# Petition — Wood Walker & Co. v. Marbury Management, Inc.

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Petition
- **Published:** January 1, 1980
- **Citation:** 449 U.S. 1011

## Text

Ze 3 4 2 Suoreme es 5"
SEP2 1980
IN THE

Supreme Court of the United bette SIR. CLERK |

OCTOBER TERM, 1980
No.

WOOD WALKER & CO.,
Petitioner,

Vv.

MARBURY MANAGEMENT INC. and HARRY BADER,
Respondent.

On Writ or CERTIORARI TO THE Unitep STATES
Court oF APPEALS FOR THE Sseconp CrRcultT

eS
PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT

as

Cuartes A. Crocco, JR.
Lunney & Crocco
641 Lexington Avenue

New York, New York 10022
(212) 355-0800
Attorneys for Petitioner

Wood Walker & Co.

IN THE

Supreme Court of the United States

October Term, 1980
No.

s
vv

Woop Waker & Co.,
Petitioner,

4

V.

Marsury ManaGeMent Inc. and Harry Baber,

Respondent.

On Writ oF CERTIORARI TO THE Unitrep STATES
Court oF APPEALS FOR THE Sseconp Circuit

a
7

PETITION FOR A WRIT OF CERTIORARI TO THE
UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT

Questions Presented

1. Is the common law concept of respondeat superior read
into the Securities Exchange Act of 1934 and specifically
into §10(b), (15 U.S.C. § 78j(b)) to hold an employer ab-
solutely liable without scienter for the acts of its employees?

2. If a collateral misstatement is made prior to the pur-
chase of a security at its fair market value and the security
thereafter declines in price solely due to market forces, are
damages for such decline recoverable by the purchaser?

Both questions were answered in the affirmative by the
Court of Appeals for the Second Circuit.

TABLE OF CONTENTS

Questions Presented .....--+--+eeereerrerreeeeees

Table of Authorities ........--.e eee eeeeeeeeeeees

Official and Unofficial Reports of Case Below .....

Jurisdiction ........cecccccccecccccecsssccrecces

Statutes Involved .........eee eee eree ee ereeenereee

Statement of the Case .....----ceeeeeceeereeeees

Reasons for Granting the Writ ......----.+eeeee:

I.

II.

Ill.

IV.

The Second Circuit Decision Is Patently In-
consistent With the Holding of the Supreme
Court as to Scienter in 10(b) Actions .......

There Is a Conflict Among the Circuits as to
Whether Respondeat Superior Can Be a Basis
for Liability Under Section 10(b) of the Se-
curities Exchange Act of 1934 and the In-
stant Second Circuit Decision Overturns Its
7 ee ee

The Court Below Applied a Measure of Dama-
ges That Flagrantly and Improperly Shifts
the Losses Away From the Customer ......

The Second Cireuit’s Opinion as to the Rele-
vance of Being a “Not Registered” Registered
Representative Flatly Contradicts the Holding
of the Ninth Circuit .........-.ceceeesscoes

Conclusion ......:ceesceunecaeeeweuceuane es eens

6

11

14

15

il

Appendix

Appendix A—Decision of the United States Court
of Appeals, Entered April 21, 1980 ............

Appendix B—Opinion of the United States Dis-
trict Court for the Southern District of New
York, Entered April 25, 1979 ............+005-

TABLE OF AUTHORITIES

Cases

Aaron v. Securities and Exchange Commission, Fed.
ees Bin Bee ABER CIB) ics ccs cciacgperncces
Abel v. Paterno, 245 App. Div. 285, 281 N.Y.S. 58
EG AIOE, ROOD Cio ss bn Swe eKede sen dene secwes
Abrahamson v. Fleschner, 568 F.2d 862 (2d Cir.
TE cekcxdaals cde teenbshss rasa ewes sh canes
Affiliated Ute Citizens v. United States, 406 U.S. 128
CONE ailie's kd daen Bee daes Ub pene RONe ward a We Rane
Armstrong, Jones & Co. v. SEC, 421 F.2d 359 (6th
Cir. 1970), cert. denied, 398 U.S. 958 (1970) ......

Christoffel v. E. F. Hutton & Co., Inc., 58s F.2d 665
CR I MR ei awiihsicbeasedesbdbenssnehusve

Darrel v. Goodson, CCH Fed. See. L. Rep. { 97,349
i SD kkk ae dks boas tan ixksrabesanens

Edwards & Hanley v. Wells Fargo Securities Clear-
ance Corp., 458 F. Supp. 110 (S.D.N.Y. 1978) ....
Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976) ..

Fey v. Walston & Co., Inc., 493 F.2d 1036 (7th Cir.
| ren Vic bie “eeeesien Nie wed Chu een «eee

Gordon v. Burr, 506 F.2d 1080 (2d Cir. 1974) .......

Hayden v. Walston & Co., 528 F.2d 901 (9th Cir.
SEAS ALY NEAT De NAGE TERE

PAGE

Al

A40

12

13

14

iii

Hotaling v. A. B. Leach & Co., 247 N.Y. 84 (1928) ..
LIT v. Cornfeld, 619 F.2d 909 (2d Cir. 1980) ....-.

Johns Hopkins University v. Hutton, 422 F.2d 1124
(4th Cir. 1970), cert. denied, 416 U.S. 916 (1974)

Kamen & Co. v. Paul H. Aschkar & Co., 382 F.2d 684
(Oth Cir. 1967) ......eceeereceecrseecencenceees

Lanza v. Drexel & Co., 479 F.2d 1277 (2d Cir. 1973)
(em DANC) ..ccsccccereccccvecreesceereteaeeers

Mihara v. Dean Witter & Co., Inc., 619 F.2d 814 (9th
Cie, 10BD) ..cvccccvccccsccesccusececescsaccess
Myezel v. Fields, 386 F.2d 718 (8th Cir. 1967), cert.
denied, 390 U.S. 951 (1970) ......ee ere eeeeeeees

Richardson v. MacArthur, 451 F.2d 35 (10th Cir.
WOTED. funeccdasicanccdsersperdeyege a sens cee es
Rochez Brothers, Inc. v. Rhoades, 527 F.2d 880 (3rd
Cae, TOTBY ca can cctcencer crn cans strectscecssves

SEC v. Lum’s, Inc., 365 F. Supp. 1046 (S.D.N.Y. 1973)
Superintendent of Insurance v. Banker’s Life and
Casualty Co., 404 U.S. 6 (L971) «ee eee eee eee ees

Woodward v. Metro Bank of Dallas, 522 F.2d 84 (5th
Civ, 1975) occ cccvcnccccvecsncccescevccscnesces

Statutes
Judicial Code
98 U.S.C. §1254(1) occ cece eee eee ee en eens
Commerce and Trade
UW UGC. § 78) wc ccc ccc crn ecccecscrveccesenes
15 UG... $ TBC cc ccccccccccccsccsccceccascoses
Secondary Materials

Prosser, Law of Torts (4th Ed.) ...-..-.seeeeeeees

PAGE

6

13

13

Official and Unofficial Reports of Case Below

The Second Cireuit Court of Appeals decision dated
April 21, 1980 is reported in CCH Fed. Sec. L. Rep. | 97 youd
[1980 transfer binder]. (Appendix, Exhibit A). The Dis-
trict Court opinion (Appendix, Exhibit B) is reported at
470 F. Supp. 509 (1979). The Second Cireuit denia!s of -
rehearing and of the petition for rehearing en banc dated
and entered June 4, 1980 are unreported.

|

_——— a

Jurisdiction

The judgment of the Court of Appeals is dated and was
filed April 21, 1980. The denial of the petition for rehear-
ing en banc was dated and filed June 4, 1980. J urisdiction
of the court is invoked under 28 U.S.C. § 1254(1).

Statutes Involved

15 U.S.C. § 78j—Manipulative and deceptive devices

It shall be unlawful for any person, directly or in-
directly, by the use of any means or instrumentality
of interstate commerce or of the mails, or of any fa-
cility of any national securities exchange—

(a) To effect a short sale, or to use or employ any
stop-loss order in connection with the purchase or sale,
of any security registered on a national securities ex-
change, in contravention of such rules and regulations
as the Commission may prescribe as necessary or ap-
propriate in the public interest or for the protection
of investors.

(b) To use or employ, in connection with the pur-
chase or sale of any security registered on a national
securities exchange or any security not so registered,

any manipulative or deceptive device or contrivance in
contravention of such rules and regulations as the Com-
mission may prescribe as necessary or appropriate
in the public interest or for the protection of investors.

15 U.S.C. § 78t—Liabilities of controlling persons

(a) Every person who, directly or indirectly, con-
trols any person liable under any provision of this
chapter or of any rule or regulation thereunder shall
also be liable jointly and severally with and to the
same extent as such controlled person to any person
to whom such controlled person is liable, unless the
controlling person acted in good faith and did not
directly or indirectly induce the act or acts constituting
the violation or cause of action.

Statement of the Case

Marbury Management Inc. and Harry Bader (plaintiffs
below) were customers of the brokerage house Wood
Walker & Co. (petitioner herein), opeining accounts in the
summer of 1968. In September 1968 a personal friend of
plaintiffs, co-defendant Alfred Kohn, joined Wood Walker
as a registered representative-trainee. While the record
below is not altogether clear (the action was dismissed as
to Wood Walker at the close of plaintiffs’ case), plaintiffs
apparently dealt principally with Alfred Kohn in their
buying of stock at Wood Walker. Kohn who was not reg-
istered, was said to hold himself out as being a “portfolio
management specialist” or “security analyst”.*

Plaintiffs alleged that they took investment advice from
Kohn, implying that they listened with particular attentive-
ness because he claimed to be a “portfolio management
specialist”.

* A title that did not exist at Wood Walker nor one recognized by
any regulatory agency.

Plaintiffs’ principal argument was that they bought stocks
based on misleading and erroneous information from Kohn
concerning the stocks. This argument was rejected by the
trial court and the Court of Appeals. The secondary allega-
tion was that because Kohn printed up business cards
identifying him as a “Portfolio Management Specialist-
Security Analyst”, and so described himself, he clothed
his advice with an aura of expertise that helped sway
plaintiffs’ decisions to buy the stocks.

Though both lower courts totally absolved Kohn of mak-
ing any statements concerning the stocks that violated
§10(b), they held that his suggestions of expertise in
selecting stocks when he was not a registered representa-
tive equalled a violation of 410(b) and that two of the
plaintiffs could recover for the drop in price of the pur-
chased securities even though the drop was totally due to
free market factors.

The Court of Appeals went on to hold (reversing the
trial court) that Wood Walker violated ¢10(b) solely by
reason of the common law doctrine of respondeat superior,
in effect a doctrine of absolute liability.

Reasons for Granting the Writ
I.

The Second Circuit Decision Is Patently Inconsistent
With the Holding of the Supreme Court as to Scienter
in 10(b) Actions.

This court has clearly held that in order to violate Rule
10(b) of the Securities Exchange Act of 1934 one must
act with scienter. Ernst & Ernst v. Hochfelder, 425 US.
185 (1976).

Nonetheless, the court below held that an entity whose
only involvement was that it was the wrongdoer’s employer
has no defense and is absolutely liable for any wrongdoing.

Ernst & Ernst v. Hochfelder, supra, clearly states in foot-
note 28 that each provision of the Securities Exchange Act
of 1934 (except 16 (b)) requires some affirmative wrong-
doing.

Recently in Aaron v. Securities and Exchange Commis-
sion, Fed. Sec. L. Rep. 97,511 (1980), this Court said:

“Tt was the view of the Court that the terms ‘manipu-
lative’, ‘device’ and ‘contrivance’—whether given
their commonly accepted meaning or read as terms of
art—quite clearly evinced a congressional intent to
proscrive only ‘knowing or intentional misconduct’,
[Citing Ernst & Ernst]. This meaning, in fact, was
thought to be so unambiguous as to suggest that
‘further inquiry may be unnecessary’.” (p. 97, 681).

Marbury is a 10(b) case yet the Second Circuit has held
that the brokerage house is liable without intent. This
cracks the cornerstone of this Court’s interpretation of
10(b). It is wrong.

The 1934 Act is fundamentally a criminal act and in-
tentionality is indispensable.

This Court said in the Aaron case,

“In our view, the rationale of Hochfelder ineluctably
leads to the conclusion that scienter is an element of
a violation of §10(b) and Rule 10b-5, regardless of
the identity of the plaintiff or the nature of the relief
sought.” (p. 97, 681).

Judge Friendly, writing for a unanimous court in J/T v.
Cornfeld, 619 F.2d 909 (2d Cir. 1980), cited the lower court

opinion in this case approvingly, and in light of Ernst &
Ernst v. Hochfelder reaffirmed Lanza v. Drexel & Co., 479
F.2d 1277 (2d Cir. 1973) (en banc), for the proposition that
scienter is an indispensable part of a violation of Section
10(b). Although the Court was addressing itself to liability
under an aiding and abetting theory, the clear inference
was that scienter was necessary to find liability. Accord-
ingly, it is incongruous to find liability on the part of Wood
Walker where the court below found that Wood Walker
had no “... wrongful participation ... nor a legally equiva-
lent recklessness”. (App. A4).®

Even against someone who aids and abets the wrongdoer
there must be proof of “. . . their conscious and intentional
complicity . . .” (App. All).

One whose liability arises only out of being a controlling
person is allowed the defense that he “. . . acted in good
faith and did not directly or indirectly induce the act or acts
constituting the violation or cause of action.” (Securities
Exchange Act of 1934, Section 20(a)).

Section 20(a), which was aimed at dummy corporations
or nondisclosed parties, gives to even those who hide their
control both a “good faith” and “did not induce” defense.
Yet the majority in the lower court would ascribe to a dis-
closed principal operating openly and publicly no com-
parable defense. This is untenable.

* References are to Appendix.

There Is a Conflict Among the Circuits as to Whether
Respondeat Superior Can Be a Basis for Liability
Under Section 10(b) of the Securities Exchange Act
of 1934 and the Instant Second Circuit Decision Over-
turns Its Own Rule.

Certain circuits have held there is no respondeat superior
liability under Section 10(b), others have not decided the
issue or made equivocal holdings, while still other circuits
have held that there is respondeat superior liability under
Section 10(b).

In a 10(b) action reviewed by the Third Circuit, Rochez
Brothers, Inc. v. Rhoades, 527 F.2d 880 (3rd Cir. 1975), an
executive vice president of a corporation sold 50 percent
of the stock of the corporation to its president. The court
held that the corporation was not liable for its president’s
activities in purchasing the stock. Judge Stanley stated:

“We are of the opinion that, after reviewing the
legislative history of the 1934 Act and the pertinent
cases, the principles of agency, i.e., respondeat su-
perior, are inappropriate to impose secondary liabil-
ity in a securities violation case,” Jd. at 884.

The Ninth Cireuit also does not apply respondeat su-
perior to Section 10(b). In Christoffel v. E. F. Hutton &
Co., Inc., 588 F.2d 665 (9th Cir. 1978), a brokerage house
was held to be not liable for losses sustained by the estate
of an incompetent due to the brokerage firm’s former ac-
count executive who had dissipated and misappropriated
assets of the estate. Judge Hufstedler stated:

“The district court correctly granted summary judg-
ment against Christoffel [the plaintiff] on his com-

mon law theory because it is the established law of
this circuit that section 20(a) supplants vicarious
liability of an employer for the acts of an employee
applying the respondeat superior doctrine,” Id. at
667.

A brokerage house was held not to be liable for the
“churning” by its account executive of a customer’s securi-
ties in Mihara v. Dean Witter & Co., Inc., 619 F.2d 814 (9th
Cir. 1980). Judge Campbell held:

“The contention that the Court incorrectly instructed
the jury regarding the applicability of respondeat
superior to a 10b-5 claim is also unsupported by the
record. The Court gave the respondeat superior in-
struction in connection with the fiduciary duty claim,
and limited it to that claim,” Jd. at 825.

The Tenth Circuit in Richardson v. MacArthur, 451 F.2d
35 (10th Cir. 1971), imposed Section 20(a) liability on an
employing corporation i. a Rule 10b-5 case, stating that
“Liability under § 20 (a) is not restricted by principles of
agency or conspiracy,” Jd. at 41. However, the court did
not analyze the facts with respect to respondeat superior.

In a footnote on respondeat superior, the Fifth Circuit
noted that the Second Circuit had not applied the concept
at that time, and the Fifth Circuit left the question un-
answered, Woodward v. Metro Bank of Dallas, 522 F.2d 84
(5th Cir. 1975).

“Apparently, the Second Circuit takes the view that
section 20 (a) of the Act, 15 U.S.C. §78t (1970),
which deals with ‘controlling persons,’ is the exclusive
way to hold someone secondarily liable. See Gordon
v. Burr, 8.D.N.Y. 1973, 366 F, Supp. 156, aff’d 2 Cir.
1974, 506 F.2d 1080. While this may be an unneces-
sarily restrictive approach to the securities acts, it

is a question that we need not resolve here,” Id. at
94, fn. 22.

The Sixth Circuit has not applied respondeat superior in
a civil context but only (as had the Second Circuit) applied
it in limited areas of SEC enforcement proceedings, Arm-
strong, Jones & Co. v. SEC, 421 F.2d 359 (6th Cir. 1970),
cert. denied, 398 U.S. 958 (1970).

Three circuits have applied respondeat superior: the
Fourth Circuit in Johns Hopkins University v. Hutton, 422
F.2d 1124 (4th Cir. 1970), cert. denied, 416 U.S. 916 (1974),
the Seventh Circuit in Fey v. Walston & Co., Inc., 493 F.2d
1036 (7th Cir. 1973), and the Eighth Cireuit in Myzel v.
Fields, 386 F.2d 718 (8th Cir. 1967), cert. denied, 390 U.S.
951 (1970). This conflict among the circuits requires the
attention of the Supreme Court.

Finally, until the decision in the instant case it was per-
fectly clear that the Second Circuit had held that, except in
a very limited area of SEC enforcement proceedings, there
was no liability under Section 10(b) of the Securities Ex-
change Act of 1934 purely on the basis of respondeat
superior.

As a matter of fact the lower court majority had to devote
multiple paragraphs to ‘‘ey »lain’’ how other circuits have
‘‘mistakenly” believed that the Second Circuit did not im-
pose respondeat superior liability.

The simple truth is that the Second Circuit in an un-
broken string of cases had declined to impose civil liability
based on respondeat superior and this divided panel over-
ruled existing law and promulgated new law.

The Second Circuit in Lanza v. Drexel € Co., 479 F.2d
1277 (1973) (en banc) per Judge Moore held that before
secondary liability would attach, some culpability on the

part of the controlling person be found. The Court ap-
provingly cited Kamen €& Co. v. Paul H. Aschkar & Co., 382
F.2d 684 (9th Cir. 1967), a case almost identical to the
present one; in Kamen the Court found that broker-dealer’s
liability was based on § 20(a), and that scienter must be
proved.

Shortly after Lanza, SEC v. Lum’s Inc., 365 F. Supp. 1046
(S.D.N.Y. 1973), citing Kamen and Lanza, held decisively
and clearly that a broker-dealer could not be held liable
even in enforcement proceedings under respondeat supe-
rior:

‘*To hold Lehman liable on a theory of respondeat

superior would also do violence to the legislative
intent underlying the Act.” 365 F. Supp. at 1063.

The same court went on to say:

‘*Insistence upon a standard or respondeat superior
would result in the imposition of absolute liability
upon broker-dealers in this context.’’ 365 F. Supp.
at 1064.

That court concluded that a standard of absolute liability
vn the part of broker-dealers in the securities industry for
the acts of its salesmen would be

“. . , to read a non-existent insurer’s liability into
the statute for broker-dealers.” 365 F. Supp. at 1064.

Also in Gordon v. Burr, 366 F. Supp. 156 (S.D.N.Y. 1973),
Judge Bauman disavowed the concept of respondeat super-
ior liability stating:

‘‘This is not, however, the view of the majority of
circuits, as Judge Tyler has recently pointed out in
S.E.C. v. Lums, Inc., 365 F. Supp. 1046, CCH Fed.
Sec. Law Rep. {| 94, 134 (S.D.N.Y. 1973). He reads
both the majority and the dissenting opinions in
Lanza v. Drexel & Co., supra, to suggest that § 20(a),

10

and not respondeat superior is the appropriate
standard for determining secondary liability under
the Securities Exchange Act. Judge Judd’s opinion
in Moerman v. Zipco., Inc. supra, which was affirmed
by the Court of Appeals, also supports the exclu-
sivity of §20(a). See also, Moscarelli v. Stamm,
288 F. Supp. 453 (E.D.N.Y. 1968) (emphasis sup-
plied). 506 F. Supp. at 168.

The Second Circuit affirmed, Gordon v. Burr, 506 F.2d
1080 (1974), holding:

‘‘Tf P.A.W. is also liable to Gordon, it must be de-
rivatively—as a “controlling person” of Lord, within
the meaning of § 20(a) of the 1934 Act.’’ 506 F.2d
at 1085.

The majority opinion below incorrectly states that the
Second Circuit has previously found that respondeat
superior applies. The majority misread those cases. An
example is their statement that:

‘‘In Edwards & Hanly v. Wells Fargo Securities
Clearance Corp., 458 F. Supp. 1110 (S.D.N.Y. 1978),
the court held that a defendant was liable for its
president’s Rule 10b-5 frauds both on the respondeat
superior and on the Section 20(a) theories .. .”
(App. A18).

However, the trial judge* in Edwards ¢ Hamnly stated
that because he found liability under § 20(a) he did not
have to decide whether respondeat superior alone would
provide a sufficient basis for damages:

‘‘On the facts of the case, this court need not resolve
‘the rather thorny controlling person-respondeat
superior issue’.” 458 F’. Supp. at 1125.

* Lee P. Gagliardi, also the trial judge in the instant case.

ee ee we eg ee ~ ern reer tag ae ee

11

The Court Below Applied a Measure of Damages
That Flagrantly and Improperly Shifts the Losses
Away From the Customer.

Judge Meskill, in his dissent herein, clearly and lucidly
set forth the argument rebutting the majority’s ca. sation
theory of damages. We respectfully refer the Court to his
opinion.

Judge Meskill points out that the majority has opened up
a potentially limitless expansion of § 10(b) liability (App.
A29). Any factor anywhere in the universe that starts a
chain of events can now be deemed to cause the ultimate
event. As Judge Meskill so appropriately quotes Judge
Weinfeld: “This is causation run riot. (App. A35).

Essentially, the majority held that
(a) if a valid recommendation is made, and
(b) there is reliance, and
(c) the advisor did not have the credentials claimed,
then all loss thereafter is the responsibility of the advisor.
Both the trial court and the Court of Appeals held that
because plaintiffs did not learn that Kohn was neither a
“portfolio management specialist” nor “security analyst”

until January 1970* and continued to hold their stocks
despite price declines, the loss falls on the defendants.

* A curious holding is that Kohn left Wood Walker in early 1969
and plaintiffs were paying no attention to Kohn after March of 1969.
From Marbury’s Trial Testimony :

(footnote continued on following page)

12

The majority implies that plaintiffs continued to hold
their stock based on the advice of Kohn and misstatements
by Kohn as to his status, which reinforced their belief that
his information was accurate. In fact, Judge Gagliardi did
not make such a finding. See dissent of Judge Meskill
(App. A39).

Even if he had made such a finding, the mere retention
of a security due to a materially false representation would
not state a claim under Rule 10b-5. Darrell v. Goodson,
CCH Fed. Sec. L. Rep. 997,349 (S.D.N.Y. 1980), citing
Abrahamson v. Fleschner, 568 F.2d 862 (2d Cir. 1977).

The causality adopted by the Second Circuit is effectively
a “but for” test, as there is no suggestion that the stock
declined in value because of anything Kohn did. Rather, it
declined after what Kohn did. The loss, nonetheless, is
attributed to him and to his employer, Wood Walker.

The anomalous revival of “but for” causation in the
context of the 10(b) actions absolutely flies in the face of

(footnote continued from preceding page)

Q. When was the last time you spoke with Mr. Kohn at
the number which you said was Wood Walker’s? A. I don't
remember that at all.

. No idea? A. No, no idea.

. Let me try it another way. According to your charge,
the last purchase you made was March 26, 1969. Clearly at
that point you were still listening to Mr. Kohn as you were
making no independent investigation and buying stocks solel
on his comments to you. What made you stop on March 26,
1969? A. Because we weren’t getting too successful results
with the stocks that he recommended,

Q. You made a concious decision not to use Mr. Kohn any
longer or for anyone to talk to? A. When you do business
with someone that you don’t have too much success—

Q. You made a conscious decision at that point of no
further dealings with Mr. Kohn? A. You are asking me
whether I remember after 8 years?

Q. I am asking you to recall as best you can. A. I would
say yes.

(Trial Transcript pp. 44/45)

13

this Court’s rulings in Affiliated Ute Citizens v. United
States, 406 U.S. 128 (1972) and Superintendent of Insur-
ance v. Bankers’ Life and Casualty Co., 404 U.S. 6 (1971).

It is as if someone asked directions of a person imper-
sonating a policeman, was given proper directions and
along his journey was struck by a car. The majority would
hold that an action would lie against the “false policeman”,

The majority lose sight of their own affirmance of the
trial court’s finding that Kohn’s alleged recommendations
were not wrongful. Not one of the ancient cases cited by
the majority allowed recovery based on a misdescribed
adviser.

If one wants a battle of ancient New York cases, Judge
Meskill’s dissent cites equally ancient but correct law that
“but for” causality is not the New York rule. See Hotaling
v. A. B. Leach & Co., 247 N.Y. 84 (1928), Abel v. Paterno,
245 App. Div. 285, 281 N.Y.S. 58 (First Dept. 1935).

Prosser, Law of Torts, quoted in Judge Meskill’s dissent
at App. A28 sums up the entire point.

. . if false statements are made in connection with
the sale of corporate stock, losses due to a subsequent
decline of the market, or insolvency of the corpora-
tion, brought about by business conditions or other
factors in no way related to the representations, will
not afford any basis for recovery. It is only where
the fact misstated was of a nature calculated to
bring about such a result that damages for it can be
recovered.

Prosser, Law of Torts 1110 at 732 (4th ed.) (footnotes
omitted).

Plaintiffs bought stock at fair market value and got ex-
actly whet they paid for. The fact that later the stock
declined in price had nothing to do with Kohn’s represen-
tations as to his expertise.

14

IV.

The Second Circuit’s Opinion as to the Relevance of
Being a “Not Registered” Registered Representative
Flatly Contradicts the Holding of the Ninth Circuit.

The majority on appeal summarily disregarded a case
directly on point: Hayden, et al. v. Walston & Co., Inc., et
al,, 528 F.2d 901 (9th Cir. 1975). The facts and the issue
are as identical as two cases can be.

In Hayden the only misleading information, as in our case
was a lack of registration.* The decision should be the
same,

If there were other misleading statements by Kohn,
there might be a distinction, but it was specifically found
by both lower courts that he did not make other misleading
statements.

The majority suggest that in Hayden, the salesman may
not have held himself out to be a duly registered repre-
sentative. How the court divined that from the sparse
opinion is unclear, but since the Hayden court found that
he was a salesman and was not registered, the reasonable
inference is that he did in fact so hold himself out.

Can it be that the majority seriously means to say that
the two cases are distinguishable on whether the unregis-
tered employee was careful not to say, “I am a duly regis-
tered representative.”’?

* “Appellants were solicited by and purchased stock through a
salesman employed by the defendant Walston & Co., who at the time
was unlicensed to sell securities... On the basis of this fact alone,
appellants seek to state a federal claim to recover their losses on the
stock . . mn Held: Appellants’ Rule 10b-5 claim is unavailing. 528
F.2d at 901.

15

We draw to this Court’s attention the absolutely appro-
priate language found in the Hayden case.

“The customer may receive thoroughly competent
service from an unregistered salesman, and be un-
harmed by violation of the rule.” 501 F.2d at 902.

Conclusion

Because of the importance of these issues to the securi-
ties industry, the fact that the Second Circuit decision is
inconsistent with the holdings of this Court, and the fact
that there is a conflict between the circuits, we request that
this Court grant certiorari.

Dated: August 29, 1980

Respectfully submitted,

Cares A, Crocco, JR.
Lunngy & Crocco
641 Lexington Avenue
New York, New York 10022

Attorneys for Petitioner
Wood Walker & Co.

APPENDIX

APPENDIX A

Decision of the United States Court of Appeals
for the Second Circuit

UNITED STATES COURT OF APPEALS
Second Circuit
Nos. 79-7363, 79-7380
April 21, 1980

Marbury Management, Inc., et al.,

Plaintiffs-Appellants,
v.

Kohn, et al.,
Defendant-Appellant.

4
v

George Berkowitz, for plaintiffs-appellants.

Fischer & Klein, Jay H. Fischer, for defendant-appellant
Kohn.

Lunney & Crocco, Charles A. Crocco, Jr., for appellee
Wood, Walker & Co.

Before:
MeskiLu and Kearse,
Circuit Judges.
Doo.ina,*
District Judge.

Appeal by defendant Kohn from a judgment of the United
States District Court for the Southern District of New

* Of the Eastern District of New York, sitting by designation.

[Al]

A2

Appendix A—Decision of the
United States Court of Appeals for the Second Circuit

York, Lee P. Gagliardi, Judge, 470 F. Supp. 509, awarding
damages under Section 10(b) of the Securities Exchange
Act to purchasers of securities who relied on Kohn’s alleged
misstatement of his status in the securities business in
making purchases through him. Cross appeal by plaintiffs
from the judgment dismissing the action against defendant-
appellee Wood, Walker & Co., Kohn’s employer.

Affirmed in part and reversed and remanded in part.

Doouine, District Judge: Marbury Management, Inc.,
(‘‘Marbury’’), and Harry Bader sued Alfred Kohn and
Wood, Walker & Co., the brokerage house that employed
Kohn, for losses incurred on securities purchased through
Wood, Walker allegedly on the faith of Kohn’s representa-
tions that he was a ‘‘lawfully licensed registered repre-
sentative,” authorized to transact buy and sell orders on
behalf of Wood, Walker.' After a non-jury trial before the
Honorable Lee P. Gagliardi, District Judge, the court found
that Kohn was employed by Wood, Walker as a trainee
and that his repeated statements that he was a stockbroker
and his use of a business card stating that he was a ‘‘port-
folio management specialist” were undeniably false; the
court found further that Kohn made the statements with
intent to deceive, manipulate or defraud in making them,
and that his misstatements were material. The court found
that Kohn’s misrepresentations about his employment
status caused Marbury and Bader to purchase securities
from Kohn between summer 1967 and April 1969. The
district court also found that the predictive statements

1 Harvey Jaffe was also a plaintiff but at the close of plaintiffs’ case
the action was discontinued as to him with prejudice and without
costs, and the judgment stated that he was not entitled to relief. Jaffe
has not appealed. The New York Stock Exchange, originally joined
as a defendant, was dismissed from ‘he ection before trial.

A3

Appendix A—Decision of the
United States Court of Appeals for the Second Circuit

Kohn made about various securities were not fraudulently
made, and that there was no evidence that they were made
without a firm basis.

Judge Gagliardi reasoned: a trainee at a brokerage firm
can accept buy or sell orders by phone only under the
supervision of a broker and cannot recommend the pur-
chase of a security outside the brokerage office; moreover,
the qualifications and expertise of a security salesman are
particularly significant criteria in evaluating any informa-
tion as inherently speculative as future earnings predic-
tions; and a reasonable investor would consider the total
mix of information that he received significantly altered
if he learned that the investment advice was being furnished
to him by a trainee in the field rather than by a specialist
Judge Gagliardi concluded that the important circumstance
was that the terms ‘‘broker’’ and ‘‘specialist’’ themselves
connote a level of competence to the reasonable investor.
Thus, he held Kohn liable to plaintiffs under § 10(b) of the
Securities Exchange Act of 1934, 15 U.S.C. § 78j(b). Infer-
entially Judge Gagliardi found that Kohn’s misstatements
of his status not only induced the purchase of the securities
involved but their retention as investments as well, until
it became evident that Kohn was not, as his business card
asserted, a ‘‘security analyst’’ and ‘‘portfolio manage-
ment specialist’’ associated with Wood, Walker, but simply
a trainee. Since both plaintiffs learned the true facts about
Kohn’s status on or about January 28, 1970, Judge Gag-
liardi computed the damage award to each plaintiff by
taking the difference between the price each plaintiff paid
for the securities and either the selling price of the securi-
ties, if sold before January 28, 1970, or the value within a
reasonable time after that date, if the securities were still
held on that date.

me ene Ce = —— - — —

A4

Appendia A—Decision of the
United States Court of Appeals for the Second Circuit

Judge Gagliardi dismissed the plaintiffs’ claims against
Wood, Walker on the ground of plaintiffs’ failure to prove
that Wood, Walker participated in the fraudulent manipu-
lation or intended to deceive plaintiffs; treating plaintiffs
as basing their claims against Wood, Walker solely on the
theory that the firm aided and abetted Kohn’s fraud, the
court found that the evidence supported neither a finding
of conscious wrongful participation by the firm nor a legally
equivalent reckiessness but at best a finding of negligence
in supervision.

Judge Gagliardi’s findings of fact are not clearly erron-
eous. The cross-appeals of defendant-appellant Kohn from
the judgment against him and of plaintiffs-appellants from
the judgment exonerating Wood, Walker from liability
raise questions of law that are hardly novel but are not
free from difficulty in application. It is concluded that the
judgment against appellant Kohn must be affirmed and
that in favor of Wood, Walker reversed.

1. The substantial question that the appeal of defendant-
appellant Kohn raises is whether Kohn’s misrepresentation
was the legal cause of the loss for which Marbury and
Bader have been allowed recovery. The securities bought
did not lose value because Kohn was not a registered repre-
sentative with Wood, Walker, and this case, accordingly,
is not one in which a material misrepresentation of an ele-
ment of value intrinsic to the worth of the security is shown
to be false, and in which it is shown that disclosure of the
falsity of the representation results in a collapse of the
value of the security on the market. In such cases one in-
duced to buy the security on the faith of the misrepresenta-
tion of the value element is obviously damaged, and the
chain of causation is clear.

A5

Appendix A—Decision of the
United States Court of Appeals for the Second Circuit

Here the claim and finding are that Kohn’s statements
by their nature induced both the purchase and the retention
of the securities, the expertise implicit in Kohn’s supposed
status overcoming plaintiffs’ misgivings, prompted by the
market behavior of the securities.? Plaintiffs’ recovery of
their whole loss measured by the decline in value of the
securities to the date when they learned the truth certainly
does not fit the familiar rubric, for example, of Section
11(e) of the Securities Act of 1933, 15 U.S.C. § 77k(e)—
limiting recovery on account of a false or misleading regis-
tration statement to the deprecipation in value of the secur-
ity resulting from the untruthfulness of the statement made
about it. Cf. Restatement (Second) of Torts § 548A (Com-
ment b, Illustration 1) (1977) (security bought on faith of
untrue representation that issuer had received full con-
sideration for it; later full consideration received by issuer,
but a court invalidated the security on other grounds; buyer
not allowed to recover his loss because it was not considered
a proximate consequence of the untrue representation),
But plaintiffs in such a case as this, whether or not their
claims fall under the more familiar rubric, are, neverthe-
less, entitled to recover the damages that they suffered as
a proximate result of the allegedly misleading statements,
Globus v. Law Research Service, Inc., 418 F.2d 1276, 1291
(2d Cir. 1969), cert. denied, 397 U.S. 913 (1970).

2 Marbury’s representative, asked why they had held one of the
securities so long, answered that Kohn told them to do it, that it was
going to go up; that Kohn had advised them to hold the other securi-
ties as well; and that Marbury continued to rely on Kohn’s advice
and to hold onto the securities until they learned that he was not a
licensed and registered representative. (See 67a, 70a, 73a, 80a-81a,
and &4a-85a.) Bader’s testimony, while less detailed and pointed,
leads to the same ultimate finding. (See 93a-94a, 97a-99a, 106a, 113a,
and 114a-116a).

AG

Appendix A—Decision of the
United States Court of Appeals for the Second Circuit

As Judge Weinfeld observed in Miller v. Schwetckart,
413 F. Supp. 1062, 1067 (S.D.N.Y. 1970) :

Proximate cause, of course, is a concept borrowed
from the law of torts, and generally requires that
one’s wrongful conduct play a “substantial” or “es-
sential” part in bringing about the damage sustained
by another.

The generalization is that only the loss that might reason-
ably be expected to result from action or inaction in reliance
on a fraudulent misrepresentation is legally, that is, proxi-
mately, caused by the misrepresentation. Restatement
(Second) of Torts 4 548A (1977). See Levine v. Seilon,
439 F.2d 328, 333-34 (2d Cir. 1971). Oleck v. Fischer, Fp.
Src. L. Rev. (CCH) {[ 96,898, at 95,702-03 (S.D.N.Y. 1979),
in effect requires that the damage complained of be one of
the foreseeable consequences of the misrepresentation. The
case for Marbury and Bader is that, since the misrepresen-
tation was such as to induce both their purchases and their
holding of the securities, their holding and its duration
determined the extent of their losses. As in Schlick v. Penn-
Dixie Cement Corp., 507 F.2d 374, 380-81 (2d Cir. 1974),
cert. denied, 421 U.S. 976 (1975), the claim is that the mis-
representation was the agency both of transaction causa-
tion and of loss causation.

Liability for representations having the effects of Kohn’s
representation was familiar in the law even before the
Securities Act of 1933 and the Securities Exchange Act of
1934 were enacted. For example, in Rothmiller v. Stein,
143 N.Y. 581 (1894), the defendant officers of a small corpo-
ration told plaintiff that the company was prospering and
would pay at least a 10% dividend, and they recommended
that plaintiff reject an offer of $80 a share for his stock

AT

Appendix A—Decision of the
United States Court of Appeals for the Second Circuit

and accept an offer at $50 a share plus a deferred payment
of $50 a share if there were an interim dividend of 10% on
the stock. Plaintiff acted on the advice, relying on the de-
fendants’ fraudulent statements about the company’s af-
fairs. In holding defendants liable, the court said that de-
fendants

. .. cannot in such case shelter themselves under
the statement that they did not make the representa-
tions, i.¢., commit the fraud with the motive or for
the purpose of inducing the plaintiff to sell his stock.
They intended to deceive the plaintiff and they were
induced thereto by other causes, yet the natural,
proximate and direct result of such deception they
knew or had reasonable ground for believing would
be this sale, although its accomplishment was not
the particular purpose of their fraud. In such case
their liability would seem to be plain.

Id. at 588. Soin David v. Belmont, 291 Mass. 450, 197 N.E.
83 (1935), plaintiff had retained stock of a certain company
and bought additional shares of the same stock in reliance
on certain representations made by defendant which were
false. The court said:

Presumably [plaintiff] continued to hold the stock
after the purchase in reliance on the representations.
The fraud was therefore continuing in its effect until
such time as the plaintiff discovered the falsity of the
representations. A loss which he suffered would
manifestly be the difference in the then value of the
stock and the price which he paid for it.

Id. at 454, 197 N.E. at 85. Similarly in Cartwright v. Hughes,
226 Ala. 464, 147 So. 399 (1933), the plaintiff bought stock

A8

Appendix A—Decision of the
United States Court of Appeals for the Second Circuit

of the defendants’ bank on their representation that it was
“a good investment,” that the bank was solvent, and that its
assets were “good clean assets.” The bank ceased to func-
tion and its stock became worthless. The issue in the ap-
pellate court was the appropriate measure of damages.
Agreeing that the ordinary rule measures damages by the
difference between value at the time of the fraud and what
the value would have been had the representations been
true (the so-called “warranty” measure of damages), the
court said:

The question of time is not often involved, but in
such a transaction as this in 4 Sutherland on Dam-
ages, § 1172, at p. 4409, it is said that “the value of
the stock sold is not uniformly fixed as of the time
of the sale, especially if the purchase was made as an
investment. The fraud in such a case has been con-
sidered operative until the purchaser learned of it;
that is regarded as the time when his cause of action
arose.”

Id. at 467, 147 So. at 401.

The proposition that fraudulent representations may in-
duce the retention of securities as an investment and entail
liability for the damages flowing from retention was given a
more general form in Continental Insurance Co. v. Merca-
dante, 222 A.D. 181, 225 N.Y.S. 488 (1st Dept. 1927). The
court there said:

Where the damage is caused by inducing plaintiff’s
inaction, it is necessarily more difficult to allege or
prove causation than in those cases where active
conduct is induced. Indeed, in all fraud cases, the
element of proximate cause is more impalpable than
in negligence cases because we are dealing with the

A9

Appendia A—Decision of the
United States Court of Appeals for the Second Circuit

plaintiff’s state of mind. The defendants cannot,
therefore, require the same exact proof of causation.

Id. at 186, 225 N.Y.S. at 494. See to the same effect Hotaling
v. A. B. Leach & Co., 247 N.Y. 84, 93 (1928) (“As long as
the fraud continued to operate and to induce the continued
holding of the bond, all loss flowing naturally from that
fraud may be regarded as its proximate result.”); Stern
Bros. v. New York Edison Co., 251 A.D. 379, 381, 296 N.Y.S.
857, 859 (1st Dept. 1937) (“Fraud which induces non-action
where action would otherwise have been taken is as culpable
as fraud which induces action which would otherwise have
been withheld.”); Hadden v. Consolidated Edison Co., 45
N.Y.2d 466, 470, 410 N.Y.S.2d 274, 276 (1978). See 1 F.
Harper and F. James, The Law of Torts 600-603 (1956).
Although the theory of plaintiffs’ case relates their dam-
ages to the inaction of retaining the securities on the faith
of their belief in Kohn’s assertion of his status, the claim
is nevertheless one within Section 10(b) and Rule 10b-5
because the representation relied upon was made in connec-
tion with the purchase of securities, and both Marbury and
Bader sue as purchasers of securities. Cf. Blue Chip Stamps
v. Manor Drug Stores, 421 U.S. 723, 731, 755 (1975) (private
damage action under Rule 10b-5 is confined to actual pur-
chasers or sellers of securities). The case is not one in
which nothing has been shown except an inducement to
hold as in Parsons v. Hornblower & Weeks-Hemphill, Noyes,
447 F’. Supp. 482, 487 (M.D.N.C. 1977), aff’d, 571 F.2d 203
(4th Cir. 1978), if that case is a correct reading of Blue
Chip. Nor is this case similar to Hayden v. Walston & Co.,
528 F.2d 901 (9th Cir. 1975): there the plaintiffs had pur-
chased securities through a salesman who was not a duly
licensed registered representative, but did not show that

A10

Appendia A—Decision of the
United States Court of Appeals for the Second Circuit

the salesman’s nondisclosure of his status rendered his
other statements misleading within the meaning of Rule
10b-5, and there was evidently no claim or proof that he
held himself out to be a duly registered representative. The
second ground of suit rejected in the Hayden case, that a
private right of action could be predicated on the violation
of the National Association of Securities Dealers rules, has
not been relied upon in this case, and was not a ground of
decision in the district court.

It follows from what has been said that the judgment
against defendant-appellant Kohn must be affirmed.’

3 The majority and dissenting opinions do not differ in recognition
of the basic principles of proximate causation in agreement that those
principles apply to the torts of fraud and deceit, and that the critical
issue is their application to those of Kohn’s statement that Judge
Gagliardi found to be untruthful and affective of the action of Mar-
bury and Bader. Kohn, it is agreed, is liable only for the damages that
his misrepresentations proximately caused. The dissenting opinion
rejects what the majority opinion considered Judge Gagliardi’s im-
plicit finding that Kohn’s representations, unrelated to the intrinsic
charateristics of the stocks bought, induced both the purchase and
the retention of the stocks on which the damages were computed.
That is implicit in Judge Gagliardi’s analysis of the representations
and their culpable untruth, the period over which he found the
untruth affective of plaintiff’s conduct (that is, until Kohn’s true
status was disclosed), the measure of damages he employed, and his
explicit reliance on Clark v. John Lamule Investors, Inc. and Harris
v. American Investment Co. The majori-y opinion neither refuses to
give effect to the traditional and acknowl :dged standard of causation,
nor does it repudiate it, or refuse to abide by it. Differentiating trans-
action causation from loss causation car be a helpful analytical pro-
cedure only so long as it does not become a new rule effectively
limiting recovery for fraudulently induced securities transactions to
instances of fraudulent representations about the value charac-
teristics of the securities dealt in. So concise+a theory of liability for
fraud would be too accommodative of many common types of fraud,
such as the misrepresentation of a collateral fact that induces a
transaction.

All

Appendix A—Decision of the
United States Court of Appeals for the Second Circuit

2. Marbury and Bader have appealed from the judgment
in favor of Wood, Walker. Judge Gagliardi considered the
case against Wood, Walker as one in which plaintiffs sought
recovery against Wood, Walker only “as an aider and
abettor of Kohn’s securities law violations.” Judge Gagli-
ardi found that the evidence did not show that Wood,
Walker intended to deceive plaintiffs, or knew of Kohn’s
violations, or provided substantial assistance to Kohn in
violating the securities law, but at most showed only negli-
gence on Wood, Walker’s part. Applying the standard of
Rolf v. Blyth, Eastman Dillon & Co., 570 F.2d 38, 44-48 (2d
Cir.), cert. denied, 439 U.S. 1039 (1978), the district court
held that plaintiffs had failed to establish essential elements
of their claim against Wood, Walker as an aider and abettor
of Kohn’s securities law violations. The court did not con-
sider Wood, Walker’s possible liability under the respondeat
superior theory, or as a “controlling person” under Section
20(a) of the Securities Act of 1934, 15 U.S.C. § 78t(a). It is
concluded, on this branch of the case, that the court’s dis-
position of the “aider and abettor” issues was correct, but
that it was error, on the record before the court, not to
consider and determine whether Wood, Walker was liable
as a controlling person or as Kohn’s employer.

(a) Marbury and Bader have in this court again argued
that Wood, Walker is liable because the evidence shows that
it did aid and abet Kohn’s commission of the fraud. If Kohn
and Wood, Walker are regarded as distinct actors liable
for each other’s acts only to the extent of their conscious
and intentional complicity in them, and the “aiding and
abetting” theory requires that approach, Judge Gagliardi’s
conelvsion is unassailable on the evidence. The circum-
stances on which plaintiffs rely to show that Wood, Walker

eee eee ee eee

wee ertes

A54

Appendix B—Decision of the United States

District Court for the Southern District of New York

Bader’s net economic loss is $20,502.25. Let the Clerk
enter judgment for plaintiff Marbury Management in the
amount of $28,727.27 and judgment for plaintiff Bader in
the amount of $20,502.25, both plus interest from January

28, 1970.

14 These figures were determined as follows:

MARBURY MANAGEMENT

Market
Stipulated Market Value
Value Per of All Shares
# of Date Purchase Share as Owned as of
Name of stock shares Purchased Price of 1/28/70 1/28/70 Loss
D.W.G. Corp. 1000 8/27/68 14,967.50 bid $4 7/8 4,875.00 $10,092.50
Responsive
Environment 100 12/ 6/68 3,385.75 bid $8 800.00 2,585.75
Universal Container 500 3/26/69. 12,406.25 bid $9 4,500.00 7,906.25
Unexcelled 500 1/20/69 22,205.00 [sold on 3/26/69 for $13,312.23] 8,892.77
$29,477.27
- 750.00*
Total loss $28,727.27

* Stipulated amount that defendant Kohn previously paid to defendant Marbury Management
regarding its loss on D.W.G. stock.

Harry Baber

Responsive

Environment
Capital Holding 1
Commuter Airlines 500
Stanrock Uranium 200

ss

12/13/68
12/27/68
9/27/68
1/ 6/69

16,928.75
687.50
6,312.50
973.50

bid $8

$4,000.00

{no market value]
{no market value]

bid $2

400.00

Total Loss

$12,928.75
687.50
6,312.50
573.50

$20,502.25

---

Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385007_0361%3A1. Public record. Not legal advice.