actions at law’ in Section 214 manifests a
legislative intent to preclude private rights of action
under the Advisers Act. We disagree. In our view,
the reason for this omission is that each of the other
Acts whose jurisdictional provisions refer to ‘actions
at law’ contains one or more sections expressly
granting injured parties a private right of action for
damages. There is no provision in the Advisers Act
18 Investment Advisers Act Amendments: Hearings on S. 2849
Before the Subcomm. on Securities of the Senate Comm. on Banking,
Housing and Urban Affairs, 94th Cong., 2d Sess. (1976) ; Invest-
ment Advisers Act Amendments: Hearings on H.R. 13737 Before
the Subcomm. on Consumer Protection and Finance of the House
1976) on Interstate and Foreign Commerce, 94th Cong., 2d Sess.
In his testimony before the Senate committee, Mr. John I. Casey,
chairman of the Investment Counsel Association, objected to the
enactment of a private right of action without limits similar to those
in § 36(b) of the Investment Company Act of 1940. Mr. Casey
submitted to the Senate committee certain legislative history materials
showing the deletion of the “actions at law” language from early
drafts of the bill in 1940.
ae Prey ee
15
which expressly provides for private actions; since
it is a less complex statute, containing no express
grants of right of action to private parties, a refer-
ence to ‘actions at law’ would be superfluous.”
(A25) (footnote omitted)
With all due respect to the majority below, that is no ex-
planation. The intentional omission of express rights of
action and of a jurisdictional grant for actions at law is no
basis for implying both such provisions in the statute.
The holding of the Court of Appeals that an action for
money damages should be implied is directly contrary to
this Court’s instruction in National Railroad Passenger
Corp. v. National Ass’n of Railroad Passengers, 414 U.S.
453, 458 (1974) that “ ‘[w]hen a statute limits a thing to
be done in a particular mode, it includes the negative of
any other mode,’” quoting Botany Mills v. United States,
278 U.S. 282, 289 (1929). When Congress limited relief
under the Advisers Act to equitable relief, “it include[d]
the negative of any other mode”, monetary liability. This
rule of statutory construction should yield only “to clear
contrary evidence of legislative intent.” 414 U.S. at 458.
In the case of the Advisers Act, no contrary legislative intent
whatever is found, either in 1940 or in the 38 succeeding
years.
Compounding the majority’s error in misreading legis-
lative history * is its failure to heed the recent decisions
19 The panel below employed the same method of legislative history
analysis it had adopted in Chris-Craft Industries, Inc. v. Piper
Aircraft Corp., 480 F.2d 341 (2d Cir. 1973), rev'd, Piper v. Chris-
Craft Industries, Inc., 430 U.S. 1 (1977).
(footnote continued on following page)
16
of this Court that counsel caution and restraint in the
creation and application of implied rights of action. See
Blue Chip Stamps, supra (reaffirms “purchase or sale” re-
quirement to prevent the “danger of vexatious litigation
which could result from a widely expanded class of plain-
tiffs under Rule 10b-5”); Ernst & Ernst v. Hochfelder, 425
U.S. 185 (1976) (dismisses Rule 10b-5 claim alleging
negligent failure to discover and disclose in light of legis-
lative history indicating requirement of some element of
scienter); Santa Fe Industries, Inc. v. Green, 430 U.S. 462
(1977) (refuses to “federalize” state corporation law that
deals with transactions in securities to serve “what is ‘at
best a subsidiary putpose’ of the federal legislations”);
Piper v. Chris-Craft Industries, Inc., 430 U.S. 1 (1977)
(analysis of the four factors enunciated in Cort v. Ash
leads to conclusion that private right of action under
§ 14(e) of 1934 Act not necessary to effectuate Congress’
goals); Securities Investor Protection Corp. v. Barbour,
421 U.S. 412 (1975) (express statutory provision for one
form of proceeding “ordinarily implied that no other means
of enforcement was intended by the Legislature”). Al-
though the majority cites Cort v. Ash in passing, it totally
(footnote continued from preceding page)
In Chris-Craft, it wrote:
“We will not infer from the silence of the statute that Congress
intended to deny a federal remedy ... .” 480 F.2d at 360-61.
Two days after this Court issued its opinion in Chris-Craft re-
versing the Court of Appeals, the same panel, this time with Judge
Gurfein in dissent, wrote in this action:
“We hesitate to reach such a result [failure to recognize a
right of action] absent clear evidence from the Act’s legislative
history that private actions were not intended.” (A23)
17
omits any point-by-point discussion of its four criteria,”
as Judge Gurfein points out in dissent (A39-40).
As this Court stated recently in Piper v. Chris-Craft In-
dustries, Inc., 430 U.S. at 26, the courts “must be wary
against interpolating [their] notions of policy in the inter-
stices of legislative provisions,” quoting Scripps-Howard
Radio v. FCC, 316 US. 4, 11 (1942).
20 Cort v. Ash, 422 U.S. 66, 78 (1975), cites four specific factors
“relevant” to the determination “whether a private remedy is implicit
in a statute not expressly providing one” :
“First, is the plaintiff ‘one of the class for whose especial benefit
the statute was enacted’?” While the clients of investment advisers
were intended to be protected by the Act, the legislative history, see
Point II, supra, also demonstrates that the Act was drafted to protect
the advisers themselves from the abuses of unbridled regulatory
oe. See, e.g., H.R. Rep. No. 2639, 76th Cong., 3d Sess. 28, 30
(1940).
“Second, is there any indication of legislative intent, explicit or
implicit, either to create such a remedy or to deny one?” The dis-
cussion in Point II and Judge Gurfein’s dissent show that “there
is implicit legislative intent to deny such a remedy” (A40).
“Third, is it consistent with the underlying purposes of the legisla-
tive scheme to imply such a remedy for the plaintiff?’ As Judge
Gurfein stated
“Analytically, it would be equally proper to say that impli-
cation of a private action under the Advisers Act is not ‘con-
sistent with the underlying — of the legislative scheme.’
Cort, supra, at 78. For though such a remedy may be con-
sistent with the goal of protecting customers of investment
advisers, it is hardly consistent with the desire not to subject
advisers to a liability, at least, until further study by
Congress.” (A40 n.9)
Fourth, “is the cause of action one traditionally relegated to state
law, in an area basically the concern of the States, so that it would
be inappropriate to infer a cause of action based solely on federal
law?” ‘There is of course nothing uniquely federal about an action
based in fraud, such as an action under § 206 would be.
18
IV
Persons who, like the petitioner general partners, manage
private and family investments in the partnership form in-
volving a substantial portion of their personal assets have
never been considered to be engaged in the “business of
advising others” so as to render them “investment advisers”
subject to the Advisers Act.”* Under partnership law, gen-
eral partners of a limited partnership are vested with full
title to the partnership estate, assume the risks of all liabili-
ties of the partnership and are legally charged with the
management of the partnership assets. As to the manage-
ment of the partnership estate, the general partners cannot
21 Early rulings of the full Commission and subsequent judicial
decisions citing those rulings have firmly established the rule. See, e.g.:
In the Matter of Roosevelt & Son, Investment Advisers Re-
lease No. 54 (September 2, 1949), 29 S.E.C. 879, [1948-1952
Transfer Binder] Fep. Sec. L. Rep. (CCH) { 76,016 (general
partners of non-public, predominantly family investment advice
vehicle, who had own assets under management and who would
serve as trustees of advised trusts not advisers under the Act) ;
In the Matter of the Pitcairn Company, Investment Advisers
Act Release No. 52 (March 7, 1949), 29 S.E.C. 186, [1948-1952
Transfer Binder] Fev. Sec. L. Rep. (CCH) § 75, (private,
family investment manager that never solicited public “clients”
not adviser under the Act) ;
In the Matter of Loring, Investment Advisers Act Release No.
33 (July 22, 1942), 11 S.E.C. ores toe Transfer Binder]
Fep. Sec. L. Rep. (CCH) § 75, (trustee “holds legal title
to the property and acts as principal” ; compensated trustee not
investment adviser under the Act) ;
In the Matter of Donner Estates, Inc., Investment Advisers
Act Release No. 21 (November 3, 1941), 10 S.E.C. 400, [1941-
1944 Transfer Binder] Fev. Sec. L. Rep. (CCH) {75,216
(private, predominantly family investment vehicle ; corporation,
which was owned by and advised separate trusts established for
family and non-family trusts, not adviser under the Act) ;
Selzer v. Bank of Bermuda Ltd., 385 F. Supp. 415, 420
(S.D.N.Y. 1974) (a “trustee acts himself as principal,” he “does
not advise the trust corpus, which then takes action pursuant to
his advice” ; compensated trustee not investment adviser under
the Act, citing Loring, supra).
19
as a matter of law be construed as being “in the business
of advising others”.
Under the rationale of the majority opinion below, not
only general partners of investment partnerships but every
compensated trustee, executor and other fiduciary with
discretionary investment powers would be deemed an “in-
vestment adviser.” Such a momentous result would be
worked in the complete absence of any evidence of con-
gressional intent to regulate with so broad a sweep, and in
derogation of the SEC’s own rulings, which have consistently
interpreted “investment adviser” to exclude persons, like
FBA’s general partners, who do not solicit funds of the
public, do not hold themselves out to the general public as
offering investment advice, and limit their activities to man-
aging private investment entities for themselves, their fami-
lies and friends.
V
The measure of damages fashioned by the Court of Ap-
peals conflicts with the basic rule of damages under the
federal securities laws.”
22 See, e.g., Harris v. American Investment Company, 523 F.2d
220 (8th Cir. 1975), cert. denied, 423 U.S. 1054 (1976); Wolf v.
Frank, 477 F.2d 467 (5th Cir.), cert. denied, 414 U.S. 975 (1973) ;
Levine v. Seilon, 439 F.2d 328 (2d Cir. 1971) ; Janigan v. Taylor,
344 F.2d 781 (1st Cir.), cert. denied, 382 U.S. 879 (1965) ; Kohler
v. Kohler Co., 208 F.Supp. 808 (E.D. Wisc. 1962), aff'd, 319 F.2d
634 (7th Cir. 1963); Estate Counseling Service, Inc. v. Merrill
Lynch, Pierce, Fenner & Smith, Inc., 303 F.2d 527, 533 (10th
Cir. 1962). Even those courts which have held that a private
right of action for exists under Section 206 of the Advisers
Act have never implied that the measure of damages under that
section would be different from the measure of damages applicable in
other antifraud provisions of the federal securities laws. See discus-
sion of Judge Carter in Abrahamson v. Fleschner (A65-74). See also
ia) v. Walston & Co., Inc., 340 F.Supp. 1076, 1093 (S.D.N.Y.
1 ,
20
The measure of damages adopted by the Court of
Appeals in this case will permit plaintiffs to select or “frac-
tionate” their investments, i.e., to isolate securities on which
profits are reaped from those on which there are losses, in
calculating damages—a procedure which another panel of
the same Court of Appeals expressly condemned. Byrnes
V. Faulkner, Dawkins & Sullivan, 550 F.2d 1303 (2d Cir.
1977).* Courts in other circuits hold that any losses suf-
fered by a plaintiff on an investment must be offset by any
gains realized. Esplin v. Hirschi, 402 F.2d 94, 105 (10th
Cir, 1968), cert. denied, 394 U.S. 928 (1969); Schaefer v.
First National Bank, 326 F.Supp. 1186 (N.D. Ill. 1970),
appeal dismissed, 465 F.2d 234 (7th Cir. 1972); Richard-
son V. MacArthur, 451 F.2d 35, 44 (10th Cir. 1971);
Garnatz V. Stifel, Nicolaus & Co., 559 F.2d 1357 (8th Cir.
1977). If the result is a net profit, a claimant should have
no actionable claim for damages under the federal securities
laws. Wolf v. Frank, 477 F.2d (Sth Cir.), cert. denied,
414 U.S. 975 (1973); Levine v. Seilon, 439 F.2d 328,
334-35 (2d Cir. 1971); Ferschtman v. Schectman, 450
F.2d 1357, 1361 (2d Cir. 1971).
*8 The irreconcilable conflict which exists between the decision of
the Court of Appeals in the Abrahamson case and the decisions of
other courts involving the measure of damages under the antifraud
provisions of the federal securities laws is best illustrated by a com-
parison of the decisions of the Second Circuit in Abrahamson and
Byrnes, supra. Abrahamson was decided on February 25, 1977,
Byrnes, on March 1, 1977. In Byrnes, the Court of Appeals, citing
the District Court’s opinion in this case, denied a claim for s
under the federal securities laws where the claimant attempted to
isolate prospective losses from prospective gains:
“Thus, far from suffering a proximate loss from the acts of
ts, see Herpich v. Wallace, 430 F.2d 792, 810 (5th
ir. 1970), Faulkner was benefitted overall by them. For
damages purposes under the Exchange Act, the transaction
cannot be fractionated, since otherwise ‘actual s on
account of the act complained of’ would be exceeded. See
Abrahamson v. Fleschner, 392 F.Supp. 740, 746-47 (S.D.N.Y.
1975).” 550 F.2d at 1314.
21
The novel measure of damages fashioned by the Court
of Appeals here can only assure a flood of claims under the
Advisers Act by claimants who, as respondents do here,
allege in hindsight that they “would have” made more
money had they withdrawn at the height of the market.
CONCLUSION
For the foregoing reasons, a writ of certiorari should
issue to the United States Court of Appeals for the Second
Circuit.
Respectfully submitted,
RICHARD E. CARLTON
125 Broad Street
New York, New York 10004
Counsel for Petitioners
Fleschner, Becker and
Fleschner Becker Associates
Davip M. OLASOV
ROBERT D. OWEN
SULLIVAN & CROMWELL
Of Counsel
MARK M. JAFFE
One World Trade Center
New York, New York 10048
Counsel for Petitioner Ehrlich
ALLAN J. GRAF
HILL, Betts & NASH
Of Counsel
March 14, 1978
Text of Statutes Involved
Section 206 of the Investment Advisers Act of 1940,
54 Stat. 852, as amended, 74 Stat. 887, 15 U.S.C. § 80b-6,
provides:
PROHIBITED TRANSACTIONS By
REGISTERED INVESTMENT ADVISERS
Sec. 206. It shall be unlawful for any investment
adviser, by use of the mails or any means or instru-
mentality of interstate commerce, directly or indi-
rectly—
(1) to employ any device, scheme, or artifice to
defraud any client or prospective client;
(2) to engage in any transaction, practice, or
course of business which operates as a fraud or
° A P P E N D I Xx | deceit upon any client or prospective client;
(3) acting as principal for his own account,
knowingly to sell any security to or purchase any
security from a client, or acting as broker for a
person other than such client, knowingly to effect
any sale or purchase of any security for the account
of such client, without disclosing to such client in
writing before the completion of such transaction
the capacity in which he is acting and obtaining
the consent of the client to such transaction. The
prohibitions of this paragraph (3) shall not apply
to any transaction with a customer of a broker or
dealer if such broker or dealer is not acting as an
investment adviser in relation to such transaction;
(4) to engage in any act, practice, or course of
business which is fraudulent, deceptive, or manipu-
lative. The Commission shall, for the purposes of
this paragraph (4) by rules and regulations define,
and prescribe means reasonably designed to pre-
vent, such acts, practices, and courses of business
as are fraudulent, deceptive, or manipulati¥e
A2
Text of Statutes Involved
Section 214 of the Investment Advisers Act of 1940,
54 Stat. 856, 15 U.S.C. § 80b-14, provides:
JURISDICTION OF OFFENSES AND SUITS
SEC. 214. The district courts of the United States
and the United States courts of any Territory or other
place subject to the jurisdiction of the United States
shall have jurisdiction of violations of this title or
the rules, regulations, or orders thereunder, and, con-
currently with State and Territorial courts, of all suits
in equity to enjoin any violation of this title or the
rules, regulations, or orders thereunder. Any criminal
proceeding may be brought in the district wherein
any act or transaction constituting the violation oc-
curred. Any suit or action to enjoin any violation of
this title or rules, regulations, or orders thereunder,
may be brought in any such district or in the district
wherein the defendant is an inhabitant or transacts
business, and process in such cases may be served in
any district of which the defendant is an inhabitant
or transacts business or wherever the defendant may
be found. Judgments and decrees so rendered shall
be subject to review as provided in sections 128 and
240 of the Judicial Code, as amended, and section 7,
as amended, of the Act entitled “An Act to establish
a court of appeals for the District of Columbia”,
approved February 9, 1893. No costs shall be as-
sessed for or against the Commission in any pro-
ceeding under this title brought by or against the
Commission in any court.
A3
UNITED STATES COURT OF APPEALS
For tHe Seconp Circuit
wow
=
No. 212—September Term, 1975.
(Submitted February 28, 1976*
Decided February 25, 1977.)
Docket No. 75-7203
-_ ==
ee
Rosert ABRAHAMSON and MarJorizE ABRAHAMSON,
Plaintiff s-A ppellants,
v.
Matcotm K. FLescHner, WituiAm J. Becker, Harowp B.
Exruicn, Leon Pomerance, FLescHNER Becker Asso-
crates, and Harry Goopkin & Company,
Defendants-A ppellees.
Before:
MANSFIELD, TIMBEs and GuURFEIN,
Circuit Judges.
-—_ =
ew
Appeal from judgment entered in the Southern District
of New York, Robert L. Carter, District Judge, 392 F.
Supp. 740, dismissing complaint, on cross-motions for sum-
mary judgment, in action to recover damages for alleged
violations of Section 10(b) of the Securities Exchange Act
of 1934 and Rule 10b-5 promulgated thereunder; and of
° See our interim opinion in this case. Abrahamson v. Fleschner, 537
F.2d 27 (2 Cir. 1975).
A4
Section 206 of the Investment Advisers Act of 1940 and
Rule 206(4)-1 promulgated thereunder.
Affirmed as to dismissal of the Securities Act claim; as
to dismissal of the Investment Advisers Act claim, re-
versed and remanded for trial.
wow
we
Ronatp H. Atensterx, New York, N.Y. (Ken-
neth A. Barry, and Shea Gould Climenko
Kramer & Casey, New York, N.Y., on the
brief), for Plaintiffs-Appellants Robert
Abrahamson and Marjorie Abrahamson.
Ricwarp E. Carttox, New York, N.Y. (Robert
D. Owen, James E. Tyrrell, and Sullivan &
Cromwell, New York, N.Y., on the brief),
for Defendants-Anpellees Malcolm K.
Fleschner, William J. Becker and Fleschner
Becker Associates.
Ricuarp G. McGanrenx, New York, N.Y. (Ken-
neth A. Sagat, and D’Amato, Costello &
Shea, New York, N.Y., on the brief), for
Defendant-Appellee Harry Goodkin & Com-
pany.
Marx M. Jarre, New York, N.Y. (Allan J.
Berdon, Joseph F. Aman, and Hill, Betts
& Nash, New York, N.Y., on the brief), for
Defendant-Appellee Harold B. Ehrlich.
Harvey L. Pitt, General Counsel, Paul Gonson,
Associate General Counsel, David J. Ro-
manski, Assistant General Counsel, James
H. Schropp, Attorney, SEC, Washington,
D.C., for Securities and Exchange Commis-
sion, Amicus Curiae.
eer
AS
Timbers, Circuit Judge:
Of the several questions presented under the antifraud
provisions of the federal securities laws, those under the
Investment Advisers Act of 1940 appear to be of first
impression at the appellate level.
The appeal is from a judgment entered in the Southern
District of New York, Robert L. Carter, District Judge,
392 F.Supp. 740, dismissing the complaint, on cross-motions
for summary judgment, in an action to recover damages
for alleged violations of Section 10(b) of the Securities
Exchange Act of 1934, 15 U.S.C. §78j(b)(1970), and of
Rule 10b-5 thereunder, 17 C.F.R. §240.10b-5 (1976); and
alleged violations of Section 206 of the Investment Ad-
visers Act of 1940, 15 U.S.C. §80b-6 (1970), and of Rule
206(4)-1 thereunder, 17 C.F.R. §275.206(4) (1976).
The essential questions presented and our rulings there-
on are as follows:
(1) Whether the complaint states a claim upon which
relief can be granted under Section 10(b) of the
1934 Act and Rule 10b-5.
We hold it does not.
(2) Whether defendants who are general partners of
the investment partnership are investment ad-
visers within the meaning of Section 202(a) (11)
of the Advisers Act.
We hold they are.
(3) Whether there is an implied private right of ac-
tion for damages under the Advisers Act.
We hold there is.
(4) Whether the complaint alleges compensable dam-
ages under the Advisers Act.
We hold it does.
A6
(5) Whether the complaint states a claim upon which
relief can be granted under Section 206 of the Ad-
visers Act and Rule 206(4)-1.
We hold it does.
We affirm the dismissal of the Exchange Act claim; but
as to the dismissal of the Advisers Act claim, we reverse
and remand for trial.
I. Facts
The following summary of the essential facts is believed
necessary to an understanding of our rulings on the ques-
tions presented. The facts are not in dispute.
Plaintiffs Robert Abrahamson and Marjorie Abraham-
son, husband and wife, were limited partners of defendant
Fleschner Becker Associates (FBA), an investment part-
nership, from its inception on July 1, 1965 until they with-
drew on September 30, 1970.
Defendants Malcolm K. Fleschner (Fleschner) and Wil-
liam J. Becker (Becker) are general partners of FBA.
Fleschner was its founder and has been a general partner
since its inception. Becker became a general partner on
April 1, 1966. Defendant Harold B. Ehrlich (Ehrlich) was
a general partner from October 1, 1968 through September
30, 1969. Defendant Harry Goodkin & Company (Good-
kin) is a firm of certified public accountants which audited
FBA’s books and certified FBA’s financial reports for the
fiscal years 1966, 1967 and 1968.
In late 1964 and in 1965 plaintiffs had several conversa-
tions with Fleschner who expressed his intention of form-
ing an investment partnership. He told plaintiffs that the
partnership would have a conservative investment policy.
! We assume familiarity with our prior opinion in this case, 537 F.2d
27, and that of the district court, 392 F.Supp. 740.
A7
Plaintiffs expressed their concern for financial security
and conservatism in their investments.
By a partnership agreement dated July 1, 1965, FBA
began as a small partnership. The original partners con-
sisted of one general partner (Fleschner) and eight lim-
ited partners (plaintiffs, four members of Fleschner’s
family and two others). Plaintiffs’ initial contribution was
$150,000.
FBA grew rapidly. By April 1, 1966 it had two general
partners and thirty-five limited partners; and by October
1, 1968 it had three general partners and sixty-six limited
partners. Each partner had an account which represented
the appreciated value of his contributions to the pooled
funds, less withdrawals and certain fees. By October 1,
1968 FBA’s assets were approximately $60 million.
For managing the partnership investments, the general
partners received substantial fees. They were paid 20% of
FBA’s net profits and net capital gains for each fiscal year.
In addition, the partnership agreement of October 1, 1968
provided for an annual salary of $25,000 for each general
partner who managed the partnership’s investments.
The limited partners did not participate in managing the
partnership’s investments. A limited partner could with-
draw all or part of the balance in his capital account at
the end of any fiscal year (September 30), provided that
he gave the required advance notice. Prior to October 1,
1968, 30 days notice was required; thereafter, 60 days no-
tice was required. There were similar notice requirements
for withdrawal from membership in the partnership.
With the increase in the number of limited partners and
the concomitant increase in the size of the firm’s assets,
certain changes were made in the structure of the partner-
ship. The original July 1, 1965 partnership agreement was
superseded by a new agreement dated April 1, 1966 which
in turn was superseded by the October 1, 1968 agreement.
A8
The principal change effected by the 1966 agreement was
the addition of Becker as a general and managing partner
and the inclusion of additional limited partners. The 1968
agreement, in addition to authorizing salaries of $25,000
per year for those general partners who managed the
partnership’s investments, included Ehrlich as a general
partner; added a large number of limited partners; ex-
panded and detailed the stated purposes of the partner-
ship; and made a number of other changes referred to
below.
During the period plaintiffs were limited partners of
FBA the general partners mailed monthly reports to all
of the firm’s limited partners. These reports Were concise,
two paragraph statements which set forth the percentage
increase or decrease in the value of the firm’s investments
for the year to date and compared this performance with
Standard & Poors 500 Stock Average.
The reports also included statements of the firm’s in-
vestment policy. Between November 1967 and April 1968
the reports repeatedly represented that FBA was maintain-
ing a “low risk stance” and “a most conservative posture.” ?
In addition to the monthly reports, during 1967 and 1968
Goodkin mailed to the limited partners certified year end
financial reports. These financial reports included balance
sheets which showed the total of FBA’s investments in
securities. The balance sheets of September 30, 1967 and
September 30, 1968 did not disclose that the firm was in-
vesting in unregistered securities.* Investments in such
securities were included in the aggregate of all portfolio
investments. The value of FBA’s total investments in se-
2 For examples of these representations in the monthly reports, see the
district court opinion, 392 F.Supp. at 742 n. 2.
3 Unregistered securities are securities which are not registered with the
Securities and Exchange Commission. They have only a limited market
and are subject to restrictions as to further sale.
A9
curities was denominated as the “market value” of the
securities.
Despite the representations in the monthly reports that
F'BA’s investments were most conservative and of low risk,
between September 1967 and September 1968 the firm in-
creased its investments in unregistered securities from
approximately 15% to approximately 72% of its portfolio.
Between September 1968 and September 1969 the firm’s
investments in unregistered securities fluctuated from
about 72% to 88% of its portfolio. During this latter
period the monthly reports continued not to disclose the
firm’s sizable investments in unregistered securities.
In either December 1969 or January 1970 plaintiffs re-
ceived the financial report for the fiscal year ending Sep-
tember 30, 1969. This report was not prepared by Goodkin,
but by another accounting firm. A footnote to this report
disclosed that approximately 77% ($30,411,868) of FBA’s
total investments in securities ($39,355,310) consisted of
unregistered securities. The firm’s total assets as of Sep-
tember 30, 1969 were $51,747,995.
Plaintiffs first learned of FBA’s substantial investments
in unregistered securities from the September 30, 1969 re-
port. Having received this report in December 1969 or
January 1970, it was too late for them to withdraw from
the firm, in accordance with the partnership agreement, at
the end of the fiscal year which ended September 30, 1969.
Plaintiffs did withdraw at the end of the following fiscal
vear, on September 30, 1970. This was the earliest they
could withdraw their investments or as partners under the
terms of the partnership agreement.
4 In their complaint in the instant action, plaintiffs alleged that during
the period they were limited partners the firm made between 40 and 80
separate purchases of unregistered securities, including the securities of
more than 40 different issuers. They alleged that most of these purchases
took place after 1967.
Al0
During the five year period they were limited partners,
both plaintiffs received substantial net profits.’ Robert
Abrahamson realized a net profit of $156,097; Marjorie
Abrahamson a net profit of $133,081.35.
Both plaintiffs claim that as of late 1968 their invest-
ments were worth considerably more than indicated by the
firm’s financial reports, and that the firm incurred sub-
stantial losses on its investments in unregistered securi-
ties. Without apportioning between losses sustained from
investments in unregistered securities and other losses,‘
Robert Abrahamson claims that between September 30,
1968 and the date of his withdrawal his capital account
sustained losses totalling $454,979. Marjorie Abrahamson
claims total losses of $799,821 during this period.
Plaintiffs commenced the instant action in the Southern
District of New York on January 25, 1971. Jurisdiction
was invoked under Section 37 of the Exchange Act, 15
U.S.C. §78aa (1970), and Section 214 of the Advisers Act,
15 U.S.C. §80b-14 (1970). The complaint embodies the
claims stated above and summarized in our prior opinion.
537 F.2d 27.
Both sides having moved for summary judgment, Judge
Carter on March 4, 1975 filed an opinion, 392 F.Supp. 740,
granting defendants’ motions and denying plaintiffs’ mo-
tion. Without reaching the merits of plaintiffs’ claims
under either the Exchange Act or the Advisers Act, the
judge held that, since plaintiffs had realized a net profit
5 See the schedule set forth in the district court opinion, 392 F.Supp. at
743, showing plaintiffs’ capital contributions, interim withdrawals, final
distributive shares and net profits.
6 Plaintiffs claim that they are entitled to recover the difference be-
tween what they received when they withdrew from the partnership in
1970 and what they would have received had they withdrawn as of Sep-
tember 30, 1968. Accordingly they did not attempt an apportionment
between losses attributable to excessive investments in unregistered se-
curities and losses from unchallenged .avestments.
All
on their overall five-year investments in FBA, they had
failed to prove damages compensable under the federal
securities laws. From the judgment entered March 27, 1975
dismissing the complaint, the instant appeal has been taken.
Il. Exocnanoce Act CLam
We need not tarry with plaintiffs’ claim under Section
10(b) of the 1934 Act and Rule 10b-5 for we find that each
of the arguments urged by plaintiffs in support of that
claim is without merit.
First, in an effort to meet the requirement of Section
10(b) and Rule 10b-5 that they must allege a fraud “in
connection with the purchase or sale of any security,” ’
plaintiffs argue that their interest in FBA was a “secu-
rity” and that the modifications of the partnership agree-
ment in 1968 constituted an exchange of one security for
another.' In support of this theory, plaintiffs rely on cases
which have held that significant modifications in the rights
of security holders may constitute a “sale” of one security
and “purchase” of another under Section 10(b) and Rule
10b-5, Ingenito v. Bermec Corp., 376 F.Supp. 1154, 1179-
82 (S.D.N.Y. 1974); or a “sale” or “issue” of a security
under the Public Utility Holding Company Act of 1935,
7 This is the familiar provision of both Section 10(b) and Rule 10b-5.
Obviously, the fraud alleged by plaintiffs was not “in connection with”
either their initial investment in the partnership on July 1, 1965 or their
withdrawal from the firm on September 30, 1970.
8 The principal modifications relied on by plaintiffs in their effort to
show that the September 30, 1968 partnership agreement fundamentally
changed the nature of their investment were: expansion of the general
partners’ authority to invest in other businesses and to make loans;
authorization of $25,000 per year salaries for managing partners; short-
ening of the notice requirement for year end withdrawals of capital;
provision for automatic termination of the partnership after ten years;
and authorization for amendment of the partnership agreement by a
vote of one-half of the limited partnership interests and two-thirds of
the general partnership interests, rather than by the Executive Com-
mittee of the general partners as before.
Al2
SEC v. Associated Gas & Elec. Co., 24 F.Supp. 899 (S.D.
N.Y.), aff'd, 99 F.2d 795 (2 Cir. 1938); or an “issue” of
stock under the Interstate Cormmerce Act, United States
v. New York, New Haven & Hartford R. Co., 276 F.2d 525
(2 Cir. 1959), cert. denied, 362 U.S. 961 (1960). We do
not believe that this line of cases supports plaintiffs’ claim
in the instant case. Before changes in the rights of a
security holder can qualify as the “purchase” of a new
security under Section 10(b) and Rule 10b-5, there must be
such significant change in the nature of the investment or
in the investment risks as to amount to a new investment.
We hold that the modifications effected by the adoption
of a new partnership agreement on September 30, 1968 did
not constitute the “purchase” and “sale” of new securities.
Second, plaintiffs argue that they are entitled to recover
under Section 10(b) and Rule 10b-5 because they were
fraudulently induced not to sell their partnership interests.
They say that they would have withdrawn from the firm
in 1968 if defendants had not misrepresented the true
nature of the firm’s investments at that time. The short
answer to this branch of plaintiffs’ argument is that the
requirement of fraud in connection with the purchase or
sale of a security is not satisfied by an allegation that
plaintiffs were induced fraudulently mot to sell their
securities. Blue Chip Stamps v. Manor Drug Stores, 421
U.S. 723, 737-38 (1975).
We affirm the dismissal of plaintiffs’ Exchange Act
claim.’
9 Our affirmance of the dismissal of the Exchange Act claim is on the
ground that the complaint fails to state a claim upon which relief can
be granted—not on the ground relied upon by the district court for
dismissal, namely, that, since plaintiffs had realized a net profit on their
overall limited partnership investment, they had failed to prove dam-
ages compensable under the federal securities laws. We shall discuss this
ground of the district court decision under the Adiveers Act claim, Sec-
tion TIT, infra.
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III. Apvisers Act CLam
. We come next to what we consider to be the chief ques-
tion presented on this appeal—whether the complaint
states a claim upon which relief can be granted under
Section 206 of the Investment Advisers Act of 1940 (the
Act)*® and Rule 206(4)-1 thereunder."
10 Section 206 of the Investment Advisers Act of 1940, 15 U.S.C. $80b-6
(4970), im relevant part provides:
“It shall be unlawful for any investment adviser by use of the
mails or any means or instrumentality of interstate commerce, di-
rectly or indirectly—
Q) to employ any device, scheme, or artifice to defraud any
client or prospective client;
(2) hes a in apy transaction, practice, or course of busi-
ness Ww operates as a fraud or deceit upon any client -
pective client; , ess
. * .
; (4) to engage in any act, practice, or course of business which
is fraudulent. deceptive, or manipulative. The Commission shall,
for the purposes of this paragraph (4) by rules and regulations
define, and prescribe means reasonably designed to prevent, such
acts, practices, and courses of business as are fraudulent, decep-
tive, or manipulative.”
ll Rule 206(4)-1, 17 C. -
Pe (4)-1, 17 C.F.R. §275.206(4)-1 (1976), in relevant part pro-
“(a) It shall constitute a fraudulent, deceptive, or manipulative
act, practice or course of business within the meaning of section
206(4) of the Act, for any investment adviser, directly or indirectly
to publish, circulate or distribute any advertisement:
(5) Which contains any untrue statement of a material fact, or
which is otherwise false or misleading.
(b) For the purposes of this section the term ‘advertisement’ shall
include any notice, circular, letter or other written communication
addressed to more than one person, or any notice or other announce-
ment in any publication or by radio or television, which offers (1)
any analysis, report, or publication concerning securities, or which
is to be used in making any determination as to when to buy or sell
any security, or which security to buy or sell, or (2) any graph
chart, formula, or other device to be used in making any deter.
mination as to when to buy or sell any security, or which security
pehine Pperbrinn Ang any other investment advisory service with
Al4
;
The subordinate questions which we must consider in
connection with this claim are (1) whether any of the
defendant general partners are “investment advisers”
within the meaning of Section 202(a)(11) of the Act;"*
(2) whether there is an implied private right of action for
damages under the Act; and (3) whether plaintiffs have
alleged compensable damages under the Act.
For the reasons below, we answer each of these questions
in the affirmative. Accordingly, we reverse the dismissal
of the Advisers Act claim and remand the case for trial
on that claim.”
(1) “Investment Advisers” Under Section 202(a)(11)
Turning first to the threshold question whether any of
the general partner defendants are “investment advisers”
within the meaning of Section 202(a)(11), we hold that
they are.
It is clear from the record that the general partners
received substantial compensation for managing the limited
partners’ investments. Each of the three partnership
agreements in effect between 1965 and 1970 provided that
the general partners would be paid for their services 20%
of the firm’s net profits and net capital gains for each
fiscal year. In addition, the partnership agreement of
12 Section 202(a)(11) of the Investment Advisers Act, 15 U.S.C. §80b-2
(a)(11) (1970), in relevant part provides:
“ ‘Investment adviser’ means any person who, for compensation,
engages in the business of advising others, either directly or through
publications or writings, as to the value of securities or as to the
advisability of investing in, purchasing, or selling securities, or who,
for compensation and as part of a regular business, issues or pro-
mulgates analyses or reports concerning securities. .. ."
13 It was the Advisers Act claim to which we invited the parties and the
SEC as amicus curiae to address their supplemental briefs when we filed
our interim opinion following oral argument of this appeal. 537 F.2d at
28. We express our appreciation for the helpful briefs from counsel for
all parties and the SEC in response to our invitation.
AIS
October 1, 1968 authorized an annual salary of $25,000 for
each general partner who managed investments.
Since the general partners received compensation for
their investment services, the only remaining inquiry under
the statute is whether they were “engage[d] in the busi-
ness of advising others” with respect to investments. On
two independent grounds, we believe they were.
First, the monthly reports which contained the alleged
fraudulent representations were reports which provided
investment advice to the limited partners. The general
partners’ compensation depended in part upon the firm’s
net profits and capital gains. These in turn were affected
by the size of the total funds under their control. The
monthly reports were an integral part of the general part-
ners’ business of managing the limited partners’ funds. In
deciding whether or not to withdraw their funds from the
pool, the limited partners necessarily relied heavily on the
reports they received from the general partners.
Second, wholly aside from the monthly reports, we be-
lieve that the general partners as persons who managed
the funds of others for compensation are “investment ad-
visers” within the meaning of the statute. This is borne
out by the plain language of Section 202(a)(11) and its
related provisions, by evidence of legislative intent and by
the broad remedial purposes of the Act.
The Investment Companies Act of 1940 and the compan-
ion Investment Advisers Act (Title II of the same enact-
ment) were among statutes designed to eliminate certain
abuses in the securities industry which were found to have
contributed to the stock market crash of 1929 and the
depression of the 1930s. SEC v. Capital Gains Research
Bureau, Inc., 375 U.S. 180, 186 (1963). The 1940 legisla-
tion was based upon exhaustive studies by the SEC which
culminated in a number of extensive reports on invest-
ment trusts, investment companies and investment advis-
Al6
ers. The Investment Companies Act and the Advisers Act
were intended to cover important areas of the securities
industry which had not been covered by the earlier stat-
utes. The Investment Companies Act is concerned with
investment companies and other persons, including certain
investment advisers, who deal with investment companies.
The Advisers Act covers all investment advisers.
As stated in Section 201 of the Advisers Act, 15 U.S.C.
§80b-1 (1970), that Act was based upon the findings and
recommendations set forth in an SEC Report on invest-
ment counsel and advisory services. Securities and Ex-
change Commission, Investment Counsel, Investment Man-
agement, Investment Supervisory and Investment Advi-
sory Services, H.R. Doc. No. 477, 76th Cong., 2d Sess., 1
(1939) (hereinafter “SEC Report”). The SEC Report
referred to two types of investment advisers: (1) those
with management powers over their clients’ funds and the
power to make purchases and sales for their clients (“dis-
cretionary”), and (2) those who merely made recommen-
dations to their clients (“advisory”). SEC Report at 13.
It noted the conspicuous need for regulation of individuals
“who may solicit the funds of the public to be controlled,
managed, and supervised ....” SEC Report at 28 (em-
phasis added). The report made it clear that its findings
and recommendations were intended to cover persons who
made purchases and sales of securities with their clients’
funds.
The House and Senate Committee reports also make
clear the intent of Congress. The Report of the Senate
Committee on Banking and Currency which accompanied
the bill to the Senate floor stated:
“The report of the Commission to the Congress and
the record before the committee is clear that the solu-
tion of the problems and abuses of investment advi-
Al?
sory services—individuals and companies which either
handle pools of liquid funds of the public or give
advice with respect to security transactions—cannot be
effected without Federal legislation.
Virtually no limitations or restrictions exist with
respect to the honesty and integrity of persons who
may solicit funds to be controlled, managed, and super-
vised.” (emphasis added) S. Rep. No. 1775, 76th Cong.,
od Sess., 21 (1940).™
Similarly, the House Committee on Interstate and Foreign
Commerce noted in its report the need to regulate firms
which “inanaged, supervised, and gave investment advice”
with respect to clients’ funds. H.R. Rep. No. 2639, 76th
Cong., 3d Sess., 27 (1940).**
In short, as for legislative intent, we believe that the
SEC Report, together with the House and Senate Reports,
make it clear that Congress intended to reach persons who
receive compensation for investing funds of their clients.
14 In its general statement on the background to the Advisers Act, the
Senate Report stated:
“Similarly, it is difficult definitely to estimate the amount of funds
under the influence or control of investment advisers. However, some
idea of the size of the funds administered by investment advisers
may be deduced from the fact that 51 firms for which information
was obtainable by the Commission managed, supervised and gave
investment advice with respect to funds aggregating approximately
$4,000,000,000." (emphasis added). S. Rep., supra at 21. .
15 In 1960 and again in 1970, Congress considerably broadened the cov-
erage of the Advisers Act. The Senate Report accompanying the bill
which contained the 1960 amendments to the Act stated, with particular
application here:
“There are at present over 1214 million individuals in the United
States who own corporate securities, nearly double those in 1952.
It has been noted that this new group offers strong temptation to
confidence men and swindlers who may give them biased advice or
misuse their funds or securities.” (emphasis added). 8. Rep. No.
1760, 86th Cong., 2d Sess. 4 (1960).
Al8
Moreover the plain language of Section 202(a)(11) and
related provisions of the Act bear out this legislative in-
tent. Section 202(a)(11) includes any person who “ad-
vises” others with respect to investments. Section 203(c)
(1)(D), 15 U.S.C. §80b-3(c)(1)(D) (1970), requires the in-
vestment adviser to disclose the nature and scope of his
“authority ... with respect to clients’ funds and accounts”
in his registration statement. And Section 205, 15 U.S.C.
§80b-5 (1970), establishes certain standards for investment
advisers with respect to “investment advisory contracts”
which include contracts “to act as an investment adviser
or to manage any investment or trading account... .”
These provisions reflect the fact that many investment ad-
visers “advise” their customers by exercising control over
what purchases and sales are made with their clients’ funds.
We hold that the defendant general partners of FBA are
investment advisers within the meaning of Section 202(a)
(11) of the Act."*
16 Defendant Harry Goodkin & Company argues that, since it was not
an “investment adviser”, it cannot be held liable for aiding and abetting
a fraud committed by those who were investment advisers. Goodkin
points out that Section 206 applies only to an investment adviser and
that Section 202(a)(11)(B) excludes from the definition of an invest-
ment adviser an accountant acting in the practice of his profession. We
agree that the exemption excludes an accountant’s usual activities from
the scope of the Act and excludes the accountant from coverage under
the registration provisions and many of the other regulatory provisions
of the Act even if the accountant is employed by an investment adviser.
But the exemption does not shield the accountant from liability under
the antifraud provisions of the Act if the accountant aids and abets an
investment adviser with knowledge that his conduct is assisting an in-
vestment adviser in defrauding a client. Cf. Section 209(e) of the Act,
15 U.S.C. §80b-9(e) (1970), which authorizes the SEC to seek injunctive
relief and, if necessary, to recommend criminal proceedings against those
who “aid, abet [or] counsel” violations of the Act. In view of the limi-
tation of Section 206 to investment advisers, however, we believe that
before Goodkin can be held liable as an aider and abetter, there must
ag ee ee
—
Al9
(2) Private Right of Action Under Section 206
As with other provisions of the federal securities laws
under which the courts have found implied private rights
of action, Section 206 of the Advisers Act does not ex-
pressly authorize private actions. We therefore must de-
cide whether a private right of action is to be implied
under that section. For the reasons below, we hold that
it is.’”
be a showing that Goodkin: (a) knew of the investment adviser-client
relationship; (b) had knowledge of the fraud; and (c) acted in concert
with the investment adviser. Cf. Ernst ¢ Ernst v. Hochfelder, 425 U.S.
185 (1976).
Whether Goodkin is liable for aiding and abetting the investment
advisers is one of the issues to be determined at trial pursuant to our
remand.
As to whether FBA itself is a proper defendant with respect to the
Advisers Act claim, for aught that appears in the record before us, we
have serious doubts. The general partners as individuals, not FBA as
an entity, were the investment advisers to the limited partners. If upon
remand, and after a hearing, the district court finds no more than the
record now discloses with respect to the liability of FBA itself under
the Advisers Act claim, it should dismiss as against the firm.
17 The SEC has submitted to Congress a number of proposed amend-
ments to the Advisers Act. One would provide explicitly for private
actions under the Advisers Act. See Investment Advisers Act Release
No. 491, 8 SEC Docket 744 (December 15, 1975). In announcing its
proposal, the SEC repeated its view that the existing language was
sufficient to imply a private right of action. Its proposal was intended
to put to rest those few decisions which had found no implied right of
action.
In the two district court cases in this Circuit in which the issue has
been considered, the court has held that an implied right of action exists
under the Advisers Act. Jones v. Equitable Life Assurance Society, 409
F.Supp. 370 (8.D.N.Y. 1975), accord, Angelakis v. Churchill Manage-
ment Corp., CCH Fed. Sec. L. Rep. 95,285 (N.D.Cal. 1975); Bolger v.
Laventhol, Krekstein, Horwath ¢ Horwath, 381 F.Supp. 260 (S.D.N.Y.
1975). Contra, Gammage v. Roberts, Scott § Co., CCH Fed. Sec. L. Rep.
994,761 (S.D.Cal. 1974); Greenspan v. Eugene Campos Del Toro, 73-
638-Civ. (S.D.Fla. May 17, 1974).
The commentators who have reviewe: these decisions agree that a
private right of action should be implied under the Advisers Act. Note,
Private Causes of Action Under Section 206 of the Investment Advisers
A20
The Supreme Court has recognized in a variety of con-
texts that private rights of action may be implied in favor
of the intended beneficiaries of a statute where necessary
to implement the statute’s underlying purposes. Super-
intendent of Insurance v. Bankers Life & Casualty Co.,
404 U.S. 6, 13 n.9 (1971); J. I. Case Co. v. Borak, 377 U.S.
426 (1964); Tunstall v. Brotherhood of Locomotive Fire-
men and Enginemen, 323 U.S. 210 (1944); Texas & Pacific
R.R. v. Rigsby, 241 U.S. 33 (1916). Cf. Bivens v. Sia Un-
known Named Agents, 403 U.S. 388 (1971); Bell v. Hood,
327 U.S. 678 (1946).
There are compelling reasons why the courts have been
particularly willing to recognize private rights of action
under the antifraud provisions of the federal securities
laws. Those provisions are designed to protect specific
classes of injured parties. Moreover the SEC—the agency
charged with administration and enforcement of the fed-
eral securities laws—does not have sufficient resources
alone to enforce the many provisions of the statutes. Ab-
sent judicial recognition of private rights of action, the
federal securities laws most assuredly would fail to pro-
vide the effective regulation over the securities industry
which Congress intended. In finding an implied right of
action under Section 14(a) of the 1934 Act, the Supreme
Court held in J. I. Case Co. v. Borak, supra, 377 U.S. at
432, that “Private enforcement .. . provides a necessary
supplement to Commission action”, and went on to state:
“(I]t is the duty of the courts to be alert to provide
such remedies as are necessary to make effective the
congressional purpose.” Id. at 433.
Act, 74 Mich. L. Rev. 308 (1975); Lybecker, Advisers Act Developments,
8 Review of Securities Regulations 927, 934 (April 23, 1975); Note,
Bolaer v. Laventhol, Krekstein, Horwath ¢ Horwath: Private Rights of
Action Under the Investment Advisers Act, 48 Temple L.Q. 433 (1975).
A21
Applying these principles, the courts of appeals con-
sistently have recognized an implied right of action under
the Investment Companies Act—the companion to the Ad-
visers Act. Moses v. Burgin, 445 F.2d 369 (1 Cir.), cert.
denied, 404 U.S. 994 (1971); Herpich v. Wallace, 430 F.2d
792, 815 (5 Cir. 1970); Esplin v. Hirschi, 402 F.2d 94, 103
(10 Cir. 1968), cert. denied, 394 U.S. 928 (1969); Taussig
v. Wellington Fund, Inc., 313 F.2d 472, 476 (3 Cir.), cert.
denied, 374 U.S. 806 (1963) ; Brown v. Bullock, 194 F.Supp.
207 (S.D.N.Y.), aff'd, 294 F.2d 415, 420-21 (2 Cir. 1961)
(en banc). It is well settled that implied rights of action
exist under Section 10(b) of the 1934 Act and Rule 10b-5,
which contain substantially the same language as Section
206 of the Advisers Act. Blue Chip Stamps v. Manor Drug
Stores, 421 U.S. 723, 730 (1975) ; Superintendent of Insur-
ance v. Bankers Life & Casualty Co., supra, 404 U.S. at 13
n.9; Fischman v. Raytheon Mfg. Co., 188 F.2d 783, 787
(2 Cir. 1951) ; Kardon v. National Gypsum Co., 69 F.Supp.
512 (E.D.Pa. 1946). Judicially implied rights of action also
have been found under Section 14(a) of the 1934 Act,
J. I. Case Co. v. Borak, supra, and under the Public Utility
Holding Company Act of 1935, Goldstein v. Greesbeck, 142
F.2d 422 (2 Cir.), cert. denied, 323 U.S. 737 (1944).
Against this background, we turn to the question whether
a private right of action should be implied under Section
206 of the Advisers Act.
In Cort v. Ash, 422 U.S. 66, 78 (1975), the Supreme
Court suggested that the following factors be considered
in determining “whether a private remedy is implicit in a
statute not expressly providing one”:
“First, is the plaintiff ‘one of the class for whose
especial benefit the statute was enacted’ . . . —that is,
does the statute create a federal right in favor of the
plaintiff? Second, is there any indication of legislative
A22
intent, explicit or implicit, either to create such a
remedy or to deny one? . .. Third, is it consistent with
the underlying purposes of the legislative scheme to
imply such a remedy for the plaintiff? .. . And finally,
is the cause of action one traditionally relegated to
state law, in an area basically the concern of the
States, so that it would be inappropriate to infer a
cause of action based solely on federal law?”
We believe that each of these factors point unmistakably
toward recognition of an implied right of action under
Section 206 of the Advisers Act. See Piper v. Chris Craft
Industries, Inc. —— U.S. ——, 45 U.S.L.W. 4182, 4192-93
(U.S. Sup. Ct. Feb. 22, 1977).
The purpose of the Advisers Act was “to protect the
public and investors against malpractice by persons paid
for advising others about securities.”"* The Act was de-
signed for the “especial” benefit of persons relying upon
their investment advisers for advice. SEC v. Capital Gains
Research Bureau, Inc., 375 U.S. 180, 186-91 (1963).
Congress enacted the Advisers Act, as it had earlier
securities legislation, mindful of the need for federal regu-
lation of the securities industry. As the Senate Committee
Report emphasized :
“The nature of the functions of investment advisers,
their increasing widespread activities, their potential
influence on security markets and the dangerous poten-
tialities of stock market tipsters imposing upon
18 S. Rep. No. 1760, 86th Cong., 2d Sess., 1 (1960).
The House Committee Report which accompanied the 1940 bill stated:
“The essential purpose of title II of the bill is to protect the
public from the frauds and misrepresentations of unscrupulous tip-
sters and touts and to safeguard the honest investirent adviser
against the stigma of the activities of these individuals by making
fraudulent practices by investment advisers unlawful.” H.R. Rep.
No. 2639, 76th Cong., 3d Sess., at 28 (1940).
ee ee)
A23
unsophisticated investors, convinces the committee
that protection of investors requires the regulation of
investment advisers on a national scale.
The report of the Commission to the Congress and
the record before the committee is clear that the
solution of the problems and abuses of investment
advisory services ... cannot be effected without Fed-
eral legislation.” (emphasis added) S. Rep. No. 1775,
76th Cong., 3d Sess. 21 (1940).
We are not aware of any statement indicating that
Congress considered the problem of private actions under
the Advisers Act at the time of its enactment. Nor is there
any indication that the SEC considered this matter when
it adopted Rule 206(4)-1. Absent specific statements of
legislative intent, we must examine the legislative purposes
underlying the Act.
As stated above, the courts consistently have recognized
that the Commission’s resources are inadequate to the task
of policing alone the federal securities laws. In enacting
the 1940 legislation, Congress intended to provide effective
federal regulation of an important segment of the securi-
ties industry. Failure to recognize a private right of action
under the Advisers Act would effectively frustrate that
purpose. We hesitate to reach such a result absent clear
evidence from the Act’s legislative history that private
actions were not intended.
Turning to related provisions of the Advisers Act, See-
tion 215(b), 15 U.S.C. §80b-15(b) (1970), provides that
any contract in violation of the Act shall be void. As the
courts have held in construing nearly identical provisions
of the other securities acts, the language of Section 215(b)
strongly suggests that a private remedy should be implied
and that such a remedy would be consistent with the other
provisions of the Act. Fischman v. Raytheon Mfg. Co..
A24
supra, 188 F.2d at 787 n. 4; Kardon v. National Gypsum,
supra, 69 F.Supp. at 514; see Slavin v. Germantown Fire
Ins. Co., 174 F.2d 799, 815 (3 Cir. 1949).
In arguing that a private right of action should not be
recognized under the Advisers Act, appellees point to ‘the
difference between the language found in the jurisdictional
provision of the Advisers Act and similar provisions of
other securities acts.’® Section 214 of the Advisers Act,
15 U.S.C. §80b-14 (1970) in relevant part provides:
“The district courts of the United States . . . shall
have jurisdiction of violations of this subchapter or
the rules, regulations, or orders thereunder, and, con-
currently with State and Territorial courts, of all suits
in equity to enjoin any violation of this subchapter or
the rules, regulations or orders thereunder.”
By contrast, Section 22 of the 1933 Act, 15 U.S.C. §77v
(1970), Section 27 of the 1934 Act, 15 U.S.C. §78aa (1970),
and Section 44 of the Investment Companies Act, 15 U.S.C.
§80-a-43 (1970), provide that the district courts shall have
19 Appellees also argue that recognition of a private right of action would
be inconsistent with Section 209(e) of the Act and other enforcement
provisions which provide that the Commission “may in its discretion bring
an action” for injunctive relief. We find no merit in this argument.
The enforcement powers given the Commission under the Advisers Act
are virtually identical to those of the other securities acts under which
we have recognized implied private rights of action. Unlike the Securities
Investor Protection Act, which was involved in Securities Investor Pro-
tection Corp. v. Barbour, 421 U.8. 412 (1975), the Advisers Act is gen-
eral, and the antifraud provisions in particular, do not manifest 4
specific legislative intent to restrict enforcement to the Commission.
Here, private suits would be consistent with Commission action. The
provision allowing the Commission the usual discretion to sue simply
makes it clear that the SEC is not compelled to sue in every case. Indeed
it would be extraordinary for Congress to require an agency to bring
enforcement proceedings in every instance. The Court in Barbour dis-
tinguished J. I. Case v. Borak, where the Court had found private suits
a necessary supplement for—rather than a hindrance to—Commission
action. 421 U.S. at 423.
-_.—
eh eet ee +
A25
jurisdiction of “all suits in equity and actions at law
brought to enforce any liability or duty created by” those
Acts.
Appellees argue that the omission of any reference to
“actions at law” in Section 214 manifests a legislative
intent to preclude private rights of action under the Ad-
visers Act. We disagree. In our view, the reason for this
omission is that each of the other Acts whose jurisdictional
provisions refer to “actions at law” contains one or more
sections expressly granting injured parties a private right
of action for damages.” There is no provision in the
Advisers Act which expressly provides for private actions;
since it is a less complex statute, containing no express
grants of right of action to private parties, a reference to
‘actions at law’ would be superfluous.
There is not a shred of evidence in the legislative history
of the Advisers Act to support the assertion that Congress
intentionally omitted the reference to “actions at law” in
order to preclude private actions by investors. Section
215, like the jurisdictional provisions of the other securities
acts, was drawn to provide jurisdiction over actions ex-
pressly authorized by the statute. Far from indicating
that Congress ever considered the matter of private actions
in drafting Section 214, the only legislative history indi-
cates that Congress attached no great importance to its
omission. In their only references to Section 214, both the
Senate and House Reports stated that the enforcement
provisions of the Advisers Act were “generally compa-
rable” to those of the Investment Companies Act, whose
20 See Sections 1] and 12 of the 1933 Act, 15 U.S.C. §§77k and 771
(1970) ; Sections 9(e), 16(b) and 18 of the 1934 Act, 15 U.S.C. §478i(e),
78p(b) and 78r (1970); Sections 16(a) and 17(b) of the Publie Utility
Holding Company Act of 1935, 15 U.S.C. §$§79p(a) and 79(q)(b)
(1970); Section 323(a) of the Trust Indenture Act of 1939, 15 U.S.C.
§77www(a) (1970); and Section 30(f) of the Investment Companies
Act of 1940, 15 U.S.C. §80a-29(f) (1970).
A26
jurisdictional provision contains the “actions at law” lan-
guage. S, Rep. No. 1775, 76th Cong., 3d Sess., at 23 (1940) ;
H. R. Rep. No. 2639, 76th Cong., 3d Sess., at 30 (1940).™
In dealing with private rights of action under other secu-
rities acts, courts have referred to the “actions at law”
language under the jurisdictional provisions to indicate
the overall structure of those acts. But the “actions at
law” language has never been relied upon as evidence that
Congress explicitly considered the matter of private dam-
age actions under the particular substantive provision in
question. Had Congress provided explicitly for private
damage actions it would be unnecessary to consider whether
the remedy should be judicially implied. Indeed, under the
antifraud provisions of other securities acts courts have
recognized the absence of any legislstive intent either to
create or to deny private rights of action for damages.
Here, as under the other statutes, it is clear that Con-
gress simply did not consider the matter.”
21 As originally introduced in the House and Senate, the proposed Ad-
visers Act merely incorporated the jurisdictional provision of the Invest-
ment Companies Act. Section 203 of 8. 3580 and H. R. 8935. The
Investment Companies Act, in turn, had adopted the same language as
found in Section 25 of the Publie Utility Holding Company Act of 1935,
15 U.S.C. §79y. Section 40(a)(1) of S. 3580 and H.R. 8935. As re-
ported out of the committees, the bills omitted all references to other
statutes; and the Advisers Act was given its own jurisdictional provi-
sion which did not contain ary reference to “actions at law brought to
enforce any liability ....”
22 We need not decide whether the language of Section 214 which grants
to the district courts jurisdiction over “violations of this subchapter or
the rules, regulations, or orders thereunder” might cover private damage
actions. See Bolger v. Laventhol, Krekstein, Horwath ¢ Horwath, supra,
381 F.Supp. at 264. Courts have implied private rights of action under
statutes which have no separate jurisdictional provision for civil damage
suits. Texas ¢ Pacific R.R. Co. v. Rigsby, supra, 214 U.S. at 39; Odell
v. Humble Oil $ Refining Co., 201 F.2d 123, 126 (10 Cir. 1953); Nar-
ramore v. Cleveland, C.C. $ St. L. Ry. Co., 96 F. 298, 300 (6 Cir. 1899).
Moreover, the general federal question jurisdictional provision, 28 U.S.C.
$1331 (1970), would apply here. See Brown v. Bullock, supra. 294 F.2d
at 418.
A279
The Supreme Court, in considering a different issue
under the Advisers Act in SEC v. Capital Gains Research
Bureau, Inc., supra, 375 U.S. at 195, emphasized that the
Act should “be construed like other securities legislation
‘enacted for the purpose of avoiding frauds,’ not technically
and restrictively, but flexibly to effectuate its remedial pur-
poses.” (footnote omitted). We find that particularly
cogent here where we are asked to determine whether there
should be a private right of action to recover damages for
what may be clear violations of the Act. Moreover, mind-
ful of the Supreme Court’s admonition in J. I. Case v.
Borak, supra, 377 U.S. at 433, we believe that we should
provide “such remedies as are necessary to make effective
the congressional purpose”, rather than adopt a construc-
tion that would effectively defeat the purpose of provid-
ing federal regulation over an important segment of the
securities industry.
We hold that there is an implied private right of action
under Section 206 of the Advisers Act.?**
22a Our concurring-dissenting colleague, in a characteristically thoughtful
and innovative opinion, urges that a private right of action for damages
should not be implied under the Advisers Act. We suggest that Judge
Gurfein’s opinion be read in the light of the following observations.
First, the basic premise of the dissent is the assumption that the
Advisers Act was intended to provide “a compulsory census of invest-
ment advisers, and not . . . a pervasive regulatory scheme.” (emphasis
added). Post, p. 6250. A careful reading of the Advisers Act shows
that, as enacted, it requires far more than a census. As the last of tie
series of federal securities laws enacted between 1933 and 1940, it is an
integra] part of a comprehensive regulatory scheme intended by Congress
to eliminate certain abuses in the securities industry. The Supreme Court
in SEC v. Capital Gains Research Bureau, Inc., supra, in referring to
a fundamental purpose of the Advisers Act and its relationship to the
other federal securities regulatory acts, stated:
“The Investment Advisers Act of 1940 was the last in a series of
Acts designed to eliminate certain abuses in the securities industry,
abuses which were found to have contributed to the stock market
erash of 1929 and the depression of the 1930's. It was preceded
by the Securities Act of 1933, the Securities Exchange Act of 1934,
A28
(3) Compensable Damages Under the Advisers Act
Appellees contend that plaintiffs have not alleged com-
pensable damages under the Advisers Act. They argue
the Public Utility Holding Company Act of 1935, the Trust Inden-
ture Act of 1939, and the Investment Company Act of 1940. A
fundamental purpose, common to these statutes, was to substitute a
philosophy of full disclosure for the philosophy of caveat emptor
and thus to achieve a high standard of business ethics in the securi-
ties industry. As we recently said in a related context, ‘It requires
but little appreciation . . . of what happened in this country during
the 1920's and 1930's to realize how essential it is that the highest
ethical standards prevail’ in every facet of the securities industry.
Silver v. New York Stock Exchange, 373 U.S. 341, 366." (footnotes
omitted). 375 U.S. at 186-87.
Second, while we do not claim the expertise of our dissenting colleague
concerning hedge funds, pp. 6253-6254 & n. 1, we do suggest that much
of the speculation of the dissent with respect to the investment policy
of the general partners as managers of the fund (e.g. whether the part-
nership “was going to operate in the most speculative of investment
activities”, post, p. 2653) and the intentions of plaintiffs in becoming
limited partners, might better await the trial on the merits to which we
have held plaintiffs are entitled. For after all, the posture of the case
as it came to us from the district court was the dismissal of the com-
plaint on the ground that plaintiffs realized a net profit on their overall
limited partnership investments and therefore failed to prove damages
compensable under the federal securities laws. 392 F.Supp. 740. While
this holding of the district court is rejected, all we hold with respect to
plaintiffs’ Advisers Act claim is that they are entitled to their day in
court and an opportunity to prove their claim. Post, pp. 2653-2654. At
that time, when the credibility of witnesses can properly be determined,
many of the speculative factual issues suggested by the dissent appropri-
ately can be resolved.
Finally, and perhaps of chief significance, the dissent does not dispute
the eloquent absence of evidence that Congress ever considered allowing
damages, as distinguished from injunctive relief, under the Advisers Act.
The question of damages was not considered because the matter of a
private right of action was not considered. The dissent’s massive reliance
upon the omission of the “actions at law” language in the Advisers Act
and its inclusion in the jurisdictional provisions of other statutes, we
think is misplaced. Judicially implied private rights of action have been
recognized under various sections of the securities laws even though those
sections, unlike other sections of the same statutes, contain no explicit
provision for private actions. Here likewise there is no evidence that the
omission was meant to exelude private actions. In this respect the present
A29
that plaintiffs themselves were neither purchasers nor
sellers of securities and that their claims are speculative
because they are based upon the assertion that plaintiffs
would heve withdrawn from FBA earlier had they been
told the truth about the partnership’s investments. We
disagree.
At the outset, we find no basis for appellees’ assumption
that plaintiffs’ only alternative, had they learned the truth
earlier about FBA’s high percentage of investments in un-
registered securities, was to withdraw their funds. Plain-
tiffs might have tried to persuade the general partners to
conform the firm’s investments to the conservative policy
they had represented. Failing that, plaintiffs might have
mobilized the other limited partners to exert pressure on
the general partners.
We find appellees’ reliance upon Blue Chip Stamps v.
Manor Drug Stores, supra, on this aspect of the instant
case to be misplaced.
The Blue Chip decision was based on the express lan-
guage of Section 10(b) and Rule 10b-5 requiring a fraud
“in connection with the purchase or sale of any security.” **
case is plainly different in a significant legal respect from National
R.R. Passenger Corp. v. National Ase’n of R.R. Passengers, 414 U.S. 453
(1974), relied upon by the dissent, where “the legislative history of the
Amtrack Act provide[d] a clear and convincing expression of Congress’
intent to preclude anyone except the Attorney General and in certain
situations an employee or his duly authorized representative from main-
taining an action under the Act against petitioners” (414 U.S. at 465
(Justice Brennan concurring) ), and transportation policies not pertinent
here militated in favor of such a limitation. No such history or policies
are to be found here.
23 The holding in Blue Chip was that persons who claimed that they had
been fraudulently induced not to purchase securities were not within the
class of persons protected by Section 10(b) of the 1934 Act and Rule
10b-5, under which recovery is limited to funds “in connection with the
purchase or sale” of securities. In reaffirming the doctrine of Birnbaum
v. Newport Steel Corp., 193 F.2d 461 (2 Cir.), cert. denied, 343 U.S.
956 (1952), the Court also stated that “actual shareholders in the issuer
A30
Neither Section 206 of the Advisers Act nor Rule 206
(4)-1 contains any such requirement. While the Court
stated in Blue Chip that the purchaser-seller limitation
under Section 10(b) protected against vexatious and spec-
ulative claims, it did not say or suggest that any claim
would be too speculative for recovery under the other secu-
rities acts unless the plaintiff was a purchaser or seller.
Indeed the Court acknowledged that provisions of the other
securities acts afford rights of action to persons who are
not purchasers or sellers. 421 U.S. at 733-34.
Acceptance of appellees’ contention, moreover, would
lead to a construction of the Advisers Act clearly incon-
sistent with the intent of Congress. As indicated above,
Congress intended to protect investors against frauds
committed by investment advisers who managed their cli-
ents’ funds, as well as frauds committed by advisers who
did not make purchases and sales for their clients. If the
claims of a client whose adviser managed his funds were
to be held to be too speculative simply because the client
failed to allege that he would have taken some remedial
action if he had known the truth, a large segment of those
investors whom Congress meant to protect would be ex-
eluded from the Act’s coverage. To accept appellees’ con-
tention would lead to the incongruous result that an in-
vestor’s claims would be speculative even if the adviser
had made fraudulent statements to conceal the fact that
he was stealing his client’s funds.
We believe that the differences in the language and pur-
poses of Section 10(b) of the 1934 Act and Section 206 of
the Advisers Act distinguish the instant case from Blue
who allege that they decided not to sell their shares because of an unduly
rosy representation or a failure to disclose unfavorable material” might
not be able to sue under Section 10(b) and Rule 10b-5. Blue Chip
Stamps v. Manor Drug Stores, supra, 421 U.S. at 737-38.
A31
Chip. We also note that the policy considerations expressed
in Blue Chip lend no support to appellees’ arguments.”
Under Section 206, the plaintiff class is limited to the
investment adviser’s own clients. Since the investment
adviser is compensated for his services, both client and
adviser understand that the client will rely upon the ad-
viser’s judgment and advice. To characterize the client’s
reliance as speculative is to ignore the essence of the rela-
tionship. See Galfand v. Chestnutt Corp., 545 F.2d 807 (2
Cir. 1976). Plaintiffs here allege fraudulent representa-
tions relating to specific purchases and sales of unregis-
tered securities, thus providing a definable measure of
damages. And a defrauded client may be deprived of
numerous means of controlling his adviser’s conduct and
the management of his investments, only one of which is
the remedy of withdrawing his funds altogether. We be-
lieve that the limited uncertainties involved in a case such
as this are not sufficient to bar recovery on an otherwise
valid claim; and they are adequately offset by requiring
proof that the misrepresentations were material and proof
of reliance.*®
24 In interpreting the express language of Section 10(b) and Rule 10b-5
in Blue Chip, the Court expressed concern about suits by persons who
neither purchased nor sold securities but who claimed that they would
have purchased or sold securities but for false representations made by
someone whom they might not even have known. The Court noted that
the “purchase or sale” requirement protected against vexatious suits by
a potentially limitless class of plaintiffs and avoided the diffecult ques-
tions of determining whether a plaintiff would or would not have pur-
chased or sold securities but for the defendant's representations. Id.
at 745-47.
Far from holding that claims of persons who were neither purchasers
or sellers would te too speculative under the other securities acts, the
Court interpreted the express language of Section 10(b) and Rule 10b-5.
And the Court expressly noted that many of the other securities acts
have no “purchase or sale” requirement. 421 U.S. at 733-34.
25 Even the claims of a person who has purchased or sold securities are
not free of uncertainties. A purchaser or seller necessarily alleges that
he would not have made the purchase or sale had he known the true facts.
A32
We hold that plaintiffs have alleged damages compen-
sable under Section 206 of the Advisers Act.”
IV. Measure or Damaces on REMAND
In view of our remand for trial on the Advisers Act
claim, we believe that the district court is entitled to some
guidance on the proper measure of damages.
We do not agree with the district court’s holding, 392
F.Supp. 740, that, since plaintiffs realized a net profit on
their overall limited partnership investment, they failed to
prove damages compensable under the federal securities
laws.
This is not to say, however, that a plaintiff may recover
for losses, but ignore his profits, where both result from
a single wrong. In determining on remand whether plain-
Although the claims of persons who neither purchased nor sold secu-
rities, in individual cases, may be less speculative than the claims of
actual purchasers or sellers, Blue Chip weeds out suits by persons who
may have had no interest in a security until discovering that someone
has made a fraudulent statement which may give rise to a lawsuit. In
view of the settlement value of a securities suit, this is an important
consideration. Obviously an investor who has paid for the advice of his
adviser is not the type of disinterested by-stander at whom the Blue
Chip decision was primarily aimed.
26 It is important to note that there is no issue in this case as to whether
an investor may recover for negligent misrepresentations by his invest-
ment adviser. See Ernst ¢ Ernst v. Hochfelder, supra; Gerstle v. Gamble.
Skogmo, Inc., 478 F.2d 1281, 1298-1301 (2 Cir. 1973) (distinguished in
Ernst & Ernst v. Hochfelder, supra, 425 U.S. at 209; SEC v. Capital
Gains Research Bureau, supra. Plaintiffs here have alleged that de-
fendants’ misrepresentations were intentional. Whether defendants
thought that the price of the unregistered securities would rise or not
has no bearing on the issue of scienter. Although the general] partners’
own funds were part of FBA’s pooled assets, they would be liable
under Section 206 if they intentionally deceived the limited partners to
prevent the limited partners from withdrawing their contributions or
for any other reason. Ernst ¢ Ernst v. Hochfelder, supra. Scienter does
not require a showing of intent to cause a loss to a plaintiff. SEC v.
Capital Gains Research Bureau, supra, 375 U.S. at 192 n. 39.
A33
tiffs have sustained any damages from the alleged fraudu-
lent investments, the district court should determine, first,
at what point defendants’ representations became fraudu-
lent due to the increasing proportion of portfolio invest-
ments in unregistered securities. The court then should
compute the total net losses on all holdings of unregistered
securities due to changes in price after that date. Finally,
the court should determine what proportion of FBA’s
holdings was’ inconsistent with representations that the
partnership was in a “most conservative posture” and the
other representations made to the limited partners. The
proper measure of damages then would be that part of net
losses incurred on unregistered securities after the point
when the defendants’ representations became fraudulent
which stems from the portion of those investments incon-
sistent with defendants’ representations.*"
We of course do not intimate any views as to whether
plaintiffs in fact have sustained any damage and, if so,
how much. All we hold is that they are entitled to their
day in court and an opportunity to prove, if they can, their
claim under the Advisers Act.
Affirmed as to the dismissal of the Securities Exchange
Act claim; as to the dismissal of the Investment Advisers
Act claim, reversed and remanded for trial.
—-—
27 The cut-off price for such unregistered securities in the portfolio at
the time plaintiffs withdrew should be the value assigned to such
securities by the general partners, since that presumably is what plain-
tiffs received. This would provide the closing out price for loss-netting
purposes with respect to securities remaining in the portfolio at the
time of plaintiffs’ withdrawal.
A34
Gurrein, Circuit Judge, concurring and dissenting:
I concur in the affirmance of the dismissal of the § 10(b)
claim.
With great respect for my brother Timbers as a master
of securities law, I must respectfully dissent from the hold-
ing that, under this complaint, we should imply a private
right of action at law for damages for alleged violation
of § 206 of the Investment Advisers Act, 15 U.S.C. § 80b-6
(“Advisers Act”) by these limited partners of a specula-
tive hedge fund.’
According to the majority, the issue in this case is
whether to imply a private right of action. It therefore
draws an analogy to other securities act provisions under
which private rights of action have been implied. It seems
to me, however, that the issue is rather whether a private
action at law for damages should be implied. With refer-
1 The Hedge Fund partnership agreement gave the general partners
the following powers:
“(a) To purchase, hold and sell stocks, bonds and other securi-
ties; (b) to sell stocks, bonds and other securities short and to
cover such sales; (¢) to purchase, hold, sell and otherwise deal in
put and call options and any combination or combinations thereof ;
(ad) to purchase, hold, sell, sell short and cover, and borrow from
brokers for that purpose, commodity contracts and to purchase,
hold, sell and otherwise deal in commodities generally dealt in on
commodity or produce exchanges, provided, however, that Partner-
ship funds used for the purpose of dealing in commodities and
commodity contracts shall not exceed at the time of any purchase
or commitment ten (10) percent of the net worth of the Partner-
ship at July 1, 1965 or at the beginning of any calendar year there-
after, as the case may be; (e) to conduct margin accounts with
brokers; (f) to open, maintain and close bank accounts; (g) to
sign checks; (h) to pledge securities for loans; (i) to engage in
the business of advising and counselling on investments and to
enter into agreements therefor; and (j) generally, to act for the
Partnership in all matters incidental to the foregoing.”
The original partnership agreement was amended twice, but the amend-
ments did not affect the management's broad discretionary powers.
A35
ence to that issue, I think that the Investment Advisers
Act differs significanty from the securities statutes upon
which the majority draws for support.
The legislative history of the Advisers Act indicates that
it was a tentative attempt to effect a “compulsory census”
of investment advisers by requiring registration rather
than to provide a full regulatory scheme. David Schenker,
representing the SEC, testified in the Senate Hearings:
Therefore, our fundamental approach to this problem
is in the first instance, before we could intelligently
make an appraisal of the economic function or of the
abuses which might exist in that type of organization,
to see if we could not get something which approx-
imated a compulsory census. Fundamentally that is
the basic approach of title 2. [The Advisers Act]. We
first would like to find out how many people are en-
gaged in this business, what their connections are,
what is the extent of their authority, what is their
background, who they are, and how they handle the
people’s funds” (emphasis added).
Hearings on S. 3580 before the Subcomm. of the Senate
Comm. on Banking & Currency, 76 Cong., 3d Session 48.
See also 8S. Rep. No. 1760, 86th Cong., 2d Sess., U.S. Code
Cong. & Adm. News 3502. There are other indications that
“as enacted, the Investment Advisers Act represented a
compromise between the SEC and the investment advisory
industry.” See Note, Private Causes of Action Under Sec-
tion 206 of the Investment Advisers Act, 74 Mich. L. Rev.
308, 319-20 & n.69 (1975).* It is in light of this cautious
approach taken by Congress in enacting the Advisers Act
as tentative legislation that Section 214, the provision which
appears to allow only suits in equity, should be read.
2 See p. 6232 & n. 5 infra.
A36
Section 214 is unlike the corresponding sections in the
other Acts. As my Brother Timbers notes, the Advisers
Act gives the district courts jurisdiction, concurrently with
state courts, only “of all suits in equity to enjoin any vio-
lation of this subchapter or the rules, regulations, or orders
thereunder.” The other Acts, by contrast, provide juris-
diction not merely over “all suits in equity,” but also over
“actions at law brought to enforce any liability or duty
created thereby, or to enjoin any violation of this sub-
chapter, or the rules, regulations or orders thereunder,”
e.g., Investment Company Act of 1940, 444, 15 U.S.C.
§ 80a-43, an act passed together with the Advisers Act in
a single bill. For similar language in other Acts, see
majority opinion p. 6233, n.20.*
3 It seems to me of some significance that early drafts of the Advisers
Act, ineluding 8. 3580 and H.R. 8935, filed on March 14, 1940, merely
incorporated by reference § 40 of the Investment Companies Act, which
did include the reference to “actions at law.” After the conclusion of
four weeks of Senate hearings on April 26, however, representatives of
the industry met with the SEC to negotiate changes in the proposed
bill. See Hearings on H.R. 10065 Before a Subcomm. of the House
Comm. on Interstate and Foreign Commerce, 76th Cong., 3d Sess. 72
(1940); 86 Cong. Rec. 10069 (1940) (remarks of Senator Wagner).
The result was a new draft, which finally met the approval of the in-
dustry, see House Hearings at 95; Jaretski, The Investment Company
Act of 1940, 26 Wash. L. Rev. 303, 309-10 (1941), and which for the
first time contained a separate jurisdictional provision referring to
“suits in equity” but omitting the reference to “actions at law” which
the majority seeks to restore to the statute.
4 While the majority opinion does not rely on the circumstance that
jurisdiction is conferred over “violations” of the statute and rules
thereunder to imply a cause of action for damages at law, a district
court has done so. See Bolger v. Laventhol, Krekstein, Horwath ¢
Horwath, 381 F. Supp. 260 (S.D.N.Y. 1974). I do not agree. “Viola-
tions” in the context means criminal violations, and violations on the
civil side are limited to suits in equity. This is made clear by the
venue provisions of §214: (1) “any criminal proceeding” may be
brought in the district court wherein any act or transaction constituting
the violation oceurred; (2) “any suit or action to enjoin any violation
may be brought in... .” There is still no reference to an “action at
A334
The attempted withholding of jurisdiction over actions
at law in the Advisers Act indicates that Congress was not
intending to provide for any liability beyond injunctive
relief.’ As Mr. Justice Powell noted in Blue Chip Stamps
v. Manor Drug Stores, 421 U.S. 723, 756 (concurring),
“(t]he starting point in every case involving construction
of a statute is the language itself.” The majority opinion
explains that the language of § 214 differs from the lan-
guage of the jurisdictional sections in every other Securi-
ties Act because “each of the other Acts whose jurisdic-
tional provisions refer to ‘actions at law’ contains one or
more sections expressly granting injured parties a private
right of action for damages,’” and hence, required the
jurisdictional provision for that reason.‘
5 One might indeed argue that there is lack of subject-matter jurisdic-
tion to enforce actions at law for damages for violations of the Advisers
Act because of the lack of any specific statutory authorization, but I
do not urge that. There is jurisdiction under a broad reading of the
“arising under” clause of 28 U.S.C. § 1331. Cf. Illinois v. City of Mil-
waukee, 406 U.S. 91, 98 (1972); Romero v. International Terminal
Operating Co., 358 U.S. 354, 393 (1959) (Brennan, J., concurring and
dissenting); Bell v. Hood, 327 U.S. 678 (1946). See also Tunstall v.
Brotherhood of Firemen, 323 U.S. 210 (1944) (“arising under” 28
U.S.C. § 1337). The majority correctly states that plaintiffs allege
jurisdiction under § 214 of the Advisers Act, the very section that does
not provide for “actions at law,” but since the pleading can be amended
I make no point of the insufficiency of a proper jurisdictional statement.
Even if an implied claim for relief is judge-made, it may “arise under
the laws of the United States.”
6 The reason given by the majority is not persuasive, for it fails to
note that in every single case in which an express civil liability is
created in any of the Acts, the jurisdiction has already been stated in
the very section creating the express liability. Thus, §11 of the 1933
Act, 15 U.S.C. § 77k, itself provides that “any person acquiring such
security . . . may, either at law or in equity, in any court of competent
jurisdiction, sue .. . .” Section 12 of the 1933 Act, 15 U.S.C. § 771, itself
provides that the purchaser “may sue either at law or in equity in any
court of competent jurisdiction ....” To the same effect, see Section
9(e) of the 1934 Act, 15 U.S.C. § 78i(e); Section 16(b) of the 1934
Act, 15 U.S.C. § 78p(b); Section 18 of the 1934 Act, 15 U.S.C. § 78r;
Section 16(b) of the Publie Utility Holding Company Act of 1935, 15
A38
But the more cogent question is why the Advisers Act,
as distinguished from every other securities act, does not
provide for any express civil liability in damages. The
majority offers no explanation for such an omission which
must have been a studied omission. I think it is highly
relevant that in each of the other Acts Congress itself did
provide for some express civil liability, yet under the Ad-
visers Act it failed to include a single section imposing
liability for damages. Congress, for example, could have
provided an express damage remedy for misrepresenta-
tions in the registration statement of the advisers as it
did for misrepresentations of the registration statement
of the underwriter, 15 U.S.C. § 77k(a)(5). This indicates
U.S.C. § 79p(b); Section 17(b) of that Act, 15 U.S.C. § 79q(b); Sec-
tion 323(a) of the Trust Indentures Act, 15 U.S.C. § 77www(a) ; Section
30(f) of the Investment Companies Act, 15 U.S.C. § 80a-29(f). The
better explanation, it seems to me, for the general jurisdictional provi-
sion in each Act—"the District Courts of the United States . . . shall
have jurisdiction” ete.—is Congress’ fear that general federal question
jurisdiction under 28 U.S.C. § 1331 might not establish jurisdiction in
the federal courts over securities law claims, particularly when the
jurisdictional amount was lacking. The separate jurisdictional provi-
sions associated with the several sections of the securities acts creating
substantive liability referred only to “any court of competent jurisdic-
tion,” and hence left open the question of whether the federal courts
were in fact courts of “competent jurisdiction.” Thus, an independent
jurisdiction was conferred on the federal courts by the general provision
of each statute (and in the case of the Securities Exchange Act, exclu-
sive jurisdiction). In short, the internal sections ¢ nferred general
jurisdiction. The jurisdictional section was drawn as broadly as pos-
sible to confer clear federal jurisdiction.
The majority opinion seeks to draw support from the fact that the
Senate and House Reports stated that the enforcement provisions of the
Advisers Act were “generally comparable” to those of the Investment
Companies Act. Ante at 6233. Aside from the fact that this begs the
crucial question—whether the Acts were comparable in this particular
respect—it ignores what was in my view the more likely meaning of
“generally comparable” as applied to the enforcement provisions: that
is, that the Advisers Act is “generally comparable” to the Investment
Company Act in that both provide for the concurrent jurisdiction of
state and feders! courts, as distinguished from the Exchange Act in
which federal jurisdiction is made exclusive.
a
A39
rather that, in its cautious approach to the regulation of
investment advisers, Congress was not yet ready to impose
any civil liability for damages.
The majority holds, nonetheless, that a private damage
action should be implied in this case “to implement the
statute’s underlying purposes.” It notes that persons rely-
ing upon investment advisers for advice, for whose “espe-
cial benefit” the Act was adopted, see Cort v. Ash, 422 U.S.
66, 78 (1975), will benefit from a private damage action.
Ante, pp. 6229-6230, citing SEC v. Gapital Gains Research
Bureau, Inc., 375 U.S. 180, 186-91 (1963).7 Such reasoning
it seems to me has become somewhat outmoded in the light
of the current standards of interpretation announced in
Cort v. Ash, supra. The four factors mentioned in Cort v.
Ash are not mere surplusage to the theme that the benefi-
cent purpose of the legislation is, by itself, sufficient war-
rant for the implication of a claim for private relief.* Such
7 That case was not, of course, a damage action, nor was it brought by
a private party.
& The majority reasons that Section 215(b) of the Advisers Act, 1£
U.S.C. § 80(b)-15(b) (1970), which provides that any contract violating
the Act shall be void, strongly suggests that a private remedy should
be implied. Ante, p. 6231, supra. But it does violence to the criteria
enunciated in Cort to imply an action simply because a contract is
made void, or to recognize an actionable tort, simply because a statute
prohibits particular conduct. Cf. Note, Section 906 Private Actions
74 Mich. L. Rev. 308, 312 n.19 (1975). Significantly, the SEC in its
amicus brief does not rely on § 215(b) of the Act.
Even if the fact that a statute renders certain contracts void were
deemed ipso facto to create a private right of action, on the theory
that this provision could be vindicated only by the private parties to
the contract, it of course hy no means follows that a damage Temedy is
proper. Rescission or restitution are, aside from damages, remedies
ordinarily available when a contract is void. Significantly, rescission
is an equitable remedy, see 5 Corbin on Contracts § 1103, so that im-
plication of a private right of action for rescission and restitution under
§ 215(b) would be well within the jurisdictional grant of § 214, and
consistent with the notion that it is only actions at law which ane in-
consistent with the statutory scheme.
A40
a single criterion is also inadequate because a statute can
have more than one “beneficient purpose”—here, to protect
investors but also to avoid undue disruption of the invest-
ment advisory industry. To put it another way, Congress
may intend a statute to protect investors—but not neces-
sarily without limit. Countervailing considerations may
result in something less than an imposition of civil liabil-
ity for money damages. The majority opinion ignores this
problem of statutory construction, in my view, because it
gives insufficient weight to the second factor listed in Cort:
“is there any indication of legislative intent, explicit or
implicit, either to create such a remedy or to deny one?” *
As shown above, there is implicit legislative intent to deny
such a remedy.’®
The majority urges that there is no evidence that Con-
gress intentionally sought to preclude private damage ac-
tions. Ante, p. 6233. But there is surely no “clear evi-
dence” that Congress affirmatively intended private actions
for damages to lie for violation of 4206. And we have
been instructed recently in National Railroad Passenger
Corp. v. National Ass’n of Railroad Passengers, 414 U.S.
453, 458 (1974) (“Amtrak”) that “‘when a statute limits
a thing to be done in a particular mode, it includes the
9 Analytically, it would be equally proper to say that implication of a
private action under the Advisers Act is not “consistent with the under-
lying purposes of the legislative scheme.” Cort, supra, at 78. For though
such a remedy may be consistent with the goal of protecting customers
of investment advisers, it is hardly consistent with the desire not to
subject advisers to monetary liability, at least, until further study by
Congress.
10 The situation in which there is express statutory provision for one
form of proceeding, as here, for equitable but not legal actions, should
be distinguished from the situation in which Congress gives broad but
unspecified remedial scope to the statute, see, ¢.g., §10(b) of the
Securities Exchange Act, 15 U.S.C. §78j(b). In the latter situation,
implication of some private actions may be not merely consistent with
the legislative purpose, but necessary in order fully to effectuate it.
A44
negative of any other mode,’” quoting Botany Mills v.
United States, 278 U.S. 282, 289 (1929). Section 214 ex-
pressly confers jurisdiction over suits in equity only, and
the Act as a whole does not provide anywhere for actions
at law. Under the Amtrak formulation, when Congress
limits relief to equitable relief, “it includes the negative
of any other mode”—monetary liability. In Amtrak Mr.
Justice Stewart observed that, in determining whether a
private action would lie, this rule of statutory construc-
tion should yield only “to clear contrary evidence of legis-
lative intent,” 414 U.S. at 458, a situation that does not
exist in the case of the Advisers Act.
Similarly, in Securities Investor Protection Corp. v. Bar-
bour (“SIPC”), 421 U.S. 412 (1975), Mr. Justice Marshall
noted that where there is express statutory provision for
one form of proceeding, this “ordinarily implies that no
other means of enforcement was intended by the Legis-
lature,” 421 U.S. at 419, again emphasizing that the impli-
cation would yield only to “clear contrary evidence of leg-
islative intent.” I think that my brothers turn this test
backwards. And as we have seen, there are strong reasons
for believing that not only is ther2 no “clear contrary evi-
dence of legislative intent” but rather that whatever evi-
dence exists looks the other way.
That a statute explicitly provides for private rights of
actions in some sections does not, of course, preclude the
implication of other actions under different sections of the
same Act. J.J. Case Co. v. Borak, 377 U.S. 426 (1964) ; see
6 L. Loss, Securities Regulation, 3869-73 (Supp. 1969). Cf.
1 A. Bromberg, Securities Law: Fraud §2.4(1) (1975);
Note, Private Rights of Action Under Amtrak and Ash:
Some Implications for Implication, 123 U. Pa. L. Rev.
1392, 1419-20 (1975).* But the Advisers Act is a statute
11 In Borak, the Court relied not only on § 27's provision for “actions
at law” but also on its language “brought to enforce any liability or
A42
which completely omits any damage actions whatever, even
though otherwise analogous statutes do not. Tv find a nega-
tive implication in such a case is more than a mechanical
rule of construction. For while under the Securities Act
the failure to include express remedies for each substan-
tive section probably is due to considerations not relevant
to the implication question, see Note, supra, 123 U. Pa. L.
Rev. at 1419-20, the failure to include any provision for
damage remedies in the Advisers Act is best explained by
reasons of policy which Congress deemed sound, and which
would actually be undermined by the implication of a pri-
vate damage action.
The Advisers Act was passed in 1940, almost four
decades ago. It. was designed as a threshold attempt to
effect a compulsory census of investment advisers, and
not as a pervasive regulatory scheme. In all these years
no litigant has urged to a Court of Appeals that Section
906 of the Act is a basis for a private damage action.”
The majority opinion suggests that when the Act first
became law in 1940, Congress gave no thought to the possi-
bility of a private right of action against investment
advisers, and finds this to be an argument in favor of
implication, as we have seen. The court ignores the circum-
duty created” under the Act. The Court specifically referred to Deckert
v. Independence Shares Corp., 311 U.8. 282 (1940), which had empha-
sized the same language in Section 22(a) of the 1933 Act, 15 U.S.C.
§ 77v(a), “to enforce any liability or duty created by this subchapter.”
The Deckert Court added: “The power to enforce implies the power to
make effective the right of recovery afforded by the Act.” 311 U.S. at
288. (Emphasis added).
12 The issue was tendered but not passed upon in Brouck v. Managed
Funds, Inc., 286 F.2d 901 (8th Cir. 1961), vacated as moot, 369 U.S.
424 (1962). In his monumental treatise, Professor Loss does not even
mention the possibility of a private damage action under § 206. He
does indicate that § 215(b) is “relevant” to the question of civil liability,
but concludes that there has been “no significant litigation.” See L. Loss,
Securities Regulation 1757 (1961 ed.); id. at 3864-65 (Supp. 1969).
A43
stance, however, that when Congress passed the 1970
amendments, Public Law No. 91-547, 84 Stat. 1413, it
specifically addressed itself to the civil liability of invest-
ment advisers. When it did, it limited that liability (a) to
investment advisers who advise investment companies and
no others, and (b) only to the extent of a breach of fidu-
ciary duty concerning compensation for services or like
payments. Investment Company Act §36, 15 U.S.C.
§ 80a-35. See Galfand v. Chestnutt Corp., slip op. 409 (2d
Cir. November 4, 1976). The implication is clear that
Congress did give specific attention to investment advisers,
but decided not to impose civil liability on those investment
advisers who were not advisers to investment companies.
It is significant also, I think, that when Congress made a
thoroughgoing revision of the Advisers Act in 1960, it
failed to create a single express liability, nor did it amend
Section 214 to include actions at law. And in the 1970
amendments, Congress indicated that when it wanted to
do so, it expanded the statutory relief available in the
companion Investment Company Act, 436, 15 U.S.C.
§ 80a-35, by providing that a court may “award such in-
junctive or other relief.” “Other relief” was added. See
Moses v. Burgin, 445 F.2d 369, 373 n.7. In addition, the
recently concluded Congress had before it an amendment
proposed by the Securities and Exchange Commission
13 When Congress expanded the scope of the Act in 1960, it did not alter
the statutory scheme. Instead, it strengthened the enforcement powers
of the SEC, see 8S. Rep. No. 1760, 86th Cong., 2d Sess. 2, 4 (1960).
Pub. L. No. 86-750, $¢ 2-6, 74 Stat. 885, amending §§ 203-04, 15 U.S.C.
§ 80b-3, -4. Moreover, the Commission was given the power to obtain
injunctive relief against aiders and abettors as well as principal violators.
Id. at § 12. Section 206 itself was amended to apply to unregistered as
well as registered advisers. Id. at §8. Suffice it to say that Congress
was aware of the problems of enforcement and that it dealt with the
problem as it saw fit. It is not for the courts to decide that this
remedial scheme is still insufficient.
A44
providing for a private damage action under the Advisers
Act. It does not appear seemly to me, unless we are under
an absolute compulsion to do so, suddenly to create such a
claim for relief by judicial legislation, without the ability
to define the outer limits of such a claim.
Congress is uniquely able to set the limits of any civil
action for damages. That this is so is emphasized by the
majority opinion on this very appeal. It holds that the
10b-5 claim is without merit, yet on the same factual alle-
gations it supports a 4206 claim. In so doing, it circum-
vents the sound policies behind the restrictions on 10b-5
claims.
Thus, for example, the 10b claim is held to have been
properly dismissed because, as my brother Timbers tells
us:
“They [plaintiffs] say that they would have withdrawn
from the firm in 1968 if defendants had not misrepre-
sented the true nature of the firm’s investment at that
time. The short answer to this branch of plaintiff's
argument is that the requirement of fraud in connec-
tion with the purchase or sale of a security is not
satisfied by an allegation that plaintiffs were induced
fraudulently not to sell their securities. Blue Chip
Stamps v. Manor Drug Stores, 421 U.S. 723, 737-38
(1975)” page 6220 (emphasis in original).
I am not sure that Blue Chip is so limited in its applica-
tion. I think that the underlying concern in Blue Chip,
though standing was involved, was not the lack of a tech-
nical “purchase or sale,” which ingenuity might have
supplied, see 492 F.2d 136, but, perhaps, the sheer inability
to disprove what a plaintiff says he would have done if he
had but known the truth. This problem is as acute in
suing investment advisers as in suing offerors, perhaps
A45
even more acute in the former situation. There is a distinct
danger that, by implying an open-ended private right of
action, the court is giving the clients of investment advisers
carte blanche to convert themselves from victims to
defrauders. Judge Hufstedler said it well in her excellent
1 opinion below in Blue Chip Stamps, 492 F.2d
at 148:
“The passive investor could always await market de-
velopments without any risk, claiming deception caused
nonbuying if the value of the securities proved more
promising than the offeror’s glum predictions and de-
ception caused nonselling if a rosier prospectus was
followed by a market decline.”
In this very case the plaintiffs received profits from the
restricted letter stock and waited almost a full year until
the market became unfavorable before seeking redemption
of their shares."* They deliberately entered into a partner-
ship that was going to operate in the most speculative of
investment activities. They gave the general partners the
power to invest in any kind of security, to sell short and
cover both securities and commodities, to buy and sell op-
tions and to cover, to play the commodities market, to
buy on margin, to lend money to partners without secu-
rity, and to pledge partnership assets for loans. See note
1, supra. Even a babe in the woods would know that he
was giving his money to the general partners for dis-
cretionary speculation. The purchase of unregistered stock,
far from being unforeseeable, fits quite well into this plan.
For, in a rising market, well-selected investment letter
14 Between the end of 1969 and September 30, 1970, the New York
Stock Exchange composite index fell over 10%; the Dow Jones industrial
average fell over 5%. Even if the hedge fund had invested in the most
conservative blue-chip portfolios, therefore, plaintiffs would have suf-
fered losses for the period.
A46
stock can prove profitable, and established investment
bankers handle such securities on an “investment letter”
basis. Given the purposes of the hedge fund and the broad
powers vested in the general partners, it is hardly likely
that the plaintiffs were interested in evaluating the port-
folio themselves. Indeed, the plaintiffs never asked for a
list of the securities held by the partnership.
The complaint does not allege self-dealing, conflict of
interest, or conversion of assets, any of which would be
actionable under §10(b), if in connection with the pur-
chase or sale of securities. See, e.g., Bird v. Ferry, 497
F.2d 112 (5th Cir. 1974) (conversion by salesman). To the
contrary, it shows that defendants themselves invested
their own money and the money of their families, and
there is no allegation that they withdrew it. The plain-
tiffs prospered under this management for a considerable
time when the market was good, reaping profits from the
investment of unregistered securities—letter stock as well
her securities in the common portfolio. Having joined
the partnership as early as 1965, they undoubtedly basked
in the euphoria of the bull market described by Judge
Friendly in Levine v. Seilon, Inc., 439 F.2d 328, 335 (2d
Cir. 1971). Conversely, however, when the market turned
down, it turned down for all, including the defendants."*
15 The majority opinion assumes that when plaintiffs discovered the
“misrepresentation” they could wait until the following year to see
how the market would go, because their redemption right was restricted
to redemption at particular stated times. But with all respect that
simply does not follow. When a person discovers that he has been de-
frauded, he may sue at once for rescission or damages, regardless of the
contractual restriction. See Prosser on Torts § 105, at 689 (4th ed.
1971); Restatement [First] of Torts § 549 note ¢ (1938). The con-
trary rule would substantially undermine congressional policy. As the
court said in Royal Air Properties, Inc. v. Smith, 312 F.2d 210, 213-14
(9th Cir. 1962): “The purpose of the Securities Exchange Act is to
protect the innocent investor, not one who loses his innocence and then
waits to see how his investment turns out before he decides to invoke
the provisions of the Act.”
A493
This practical consideration indicates to me, not, as it
is suggested in the majority opinion, that the plaintiffs
should not be given a chance to prove their case, see foot-
note 22a, but that, in the absence of a legislative determina-
tion of the policy questions involved, we are treading on
dangerous ground in implying a priavte action under § 206
on the fact pattern alleged here, and ought instead to leave
the issue to Congress. To create an analogue to Section
10(b) without the requirement that the “fraud” be “in
connection with the purchase or sale” of a security hardly
gives broad effect to the policy considerations so clearly
expressed in the majority opinion of the Supreme Court in
Blue Chip Stamps and in Mr. Justice Powell’s concurring
opinion, as well as Judge Hufstedler’s dissent in the Court
of Appeals. The majority specifies no limits to the civil
liability under § 206 which it is in the process of creating
over this dissent. Yet, it is simply extending 10b-5 by re-
sort to a different statute. As the Court said in Ernst &
Ernst v. Hochfelder, —— U.S. —, 96 8. Ct. 1375, 1389
(1976), “We would be unwilling to bring about this result
bsent substantial support in the legislative history, and
there is none.” We do not know, if Congress creates an
express private cause of action for damages under § 206,
that it will not limit the right as it did with respect to
§10(b), by imposing a purchase or sale requirement, and
perhaps also by defining the measure of damages and en-
acting a separate statute of limitations."
16 The SEC, for whose excellent work I have the highest admiration,
has been rebuffed by the Supreme Court in its attempt to repeal the
requirement of “in connection with the purchase or sale of a security.”
See Blue Chip Stamps, supra, 421 U.S. at 732. It has also been rebuffed
by this court, see Levine v. Seilon, 439 F.2d 328, 329 (24 Cir. 1971).
And in the Blue Chip Stamps case, Mr. Justice Powell commented that
the SEC had “joined, surprisingly” in urging expansion of the statute.
421 U.S. at 759.
A48
The Commission, in its amicus brief, argues for an im-
plied civil right of action for damages, on the ground that
“the claim asserted by plaintiffs herein is not one that
would test the outer limits of the cause of action created
by the antifraud provisions of the federal securities laws.”
(Emphasis added). But what are the limits to what is
essentially a Rule 10b-5 action, if not the prerequisite that
the claim relate to the “purchase or sale of a security”?
Implying a claim for relief without limitation will encour-
age actions against investment advisers for poor judgment,
disguised by pleadings subtly implying fraud and deceit.
The unfounded allegation itself, contrary to the solicitude
originally expressed by the SEC itself, will spell grief for
the investment adviser, and the expense of defending the
action will often compel settlement.’ Each consideration
is a policy ground that should be weighed. See Blue Chip
Stamps, SIPC, and Amtrak, Indeed, in its early days the
SEC itself was vitally concerned with these considerations
militating against public disclosure."* This belies any in-
17 Mr. Justice Rehnquist in Blue Chip Stamps, 421 U.S. at 740, stated
that it was a policy concern that “even a complaint which by objective
standards has very little chance of success at trial has a settlement value
to the plaintiff out of any proportion to its prospect of success at trial
so long as he may prevent the suit from being resolved against him by
dismissal or summary judgment.” And Mr. Justice Powell considered
that “allowing this type of open-ended litigation would itself be an
invitation to fraud.” 421 U.S. at 761.
Similarly, in Securities Investor Protection Corp. v. Barbour, 421
U.S. 412 (1975), Mr. Justice Marshall noted that “except with respect
to the solidest of houses, the mere filing of an action predicated upon
allegations of financial insecurity might often prove fatal.” 421 U.S.
at 422. He added: “These consequences are too grave, and when un-
necessary, too inimical to the purposes of the Act, for the Court to
impute to Congress an intent to grant every member of the investing
publie control over their occurrence.” Id. at 423.
18 How strikingly similar was the explanation by the SEC representa-
tive to the House of the provisions of § 210:
“The only other provision of consequence is section 2)0, which in
our opinion will have a very salutary effect. The investment counsels
A49
tention by Congress to open wide private civil complaints
which, in the nature of our adversary proceedings, become
public property at once.
The blackmail effect of allowing customers to sue invest-
ment advisers for damages for what the customer might
have done if he had but known, seems obvious for the
reasons so well stated by Mr. Justice Marshall. The cus-
tomer has ample relief under § 10(b), for misrepresenta-
tions made by the investment advisers in the process of
getting him into the adviser’s fund.” And if Congress
wishes to go further, it can do so.
Since my brethren wish to create a new implied right of
action, I have given my reasons for dissenting from their
view. As indicated, I concur in the dismissal of the § 10(b)
claim, but would carry over some of the reasoning to dis-
miss the asserted claim under § 206 as well.
were a little concerned about the effect on their business if it got
around that the Securities and Exchange Commission was conducting
an investigation. In order to safeguard against this danrer section
210(a) and (b) provide that there shall not be any disclosure of
any investigation by the Securities and Exchange Commission until
it has made up its mind that a public hearing is to be held. Then
in order to safeguard them further, subsection (¢), provides that
the Commission can not ask these investment counsellors to dis-
close their clients, and what their investments are, except if there
is some indication of wrongdoing. Thereafter, in connection with
the investigation, they have to make the disclosure.”
Hearings on H.R. 10066 before the Subcomm. of the House Comm. on
Interstate and Foreign Commerce, 76th Cong., 3d Sess. 138 (1940);
sce also Senate Hearings, supra, at 713, 715.
19 The Commission in its amicus brief asserts that “this private action
undeniably could te maintained [on the basis of §$10(b)] alone.” This
is contrary to our unanimous holding on this appeal. But we all agree
that in proper cireumstances, investment advisers are as liable as any
other persons under §10(b). Cf. Superintendent of Insurance v.
Bankers Life $ Cas. Co., 404 U.S. 6 (1971); Herrfeld v. Laventhol,
Krekstein, Horwath ¢ Horwath, CCH Fed. Sec. L. Rotr. 795,660 (24
Cir., July 15, 1976); Shapiro v. Merrill Lynch, Pierce, Fenner & Smith,
Inc., 495 F.2d 228 (2d Cir. 1974). This fortifies the argument that there
is no need for an additional judicially created remedy against advisers
where the purchase or sale of securities is involved.
A50
Order on Petitions for Rehearing
UNITED STATES COURT OF APPEALS
SECOND CIRCUIT
75-7203
At a Stated Term of the United States
Court of Appeals, in and for the
Second Circuit, held at the United
States Court House, in the City of
New York, on the sixth day of Janu-
ary, one thousand nine hundred and
seventy-eight.
Present:
Hon. WALTER R. MANSFIELD,
Hon. WILLIAM H. TIMBERS,
Hon. Murray I. GuRFEIN,
Circuit Judges.
vw
ROBERT ABRAHAMSON and MARJORIE ABRAHAMSON,
Plaintiffs-A ppellants,
Vv.
MALCOLM K. FLESCHNER, WILLIAM J. BECKER, HAROLD
B. EHRLICH, LEON POMERANCE, FLESCHNER BECKER
ASSOCIATES, and HARRY GOODKIN & COMPANY,
Defendants-A ppellees.
«
Petitions for rehearing having been filed herein by coun-
sel for appellees, pursuant to F.R.A.P. 40, addressed to this
Court’s panel opinions of February 25, 1977, — F.2d -,
slip op. 6211; and
AS1
Order on Petitions for Rehearing
This Court by an order entered April 15, 1977 having
granted the said petitions for rehearing to the extent of
requesting the parties and the SEC to file further supple-
mental briefs on the issue of whether the general partners
of defendant Fleschner Becker Associates are investment
advisers within the meaning of the Investment Advisers Act
of 1940 (the issue dealt with in section III(1) of the panel
majority opinion of February 25, 1977, — F.2d at — - —,
slip op. 6222-6226); and
This Court having granted leave to various interested
persons to file amicus curiae briefs in connection with appel-
lees’ petitions for rehearing; and
This Court having received and considered the further
supplemental briefs of the parties and of the SEC and the
amicus curiae briefs, and having given due consideration
to all claims raised on the petitions for rehearing and in the
briefs referred to above; it is
ORDERED as follows:
(1) From the second sentence of the last paragraph of
footnote 16 of the majority panel opinion, the last
four words, i.e. “to the limited partners” are stricken,
so that the sentence as revised will read:
“The general partners as individuals, not FBA
as an entity, were the investment advisers.”
(2) In all other respects, the petitions for rehearing are
denied and the panel opinions are adhered to.
/S/ WALTER R. MANSFIELD
Walter R. Mansfield
/s/ WILLIAM H. TIMBERS
William H. Timbers
[not signed]
Murray I. Gurfein
Circuit Judges
A52
Order on Petitions for Rehearing
MEMORANDUM ON “ORDER ON PETITIONS FOR REHEARING”
1. Since I dissented from the majority opinion I do not
participate in its correction.
2. Since I believe that the complaint should be dis-
missed, as stated in my dissenting opinion, on the ground
that there is no claim for relief in money damages under
the Advisers Act, I do not now reach the question of
whether the defendants were or were not investment ad-
visers. In view of the fact that the majority adhere to their
order for a remand, I would prefer, on the basis of my study
of the supplemental briefs, to rule on the question only
after appropriate findings of fact by the District Court
concerning who holds title to the assets; whether the general
partners contributed their own money in substantial sums;
the characteristics of the limited partners; whether there
was any solicitation of the public; what advice, if any, was
given to the limited partnership, and how it differs from
“advice” given to any trust or partnership by a trustee or
general partner when he buys or sells securities.
Since I am outvoted in any event on the remand, I join
in the denial of the petitions for rehearing with the fore-
going comment.
/s/ Murray I. GURFEIN
Circuit Judge
AS53
Order on Petitions for Rehearing
UNITED STATES COURT OF APPEALS
SECOND CIRCUIT
At a stated term of the United States
Court of Appeals, in and for the
Second Circuit, held at the United
States Court House, in the City of
New York, on the sixth day of Janu-
ary, one thousand nine hundred and
seventy-eight.
&
-
ROBERT ABRAHAMSON and MARJORIE ABRAHAMSON,
Plaintiffs-A ppellants,
Vv.
MALCOLM K. FLESCHNER, WILLIAM J. BECKER, HAROLD
B. EHRLICH, LEON POMERANCE, FLESCHNER BECKER
ASSOCIATES, and HARRY GOODKIN & COMPANY,
Defendants-A ppellees.
¢
A petition for rehearing containing a suggestion that the
action be reheard in banc having been filed herein by coun-
sel for defendants-appellees, and no active judge or judge
who was a member of the panel having requested that a
vote be taken on said suggestion,
Upon consideration thereof, it is
Ordered that said petition be and it hereby is denied.
/s/ IrnvinGc R. KAUFMAN
Irving R. Kaufman
Chief Judge
A54
Order and Opinion of Judge Carter
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
71 Civ. 344
a
vv
ROBERT ABRAHAMSON and MARJORIE ABRAHAMSON,
Plaintiffs,
—against—
MALCOLM K. FLESCHNER, WILLIAM J. BECKER, HAROLD
B. EHRLICH, FLESCHNER BECKER ASSOCIATES, and
HARRY GOODKIN & COMPANY,
Defendants.
=
APPEARANCES:
MEssrs. SHEA GOULD CLIMENKO & KRAMER
330 Madison Avenue
New York, New York 10017
by: RONALD H. ALENSTEIN, Esq.
Attorneys for Plaintiffs
MEssRS. SULLIVAN & CROMWELL
48 Wall Street
New York, New York 10005
by: RICHARD E. CARLTON, Esa.
Attorneys for Defendants
Malcolm K. Fleschner
William J. Becker
Fleschner Becker Associates
A55
Order and Opinion of Judge Carter
MEssrs. HILL, Betts & NASH
One World Trade Center
Suite 5215
New York, New York 10048
by: MarRK M. JaFrzg, Eso.
Attorney for Defendant
Harold B. Ehrlich, Esq.
MEssrs. D’AMATO, COSTELLO & SHEA
116 John Street
New York, New York 10038
by: RICHARD G. MCGAHREN, Eso.
KENNETH A. SAGAT, Eso.
Attorneys for Defendant
Harry Goodkin & Company
A56
Order and Opinion of Judge Carter
CaRTER, District Judge
Plaintiffs, Marjorie and Robert Abrahamson, are former
limited partners of defendant Fleschner Becker Associates
(“FBA”), an investment partnership. In addition to suing
the limited partnership, plaintiffs also bring this action
against three general partners of FBA and the firm of
certified public accountants which audited the books of
FBA for the fiscal years 1966, 1967, and 1968. Generally,
the plaintiffs allege acts of securities fraud. Specifically,
they assert violations of Section 10(b) of the Securities
Exchange Act of 1934, 15 U.S.C. § 78j(b), and of Rule
10b-5 promulgated thereunder, and of Section 206 of the
Investment Advisers Act of 1940, 15 U.S.C. § 80b-6.
Federal jurisdiction is based upon Section 27 of the 1934
Act, 15 U.S.C. § 78aa, and Section 214 of the Investment
Advisers Act, 15 U.S.C. § 80b-14.
Plaintiffs’ principal claim is that defendants concealed
from them that an enormous percentage of FBA’s portfolio
consisted of unregistered or restricted securities.’ Plaintiffs
allege that in 1970 they withdrew from FBA as soon as
they learned of FBA’s disproportionate investment in un-
registered securities, but claim they received far less than
they would have received had they been informed of the
truth earlier and withdrawn at the end of an earlier fiscal
year. It is asserted that the concealment of the true facts
concerning FBA’s investments resulted in damages to them
in excess of $1,000,000.
1 “Restricted securities” are securities acquired directly or in-
directly from an issuer or its affiliates in a transaction not in-
volving a public offering. Absent registration, such securities
are subject to restrictions regarding any later public sale. See
te SEC Securities Act Release No. 5 (January 11,
1 .
AS7
Order and Opinion of Judge Carter
BACKGROUND FACTS
The following facts are not in dispute. On or about
July 1, 1965, plaintiffs became limited partners of FBA
(then known as The Fleschner Co.) following several con-
versations with defendant Malcolm Fleschner in late 1964
and in 1965. In those conversations, plaintiffs expressed
their concern for financial security and conservatism in
investment; Fleschner, in turn, expressed his intent to
create an investment partnership with a conservative in-
vestment policy.
FBA was started as a small partnership. By April, 1966,
it grew to 35 limited partners, and by October, 1968, it
had at least 66 limited partners. Def
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