Opposition — First Houston Investment Corp. v. Wilson

a

,

Supreme Court. U. S,

FILED

———————__|+—_—_" Ks |

MICHAEL RODAK, JR., CLERK

In the

Supreme Court of the United States

October Term 1977

No. 77-1717

First Houston INVESTMENT CORPORATION,

WILutiaM A. WALSER, JERRY ALLGOOD

and MICHAEL BARKER,

Petitioners,

v.

JOHN M. WILson,

Respondent.

Brief in Opposition to Petition for Writ of

Certiorari to the United States Court of Appeals

for the Fifth Circuit

TINSMAN & Houser, INc.,

1900 N.B.C. Building,

San Antonio, Texas 78205,

(512) 225-3121,

Attorneys for Respondent.

SS NT TS TES

Page

rr 1

QUESTIONS PRESENTED ..._«_ a2

STATUTES INVOLVED 22 ooccococceceececceceee. 2

STATEMENT OF THE CASE... 2

REASONS WRIT SHOULD NOT BEGRANTED __ 3

osc. ccecnecostsescescseccccececcecece. 6

CERTIFICATE OF SERVICE... 6

cc cccmcanseovapecorecenens A1-A27

Statute

Investment Advisers Act of 1940, Secs. 206 and

214, 15 U.S.C. 80(b) — 6 and 80(b) — 14... 2

ii TABLE OF AUTHORITIES

Page

Cases

Abrahamson v. Fleshner, 1976-77 Transfer Binder F.

Sec. Law Rpt. (C.C.H.) 1 95,889 bso Cir. oo

cert. pending No. 77-1279 _.. a 3

Blitzstein vy Ford Motor Company, 288 F. 2d

738 (5th Cir. 1961) tiesiigeaees a ae

Cort v. Ash, 422 U.S. 66 (1975) CE ee

Foreman v. Davis, 371 U.S. 178 Ce gee enn et RE 4

Jones v. Chaney & James Construction Company, Inc.,

399 F. 2d 84, 86 (5th Cir. 1966) es,

Lewis v. Transamerica Corp., No. 75-1285 9th Cir. ss 3

M. T. Reed Construction Company v. Virginia

Metal Products Corp., 214 F. 2d 127 (5th ( Cir. 1954) .. 4

Roth v. Hyer, 142 F. 2d 227 (5th Cir. mee

cert. denied 323 U.S. 712... al A Porch ria ARE 4

Federal Rules of Civil a

SR ae) Sun cian waco ~

Treatise

Wright and Miller, Federal Practice and Procedure,

Vol. 6, Section 1476, pgs. 393-394... sists 4-5

In the

Supreme Court of the United States

October Term 1977

No. 77-1717

First HoustoN INVESTMENT CORPORATION,

WILLIAM A. WALSER, JERRY ALLGOOD

and MICHAEL BARKER,

Petitioners,

Vv.

JOHN M. WILSON,

Respondent.

Brief in Opposition to Petition for Writ of

Certiorari to the United States Court of Appeals

for the Fifth Circuit

OPINIONS BELOW

The opinion of the Court of Appeals (A 1-20) is reported

at 566 F. 2d 1235 (5th Cir. 1978). The decision of the District

Court dismissing the claim under the Investment Advisers

Act of 1940, and the Securities Exchange Act of 1934

(A 21-23), and its decision granting judgment on the plead-

ings with respect to the claim under the Securities Exchange

Act of 1934 (A 28) are unreported.

2

QUESTIONS PRESENTED

I.

Whether the United States Court of Appeals for the Fifth

Circuit properly held that a private right of action for dam-

ages should be implied under the Investment Advisers Act

of 1940,

II.

Whether the United States Court of Appeals for the Fifth

Circuit properly held that it had jurisdiction to consider

Respondent’s claim under the Investment Advisers Act

of 1940.

STATUTES INVOLVED

Section 206 of the Investment Advisers Act of 1940 (15

U.S.C. §80b-6) and Section 214 of that Act (15 U.S.C.

§ 80b-14) are set forth in the appendix to this brief. (A 1-3).

STATEMENT OF THE CASE

Petitioners’ statement of the case is largely correct. How-

ever, it should be pointed out that when Respondent filed

the Amended Complaint to allege a cause of action under

Section 10(b) of the Securities Exchange Act of 1934, this

was the only claim on which the Court had granted permis-

sion for filing of an amended complaint. Also, there was no

order issued pursuant to Federal Rule of Civil Procedure

54(b) to make the Court’s prior order final and appealable.

3

I.

REASONS WHY THE WRIT SHOULD NOT

BE GRANTED

A.

THE FIFTH CIRCUIT’S DECISION IS CONSISTENT

WITH EVERY CIRCUIT WHICH HAS CONSIDERED

THE INVESTMENT ADVISER’S ACT.

The decision of the Fifth Circuit to imply a private cause

of action in this case is consistent with every other circuit

court that has considered this matter. Lewis v. Trans-

American, Corp., 9th Cir. No. 75-1285, Abrahamson v.

Fleshner, 1976-77 Transfer Binder, Fed. Sec. Law Rep.

(CCH) Paragraph 95,889 (2nd Circuit 1977). Cert. pending

No. 77-1279. Further, as the Fifth Circuit held, permitting

an implied cause of action is in accordance with this court’s

decision in Cort v. Ash, 422 U.S. 66 (1975).

Indeed, what Petitioner is asking this Court to hold is

that although fraudulent acts by investment advisers are

prohibited, nevertheless if the prohibited actions occur, a

party who has lost his money because of such actions cannot

recover for the violation of the act. In short, the act would

be reduced to a virtual nullity and investment advisers who

violate the act would have no financial liability to persons

they injure.

B.

THE SINGLE FINAL JUDGMENT BRINGS FORTH

ALL RULINGS WHICH PRECEDED IT.

The Fifth Circuit correctly held that Plaintiffs’ allegations

under Investment Advisers Act were properly preserved for

4

review. Foreman v. Davis, 371 U.S. 178. A Notice of Appeal

from the fina] judgment presents for consideration all prior

rulings of the trial court and all interlocutory and relevant

matters which preceded the final judgment. M. T. Reed Con-

struction Company v. Virginia Metal Products Corp., 214 F.

2d 127 (5th Cir. 1954), Roth v. Hyer, 142 F. 2d 227 (5th Cir.

1944) cert. denied 323 U.S. 712, Blitzstein v. Ford Motor

Company, 288 F. 2d 738 (5th Cir. 1961), Jones v. Chaney &

James Construction Company, Inc., 399 F. 2d 84, 86 (5th

Cir. 1966), Roth v. Hyer, 142 F. 2d 227 (5th Cir. 1944).

The Rule which should be applied is stated by Wright and

Miller as follows:

“A rule that a party waives his objections to the court’s

dismissal if he elects to amend is too mechanical and

seems to be a rigid application of the concept that a

Rule 15(a) amendment completely replaces the plead-

ing it amends. Without more, the action of the amend-

ing party should not result in completely denying him

the right to appeal the court’s ruling. By way of con-

trast, if the motion to dismiss is denied and defendant

answers and defends on the merits, he still retains the

right to object to the denial of his motion to dismiss

on an appeal from the ultimate judgment. Similar

principles apply to plaintiff when he unsuccessfully

moves to strike a defense as legally insufficient and later

serves a reply by order of the court. It therefore is not

logical to deny a party the right to appeal simply be-

cause he decides to abide by the court’s order and amend

his pleading rather than allowing the judgment to be

entered against him and taking an immediate appeal.

The reviewing court also should consider the reasons

why the party elected to amend. For example, a party

may wish to avoid the expense and delay involved in

a direct appeal from the dismissal of the complaint.

5

Moreover, waiver should not be imposed without con-

sidering the possible prejudicial impaci on the amending

party. There is some very good support in the cases for

a flexible approach. In Blazer v. Black, the district court

granted defendant’s motion to strike portions of the

complaint and ordered plaintiff either to amend his

pleadings to conform to the ruling or to proceed to trial

on the complaint without the stricken allegations. Plain-

tiff amended his complaint but, on appeal from a

directed verdict in favor of defendant, challenged the

order to strike on the ground that eliminating the allega-

tions had the effect on changing the claim asserted in

the original complaint. In a strong dictum, Judge

Murrah, speaking for the Tenth Circuit, stated that a

party who amends his pleading to conform it to a

court ruling only waives his objections to that order

insofar as it applies to technical defects in the pleading;

he does not waive his exceptions to rulings that strike

a “vital blow” to a substantial portion of his claim. This

seems to be a reasonable standard for determining when

a party who amends his pleadings to avoid dismissal

should be permitted to assert the court’s alleged error

in its original determination on appeal.” 6 Wright and

Miller, Federal Practice and Procedures, Section 1476,

pages 393 and 394.

When the District Court dismissed the investment advisers

claim for lack of jurisdiction, and permitted further amend-

ment on the 10(b) 5 claims but did not certify its dismissal on

the investment advisers claim, pursuant to Federal] Rule 54 in

order to make it appealable, the Fifth Circuit properly held

that the notice of appeal properly brought forth this dis-

missal for review.

6

CONCLUSION

Respondent respectfully requests that the Application for

Writ of Certiorari be in all things denied.

Respectfully submitted,

haiti

1900 N.B.C. Building Counsel for Respondent

San Antonio, Texas 78205

(512) 225-3121

CERTIFICATE OF SERVICE

I hereby certify that three true and correct copies of the

foregoing Response To Petition For Writ of Certiorari and

the following Appendix thereto have been served upon

Petitioners’ counsel by mail, postage prepaid, on this the

29th day of June, 1978, addressed as follows:

Brice A. Tondre

2684 South Tower

Pennzoil Place

Houston, Texas 77002 ped Mk (7 ? Le»

—S

Al

APPENDIX

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

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;

A2 A3

(4) to engage in any act, practice, or course of provided in sections 128 and 240 of the Judicial

business which is fraudulent, deceptive, or manipu- Code, as amended, and section 7, as amended, of the

lative. The Commission shall, for the purposes of Act entitled “An Act to establish a court of appeals

this paragraph (4) by rules and regulations define, for the District of Columbia”, approved February 9,

and prescribe means reasonably designed to pre- 1893. No costs shall be assessed for or against the

vent, such acts, practices, and courses of business Commission in any proceeding under this title brought

as are fraudulent, deceptive, or manipulative. by or against the Commission in any court.

TEXT Or 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 SiTs

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, concurrently with State and Territorial courts,

of all suits in cquity to enjoin any violation of this

title or the rules, regulations, or orders thereunder.

Any criminal proceeding may be brought in the dis-

trict wherein any act or transaction constituting the

violation occurred. 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 in-

habitant 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 rendercd shall be subject to review as

A4

John M. WILSON, Plaintiff-Appellant,

Vv.

FIRST HOUSTON INVESTMENT CORPORATION

et al., Defendants-Appellees.

No. 75-3422

UNITED STATES COURT OF APPEALS

Fifth Circuit

Feb. 2, 1978.

Appeal from the United States District Court

for the Western District of Texas.

Before GODBOLD, TJOFLAT and HILL, Circuit

Judges.

GODBOLD, Circuit Judge:

This is an appeal from the dismissal of plaintiff's suit

against his investment adviser, which plaintiff sought to

bring under the Investment Advisers Act of 1940, § 214,

15 U.S.C. § 80b-14 (1970) (the “IAA”), as well as

Rule 10b-5, 17 C.F.R. 240.10b-5 (1977). The district

court dismissed plaintiff's complaint and first amended

complaint, and plaintiff appealed.

The plaintiff alleged the following facts, drawn largely

from his amended complaint. For a number of years he

had maintained a stock portfolio. He became dissatisfied

with his investment advisers. He became interested in

First Houston Investment. Corporation’ after reading two

1. The defendants are First Houston Investment and three of

its employees.

AS

magazine articles which purported to describe its invest-

ment management techniques. In particular the articles

represented that First Houston utilized a system of com-

puter analysis of the market and promptly eliminated

stocks not meeting certain performance standards.

Plaintiff met with a representative of First Houston

who stated that the magazine articles were accurate. As

a result of these representations plaintiff executed a power

of attorney giving First Houston full discretionary au-

thority to manage plaintiff's stock portfolio, then valued

at $104,358. First Houston assumed management of

plaintiff's portfolio in March of 1972 and immediately

converted all of his stocks into securities of its own

choosing. In September 1973 First Houston notified

plaintiff that it was resigning from management of the

account because the account had become too small.

The account was then worth $5,441 and included 1000

shares of Teleprompter stock, trading of which had been

suspended. At no time did First Houston reveal to the

plaintiff that the computer analysis system was no longer

being used or that it had never been fully utilized.

[1] In his original complaint plaintiff sought to assert

an implied right of action for damages under the IAA

and a Rule 10b-5 claim as well. Motion to dismiss for

lack of subject matter jurisdiction was granted. The trial

court reasoned that a private right of action should not

be implied under the IAA and that the complaint failed

to allege a valid 10b-5 claim.”

2. The trial court stated that it was dismissing for lack of

subject matter jurisdiction. According to the district court’s analysis,

the complaint more properly should have been dismissed for failure

to state a claim upon which relief can be granted. See Mobil Oil

Corp. v. Kelley, 493 F.2d 784, 786 (CA 5), cert. denied, 419 US.

54 (1971).

A6

Plaintiff was given leave to file an amended complaint,

and he did so, again attempting to state a 10b-5 claim.

However, he did not reassert his claim under the IAA,

nor did he incorporate by reference the allegations of

the original complaint. First Houston’s motion to dismiss

the amended complaint was granted.

I.

(2, 3] Plaintiff did not waive his right to appeal the

order dismissing his claim under the IAA by filing an

amended complaint which failed to make reference to

that alleged cause of action. As a general rule an amended

complaint suspersedes and replaces the original com-

plaint, unless the amendment specifically refers to or

adopts the earlier pleading. La Batt v. Twomey, 513

F.2d 641, 651 (CA 7 1975); Cedillo v. Standard Oil

Co. of Texas, 261 F.2d 443 (CA 5 1958). See also

6 Wright & Miller, Federal Practice and Procedure: Civil

§ 1476 (1971); 3 Moore’s Federal Practice q 15.08[7]

(1974). But we hold that plaintiff, by filing an amended

complaint after a dismissal with leave to amend, was not

barred from raising on appeal the correctness of the

dismissal order.

A rule that a party waives his objections to the

court's dismissal if he elects to amend is too mechani-

cal and seems to be a rigid application of the con-

1022, 95 S.Ct. 498, 42 L.Ed.2d 296 (1974). As pertains to the

asserted cause of action under the IAA, general federal question

jurisdiction is conferred by 28 U.S.C. § 1331 (1970). See Abraham-

son v. Fleschner, No. 75-7203, F.2d , at n. 5 (CA

2 1977) (the dissent and majority agree on this point). See generally

Note, /mplying Civil Remcdics from Federal Regulatory Statutes,

77 Harv. L. Rev. 285, 287 (1963) (two possible theories of juris-

diction).

A7

cept that a Rule 15(a) amendment completely

replaces the pleading it amends. Without more, the

action of the amending party should not result in

completely denying him the right to appeal the

court’s ruling. By way of contrast, if the motion

to dismiss is denied and defendant answers and de-

fends on the merits, he still retains the right to

object to the denial of his motion to dismiss on an

appeal from the ultimate judgment. Similar prin-

ciples apply to plaintiff when he unsuccessfully moves

to strike a defense as legally insufficient and later

serves a reply by order of the court. It therefore

is not logical to deny a party the right to appeal

simply because he decides to abide by the court’s

order and amend his pleading rather than allowing

judgment to be entered against him and taking an

immediate appeal.

6 Wright & Miller, Federal Practice and Procedure: Civil

§ 1476, at 393 (1971) (footnotes omitted). The authors

refer with approval to the approach suggested in Blazer

v. Black, 196 F.2d 139, 143-44 (CA 10 1952) (citation

omitted):

[While the pleader who amends or pleads over,

waives his objections to the ruling of the court on

indefiniteness, incompleteness or insufficiency, or

mere technical defects in pleadings, he does not

waive his exception to the ruling which strikes

“a vital blow to a substantial part” of his cause of

action.

There is authority to the contrary,* but such an approach

spawns piecemeal appeals. We hold that the question

3. Loux v. Rhay, 375 F.2d 55, 57 (CA 9 1967). Sce also Sacra-

mento Coca-Cola Bot. Co. v. Chauffeurs Local 150, 440 F.2d 1096,

1098 (CA 9), cert. denied, 404 U.S. 826, 92 S.Ct. 57, 30 L.Ed.2d

A8

whether a private right of action should be implied under

the IAA is properly before us on appeal.

II.

[4] The broad antifraud provision of the IAA, § 206,*

makes no express provision for a private right of action

for damages. But this alone does not preclude the recog-

nition of a private right of action. See, e. g., Blue Chip

Stamps v. Manor Drug Stores, 421 U.S. 723, 730, 95

S.Ct. 1917, 1922, 44 L.Ed.2d 539, 546 (1975); J. I.

Case Co. v. Borak, 377 U.S. 426, 432, 84 S.Ct. 1555,

1559, 12 L.Ed.2d 423, 427 (1964). The question is

whether the implication of the cause of action is neces-

4. 15 U.S.C. § 80b-6 (1970) provides:

“It shall be unlawful for any investment adviser, by use of the

mails or any means or instrumentality of interstate commerce,

directly or indirectly—

“(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 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 trans-

action. The prohibitions of this paragraph 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 rela-

tion to such transaction;

“(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, deceptive, or manipulative.”

A9

sary to achieve the goals of Congress in enacting the

legislation. Piper v. Chris-Craft Industries, Inc., 430 U.S.

1, 26, 97 S.Ct. 927, 941, 51 L.Ed.2d 124, 143 (1977).

In Abrahamson v. Fleschner, No. 75-7203, _.. F.2d

at (CA 2 1977), a majority of the panel held that

a private cause of action for damages should be implied

under the IAA. Judge Gurfein filed a strong dissent. Prior

to Abrahamson this question had been considered by

several district courts. Angelakis v. Churchill Manage-

ment Corp. [1975-1976 Transfer Binder] Fed. Sec. L.

Rep. (CCH) 4 95,285 (N.D. Cal. 1975) (cause of ac-

tion implied); Bolger v. Laventhol, Krekstein, Horwath

& Horwath, 381 F.Supp. 260 (S.D.N.Y. 1974) (cause

of action implied); Greenspan v. del Toro, No. 73-638

CIV JE (S.D. Fla. May 17, 1974) (no right of action),

appeal dismissed for want of prosecution, No. 74-2943

(CA 5 Sept. 5, 1974); Gammage v. Roberts, Scott &

Co., [1974-1975 Transfer Binder] Fed. Sec. L. Rep.

(CCH) 4 94,760 (S.D. Cal. 1974) (no right of action).

See also Note, Private Causes of Action Under Section

206 of the Investment Advisers Act, 74 Mich. L. Rev.

308 (1975).

In Piper v. Chris-Craft Industries, Inc., the Supreme

Court was presented with the question whether a cause of

action for damages should be implied under § 14(e) of

the Securities Exchange Act of 1934, as amended by

the Williams Act of 1968, 15 U.S.C. § 78n(e) (1970),

in favor of an unsuccessful tender offeror who alleged that

his bid for corporate control failed as a result of fraud

on the part of the successful tender offeror and various

other individuals. C'.ief Justice Burger, writing for the

majority, noted that:

A10

[W]here congressional purposes are likely io be

undermined absent private enforcement, private rem-

edies may be implied in favor of the particular class

intended to be protected by the statute.

430 US. 1, 25, 97 S.Ct. 927, 941, 51 L.Ed.2d 124, 143

(1977). Having so stated the Court applied the follow-

ing methodology in deciding the question:

Once we identify the legislative purpose, we must

then determine whether the creation by judicial

interpretation of the implied cause of action as-

serted by Chris-Craft is necessary to effectuate Con-

gress’ goals.

Id. The Court examined the legislative history of the

Williams Act and determined that Congress had intended

to protect the shareholders of target companies by regu-

lating takeover bidders. Chris-Craft, the defeated tender

offeror, was not a member of the class Congress sought

to protect. Consequently an implied right of action in

favor of Chris-Craft was not necessary to effectuate

Congress’ goals.

The Court confirmed this conclusion by applying the

analysis of Cort v. Ash, 422 U.S. 66, 95 S.Ct. 2080, 45

L.Ed.2d 26 (1975). Cort set out four relevant factors

to be considered in deciding whether to infer a private

remedy:

First, is the plaintiff “one of the class for whose

especial benefit the statute was enacted,” Texas &

Pacific R. Co. v. Rigsby, 241 U.S. 33, 39, 36 S.Ct.

482, 60 L.Ed. 874 (1916) (emphasis supplied)—

that is, does the statute create a federal right in

favor of the plaintiff? Second, is there any indication

of legislative intent, explicit or implicit, either to

All

create such a remedy or to deny one? See, e.g.,

National Railroad Passenger Corp. v. National Assn.

of Railroad Passengers, 414 USS. 453, 458, 460,

94 S.Ct. 690, 38 L.Ed.2d 646 ( 1974) (Amtrak).

Third, is it consistent with the underlying purposes

of the legislative scheme to imply such a remedy for

the plaintiff?’ See, e.g., Amtrak, supra; Securities

Investor Protection Corp. v. Barbour, 421 US.

412, 423 95 S.Ct. 1733, 44 L.Ed.2d 263 (1975);

Calhoon v. Harvey, 379 U.S. 134, 85 S.Ct. 292, 13

L.Ed.2d 190 (1964). 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? See Wheeldin vy.

Wheeler, 373 U.S. 647, 652 83 S.Ct. 1441, 10

L.Ed.2d 605 (1963); cf. J. I. Case Co. vy. Borak,

377 U.S. 426, 434, 84 S.Ct. 1555, 12 L.Ed.2d

423 (1964); Bivens v. Six Unknown Federal Nar-

cotics Agents, 403 U.S 388, 394-395, 91 S.Ct.

1999, 29 L.Ed.2d 619 (1971); Id., at 400, 91

S.Ct. 1999 (Harlan, J., concurring in judgment).

Id, at 78, 95 S.Ct. at 2088, 45 L.Ed.2d at 36-37. The Court

in Piper found that: (1) the plaintiff was not a member

of the class “for whose especial benefit the statute was en-

acted . . .”; (2) the legislative history supported the

conclusion that Congress did not intend to imply a pri-

vate right of action in favor of tender offerors; (3) it

was not consistent with the underlying legislative purpose

to imply such a right in favor of Chris-Craft; and (4) it

was appropriate to relegate the plaintiff to whatever reme-

dy is created by state law. 430 U.S. at 37-41, 97 S.Ct. at

947-949, 51 L.Ed.2d at 150-53.

In addition to applying the Cort factors the Court

considered whether, in view of potential impact on share-

Al2

holders, there was a less drastic means available for

achieving the congressional goal.

In short, we conclude that shareholder protec-

tion, if enhanced at all by damages awards such as

Chris-Craft contends for, can more directly be

achieved with other, less drastic means more closely

tailored to the precise congressional goal underlying

the Williams Act.

Id. at 40, 97 S.Ct. at 949, 51 L.Ed.2d at 152-53.

Nor can we agree that an ever-present threat of

damages against a successful contestant in a battle

for control will provide significant additional pro-

tection for shareholders in general. The deterrent

value, if any, of such awards can never be ascer-

tained with precision. More likely, however, is the

prospect that shareholders may be prejudiced be-

cause some tender offers may never be made if

there is a possibility of massive damages claims for

what courts subsequently hold to be an actionable

violation of § 14(e). Even a contestant who “wins

the battle” for control may wel! wind up exposed to

a costly “war” in a later and successful defense of

its victory. Or at worst — on Chris-Craft’s damage

theory — the victorious tender offeror or the target

corporation might be subject to a large substantive

judgment, plus high costs of litigation.

Id. at 39, 97 S.Ct. at 948, 51 L.Ed.2d at 152 (footnote

omitted).

We turn to consideration of the Cort factors with the

gloss of Piper, as they apply to the present case.

Al3

A. “Class for whose especial benefit the statute was

enacted .. .”

The crucial shortcoming of the plaintiff's case in Piper

was that plaintiff was not a member of the protected

class. In the instant case, the plaintiff is a member of

the class of intended beneficiaries of the IAA.

In the opinion of the committee, the Securities

and Exchange Commission, and the industry itself,

this legislation is needed to protect small investors

from breaches of trust upon the part of unscrupu-

lous managements and to provide such investors

with a regulated institution for the investment of

their savings.

H.R.Rep. No. 2639, 76 Cong., 3d Sess. 10 (1940). This

same theme appears in S.Rep.No. 1775, 76th Cong., 3d

Sess. 21 (1940):

The nature of the functions of investment ad-

visers, their increasing widespread activities, their

potential influence on security markets and the

dangerous potentialities of stock market tipsters im-

posing upon unsophisticated investors, convinces

this committee that protection of investors requires

the regulation of investment advisers on a national

scale.

B. “Legislative intent . . . to create such a reme-

ee

Our understanding of the legislative purpose is con-

sistent with the reading given it by the Supreme Court in

S. E. C. v. Capital Gains Research Bureau, 375 US.

Al4

180, 186-92, 84 S.Ct. 275, 279-283, 11 L.Ed.2d 237,

243-46 (1963):

Although certain changes were made in the bill

following the hearings, there is nothing to indicate

an intent to alter the fundamental purposes of the

legislation. The broad proscription against “any .. .

practice . . . which operates . . . as a fraud or deceit

upon any client or prospective client” remained in

the bill from beginning to end.

Id. at 191, 84 S.Ct. at 282, 11 L.Ed.2d at 246.

The appellecs argue that the omission of the phrase

“actions at law” from the jurisdictional section of the Act

is strong evidence that Congress did not intend to au-

thorize federal jurisdiction over a private cause of action

for damages.° The jurisdictional provisions of other se-

5. Section 214 of the Act states:

“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

subchapter or the rules, regulations, or orders thereunder, and,

concurrently with State and Territorial courts, of all suits in

equity to enjoin any violation of this subchapter or the rules,

regulations, or orders thereunder. Any criminal proceeding may

be brought in the district wherein any act or transaction con-

stituting the violation occurred. Any suit or action to enjoin

any violation of this subchapter 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 de-

crees so rendered shall be subject to review as provided in

sections 225 and 347 of Title 28, 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 assessed for or against the Commission in any proceed-

Al5

curities acts specifically provide for jurisdiction over

“actions at law”.® Judge Gurfein emphasized this point

in his dissent in Abrahamson.

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 Advisers Act it

failed to include a single section imposing liability

for damages. Congress, for example, could have pro-

vided 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 rather that, in its cautious approach

to the regulation of investment advisers, Congress

was not yet ready to impose any civil liability for

damages.

at (emphasis in original). An equally persuasive

argument can be made that Congress omitted the “ac-

ing under this subchapter brought by or against the Commission

in any court.”

15 U.S.C. § 80b-14 (1970) (emphasis added).

6. The “actions at law” language is found in the following pro-

visions: §§ 11 and 12 of the 1933 Securities Act, 15 U.S.C. 8§ 77k

and 771 (1970); §§ 9(*), 16(b) and 18 of the 1934 Securities Ex-

change Act. 15 U.S.C. §§ 78i(e), 78p(b), 78r (1970); §§ 16(a) and

17(b) of the Public Utility Holding Co. Act of 1935, 15 U.S.C.

§§ 79p, 79q (1970): §30\f) of the Investment Company Act of

1940, 15 U.S.C. § 80a-29/7) (1970).

Al6

tions at law” language from the general jurisdictional

section because the Act does not contain any express

provision authorizing a private party to bring a civil

action for damages. This rationale was accepted by the

majority in Abrahamson and in Bolger v. Laventhol,

Krekstein, Horwath & Horwath, 381 F.Supp. 260, 264-65

(S.D.N.Y.1974). The court in Bolger stated:

[Aj plausible explanation exists for the hiatus in

the language in this statute. Unlike each of the

other securities laws, the Advisers Act does not

contain any provision expressly authorizing a civil

action by a private person injured by a violation of

one of the provisions of the Act. Accordingly, it was

necessary in those statutes to make reference to

“actions at law” in the jurisdictional sections. Such

a provision was unnecessary in the Advisers Act.

Id. at 264-65 (footnote omitted). Judge Gurfein’s dissent

in Abrahamson took exception to this analysis:

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. . . . The

better explanation, it seems to me, for the general

jurisdictional provision in each Act . . . 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,

Al7

particularly when the jurisdictional amount was

lacking.

at n. (emphasis in original).

The dissent in Abrahamson also attached significance

to the absence of any section of the IAA that imposes

liability for damages. /d. at . The dissent reasoned

that the omission of a section imposing liability for

damages suggested that Congress, in a cautious approach

to the regulation of investment advisers, was not yet

ready to impose civil liability for damages. Id. at

While this presentation of the former of our two choices

is plausible it is no more persuasive than the reading given

this matter by the majority in Abrahamson. We get no

substantial assistance from the legisl#tive history with re-

spect to Congress’ intentions.

C. “Consistent with the underlying purposes of the

legislative scheme. . . .”

As we have previously stated, Congress sought to pro-

tect investors from the “problems and abuses of invest-

ment advisory services” by regulation of the industry.

S.Rep. No. 1775, 76th Cong., 3d Sess. 21 (1940). The

concept of implying a private right of action for dam-

ages in favor of investors injured by violations of the Act

is consistent with the remedial purposes contemplated by

Congress.

In Piper the Supreme Court reasoned that “the Williams

Act cannot consistently be interpreted as conferring a

monetary remedy upon regulated parties... .” 430 US.

at 39, 97 S.Ct. at 948, 51 L.Ed.2d at 152. Again the

reasoning of Piper simply does not apply to the instant

case where plaintiff is a member of the protected class.

Als

D. “The cause of action [is] one traditionally rele-

gated to state law.

The area of activity in question is not one, in the

language of Cort, “[so] basically the concern of the

States . . . that it would be inappropriate to infer a

cause of action based solely on federal law?” 422 US.

at 78, 95 S.Ct. at 2088; 45 L.Ed.2d at 36. Federal

regulation of the securities industry is very broad. An

‘investor had little common law protection against his

adviser.

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 stc~k market crash

of 1929 and the depression of the 1930’s....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 securities

industry.

S. E. C. v. Capital Gains Research Bureau, 375 US.

180, 186, 84 S.Ct. 275, 280, 11 L.Ed.2d 237, 243

(1963). In that case the Court examined the relation

between its interpretation of the IAA and common law

of fraud. The Court pointed out that its conclusion—

that injunctive relief was available without proof of intent

to injure or cvidence of actual injury—was not in deroga-

tion of the common law. /d. at 192, 84 S.Ct. at 283, 11

L.Ed.2d at 246. As pertains to our inquiry, the Court

went on to note:

There has also been a growing recognition by

common-law courts that the doctrines of fraud and

Al9

deceit which developed around transactions involv-

ing land and other tangible items of wealth are ill-

suited to the sale of such intangibles as advice

and securities, and that, accordinglly, the doctrines

must be adapted to the merchandise in issue.

Id, at 194, 84 S.Ct. at 284, 11 L.Ed.2d at 248.

E. The factors applied

We do not find in the present case the less drastic and

more closely tailored means for achieving the con-

gressional goal which the Court found in Piper. Nor do

we foresee that recognition of a private right of action

for damages is likely to cause investment advisers not

to offer their services to the public.

[5] Thus we arrive at the ultimate question whether

it is necessary to imply the cause of action to achieve

the goals of Congress. We conclude that it is. Plaintiff

is a member of the benefited class; the recognition of an

aggrieved investor’s private right of action for damages is

consistent with the underlying purposes of the legislative

scheme, the cause of action is not one traditionally within

the province of state courts; and Icgislative intent either

to create or deny such a cause of action is a neutral

factor. Congress sought to protect investors such as the

plaintiff who have relied on the advice of investment

advisers, from the possibility of overreaching and fraudiigms

lent conduct on the part of investment advisers. To deny

investors a right of action for damages incurred as a

direct result of fraudulent advisory practices would under-

mine this purpose. We find additional support in the

language of the Supreme Court in S. E. C. v. Capital

Gains Research Bureau:

A20

Congress intended the Investment Advisers Act of

1940 to be construed like other securities legislation

“enacted for the purpose of avoiding frauds,” not

technically and restrictively, but flexibly to effectuate

its remedial purposes.

375 U.S. at 195, 84 S.Ct. at 284, 11 L.Ed.2d at 248.

Finally, we perceive neither a less stringent means to

achieve the congressional goal nor serious adverse impact

on investors by implying the cause of action.

III.

{6] The trial court was correct in dismissing plaintiff's

Rule 10b-5 claims. Plaintiff advances two theories to this

court. The first is that transfer of control over his stock

portfolio somehow satisfied the requirement that the al-

leged fraud be “in connection with the purchase and sale

of securities."" We believe that any purchase and sale

which took place incident to this arrangement was too

remote to satisfy the “in connection with the purchase and

sale” requirement as contemplated by Blue Chip Stamps

v. Manor Drug Stores, 421 U.S. 723, 95 S.Ct. 1917, 44

L.Ed.2d 539 (1975).

[7] Plaintiff's second theory is that the contractual

arrangement with First Houston constitued an investment

contract and therefore was a security under §. E. C. v.

Howey Co., 328 U.S. 293, 298-99, 66 S.Ct. 1100, 1102-

1103, 90 L.Ed. 1244, 1249-50 (1946). This contention

was made in a proposed second amended complaint

7. On appeal plaintiff contends that the right to make purchases

and sales was secured as a result of the fraud. In his complaint

he pursued a slightly different approach, arguing that the purchase

and sale requirement was satisfied when the defendants immediately

sold all of his securities upon assuming management of his portfolio.

A21

which was never filed. It was not properly before the

trial court and consequently is beyond the scope of

this appeal.°

The judgment of the trial court is AFFIRMED in part

and REVERSED in part and the cause is REMANDED.

HILL, Circuit Judge, dissenting:

My brothers in the majority today have found that

a private right of action exists where the United States

Congress has failed to provide for one. Finding this

inappropriate for several reasons, I dissent.

The Act here under investigation is the last of a series

of measures designed to provide some regulation in the

field of securities and similar investments. It differs

noticeably from the others. The Investment Advisers

Act of 1940 was designed, largely, to provide a mecha-

nism for the Congress to obtain information about what

was, at the time of enactment, a relatively new industry.

15 U.S.C.A. §§ 80-b-1-80-b-21. Implicit in a measure

calculated to gather information is the intention of the

Congress, when equipped with full information, to legis-

late further if the information thus obtained indicated a

need for regulation. The Congress may have concluded

that mandating a code of conduct and dealing which

would be enforced by the Securities and Exchange Con-

mission through penalties, injunctions, and the like, would

be sufficient. The Congress may yet conclude that the

industry would be better policed if those dealing with

members of that industry have a private right of action

8. Whether on remand plaintiff can amend to raise this is in the

discretion of the district court, Fed. R. Civ. P. 15(a).

\

A22

against advisers violating the law. In any event, it is ap-

propriate that the legislative branch make such a decision.

No legislation states that a person shall have a right of

action in the federal courts under these circumstances.

Yet, eminent jurists of the United States Court of Appeals

for the Second Circuit have, like my brothers today, dis-

covered the need for a private cause of action and, in a

gesture somewhat patronizing of the Congress, have de-

termined to complete the work of that body by reading

one into the Act. Abrahamson vy. Fleschner, F.2d

___., at ___._ (2d Cir. 1977). Perhaps the Congress

should pass a law providing what my brothers find to be

needcd. If so, and if the inaction of the Congress leaves a

void, that is regrettable.

It may be that sovereignty, like nature, abhors a

vacuum. In nature, molecules of gasses mindlessly rush

in to fill and destroy any vacuum that occurs. But in the

political sciences and the governing arts, those of us who

might be tempted to fill a vacuum are not mindless. We

are given rcason by which we may determine, for our-

selves, whether one branch of the Government should

rush into the province of another when the inaction of

the other seems to create a vacuum. More than one-

hundred and eighty ycars ago, Alexander Hamilton labeled

the judiciary “the least dangerous branch” of government

because it “. . . has no influence over either the sword

or the purse, no direction of either the strength or of the

wealth of the society, and can take no active resolution

whatever. It may be truly said to have neither Force nor

Will, but merely judgment; and must ultimately depend

upon the aid of the cxecutive arm even for the effiacy

of its judgments.” Cooke, J. (ed.), The Federalist 522-23

A23

(1961). As for me, I should rather leave the abhorrent

vacuum than to breach the separation of powers so wisely

mandated in our Constitution. I have no yearning to be

patronizing of the distinguished men and women who

serve in the United States House of Representatives and

the United States Senate. If the necd exists for a private

right of action so that “private attorneys general” may

help enforce the Investment Advisers Act of 1940, our

Congress is quite sufficient to the task of meeting it.

Even were it to be found that the Congress has attempted

to abdicate this part of its legislative function to the

courts, I feel that proper concern for the Constitution

requires that we decline the invitation to assist in such

an inappropriate way.

It may be that the Act now created by our Court is a

better or more complete Act than the one actually

passed by the Congress. Who knows? Its deficiency is

that the judicially created Section, establishing a private

cause of action, was never submitted to the people’s

elected representatives and adopted by them. Unlike the

judiciary, the legislative branch does its work through

open debate, negotiation and, often, compromise. Por-

tions of the Investment Advisers Act of 1940 which were

enacted may have been obtained at the cost of leaving

out any private cause of action for damages. If so, we

might even assume that no act would have passed had that

compromise not been effected.’ This possibility pretermits

1. Facially desirable proposals may fail because they are seen

to have undesirable ‘‘side effects.” Somewhat analogous is the asser-

tion now being made by, and on behalf of, the Courts that the

Congress has created jurisdiction in the federal courts to hear and

determine a host of disputes in areas that ought not require an

Article IIIT court for their resolution. This tendency has resulted

in overburdening the courts to the detriment of the quality of justice

A24

“judicial-legislating,” a constitutional contradiction in

terms. Suffice it to say that I am in complete agreement

with Judge Gurfein’s concurring and dissenting opinion

in Abrahamson v. Fleschner, supra at , concerning

the impropriety of implying a private cause of action in

these circumstances.

So, I respectfully dissent.

i o those litigants whose causes ought properly be before

‘aac ae A Reena or Member of the House, heeding such

warnings, might resolutely oppose an otherwise well intended measure

that would add to our burden. My brothers today offer him no

encouragement by, themselves, creating a new federal cause of action

which the Congress never provided. It may be that what we do

speaks so loudly that no one will hear what we say.

A25

UNITED STATES DISTRICT COURT

WESTERN DISTRICT OF TEXAS

SAN ANTONIO DIVISION

Civil Action SA 74-CA-42

JOHN M. WILSON,

Plaintiff,

Vv.

FIRST HOUSTON INVESTMENT CORPORATION,

WILLIAM A. WALSER, JERRY ALLGOOD,

MICHAEL BARKER, MERRILL LYNCH,

PIERCE, FENNER & SMITH, ING. and

CHARLES HUNDLEY, |

Defendants.

ORDER

Defendants, First Houston Investment Corporation,

William A. Walser, Jerry Allgood and Michael Barker,

move to dismiss plaintiff's complaint on the ground that

this Court lacks jurisdiction over the subject matter of

the Causes of action attempted to be alleged by plaintiff

under The Investment Advisers Act of 1940 and Securi-

ties Exchange Act of 1934 (15 USC § 78j(b) and Rule

10b-5 (17 CFR § 240.10b-5).

Defendants Merrill Lynch, Pierce, Fenner and Smith,

Inc. and Charles Hundley move for summary judgment

upon the ground that there is no genuine issue:of material

fact for determination at any trial of the matter and the

law requires judgment for these moving defendants.

A26

1. The Investment Advisers Act, 15 USC § 80b et seq.

The relative position of the parties are expounded in

three cases—one permitting a private action for damages

and two denying such action. These are respectively

Bolger v. Laventhol, Krekstein, Howath & Howath, 381

F. Supp. 26 (S.D.N.Y. 1974), Gamage v. Roberts, Scott

& Co., Inc., 74 Fed. Sec. Law R. § 94, 760 (S.D. Cal.

613-74) and Greenspan v. Del Toro (unreported) No.

73-638-CIV-JE (S.D. Fla. 5-17-74).

This Court is of the opinion that Gamage (supra) and

Greenspan (supra) more accurately state the proper

interpretation to be given The Investment Advisers’ Act

15 USC § 80b et seq.

IT IS ORDERED the motion to dismiss as to all parties

is granted for each of subject matter jurisdiction.

2. The 10 b-5 claims

(a) Merrill Lynch, Pierce, Fenner and Smith, Inc.

and Charles Hundley.

These defendants under the undisputed facts are—at

most—responsible only for causing plaintiff to hire in-

competent and fraudulent investment advisers. That just

cannot be tortured into a 10 b-5 claim.

IT IS ORDERED that motion for summary judgment

of defendants Merrill Lynch, Pierce, Fenner and Smith,

Inc. and Charles Hundley is granted.

(b) First Houston Investment Corporation, William

A. Walser, Jerry Allgood and Michael Barker.

Plaintiff's complaint as it now stands alleges no claim

against these defendants which is cognizable under 10 b-5,

A27

Federal Rules of Civil Procedure Rule 9(b). It is con-

ceivable however that plaintiff may be able to allege a

claim of misrepresentation, fraud, deception or failure

to disclose, “in connection with” the purchase or sale of

a security within the liberal concept enumerated in

Superintendent of Insurance of New York v. Bankers Life

and Casualty Co., 404 U.S. 6, 30 L.Ed.2d 128, 92 S.Ct.

165 (1971). He does not come within the broad concept

of Bankers Life (supra) in his complaint. Nor does the

memorandum filed make such a claim viable. The purpose

of 10 b-5 is to give investors the knowledge they need

to make prudent investments i.e., a security the investor

then contemplates buying or selling.

Perhaps plaintiff can meet that requirement.

au IS ORDERED the motion to dismiss of defendant

First Houston Investment Corporation, William A. Walser,

Jerry Allgood and Michael Barker is granted. Plaintiff

shall file an amended complaint on or before May 20,

1975.

In default of the filing of an amended complaint on or

before May 20, 1975 the action shall be dismissed.

Dated: May 1, 1975.

/s/ MANUEL L. REAL

Manuel L. Real

United States District Judge