Petition — Smith v. Harmsen
Supreme Court brief1983
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IN THE
Supreme Court of the United States
October Term, 1982
HELEN SMITH,
Petitioner,
VS.
FRED H. HARMSEN, ef al.,
Respondents.
Petition for Writ of Certiorari
to the United States Court of Appeals
for the Ninth Circuit.
JENNINGS, ENGSTRAND & HENRIKSON,
PAUL D. ENGSTRAND,
GEORGE J. BERGER,
Horvitz & GREINES,
ELLis J. HORVITZ,
ALAN G. MARTIN,
16000 Ventura Boulevard,
Suite 401,
Encino, Calif. 91436,
(213) 995-0800,
Attorneys for Petitioner.
Parker & Son, Inc., Law Printers, Los Angeles. Phone 724-6622
i
Questions Presented for Review.
Petitioner Helen Smith respectfully seeks review of the
following questions, which arise out of a federal class action
imposing multi-million dollar liability upon her for second-
ary violation of federal securities laws and related pendent
claims:
1. Whether under § 10(b) of the Securities Exchange
Act of 1934 and Rule 10b-5 (17 CFR § 240.10b-5) civil
liability may be imposed under an aiding and abetting the-
ory, f.e., a non-statutory, ‘“‘add-on’’ theory of secondary
liability derived from common law.' This Court has ex-
plicitly reserved this issue for decision.
2. Assuming that ‘‘add-on’’ theories of secondary lia-
bility are permitted under § 10(b) and Rule 10b-5, whether
secondary civil liability may be imposed without proof of
the requisite elements of a cause of action for primary civil
liability under § 10(b) and Rule 10b-5, specifically where:
a. Petitioner lacked any connection with the purchase
or sale of securities, she had no independent duty of dis-
closure, and her secondary liability was predicated solely
on her inaction in the face of the primary defendant's aileged
nondisclosure of material facts to the market at large;
b. Petitioner’s alleged failure to disclose material facts
was not accompanied by scienter (/.e., intent to deceive,
manipulate or defraud); and
c. There was no proof of any causal connection between
Petitioner’s silence and any damage to plaintiffs.
3. Whether named plaintiffs have standing to assert any
violation of § 10(b) and Rule 10b-5 against Petitioner where
they acquired securities prior to any alleged secondary vi-
olation by her.
‘This question similarly embraces other non-statutory common law
theories of secondary liability.
ii
4. Whether Petitioner has been denied due process of
law by being required to defend a federal class action suit
where:
a. A nationwide class of shareholders was certified to
pursue claims under the National Bank Act, but there was
no claim against Petitioner under the National Bank Act:
b. The only federal causes of action against Petitioner
asserted claims of secondary liability under § 10(b) and Rule
10b-5, but no class or subclass of purchasers or sellers of
securities was ever certified under Rule 23, Federal Rules
of Civil Procedure, and the named plaintiffs lacked any
individual cause of action against Petitioner under § 10(b)
and Rule 10b-5; and
c. The district court excluded Petitioner's proffered ex-
pert testimony demonstrating the non-materiality of any
nondisclosure relating to her thus denying her the oppor-
tunity to negate any possible inference of a ‘‘fraud on the
market.”’
TABLE OF CONTENTS
Page
Questions Presented for Review .............cceseeeeeeeees i
PE er ain ccudanrsntensieuers .axéaharncrs sapineiey l
CSOUIOGE ONO Soe sis isiesvsssoccedesvns(stssvasuvusvensese 2
PT isdn fb cacadnnds ray cnaenie a cache teussciaeang aes 2
Constitutional Provisions, Statutes and Regulations In-
WROD gitecietincisaca ee Ciacci 2
OIE CE GN II ice chet da cd chdecsdace ieenniees 3
1. Jurisdiction in the Court of First Instance ....... 3
2. Summary of Underlying Facts ................0005 3
D. PROUT SUEY oe ces nbstsencsvetsesasnncsinecnen 5
4. The Court of Appeals Opinion .................65 7
Reasons for Granting Review ..........ssscsscecscssssseees 9
1. This Court Should Now Address the Fundamen-
tally Important Issue It Has Explicitly Reserved,
Namely, Whether Civil Liability Under § 10(b)
and Rule 10b-5 May Be Imposed on the Basis
of the Common Law Theory of Aiding and Abet-
NE sccscakankeunnnsta eashanceuvunss(nacaiiareiant 9
By Expanding Secondary Liability Beyond Any
Prior Bounds, the Court of Appeals Has Effec-
tively Eliminated Proof of the Requisite Elements
of Civil Liability Under § 10(b) and Rule 10b-5
as Previously Established by This Court, Thus
Opening Vast New Vistas of Civil Liability for
Anyone Even Remotely Connected, Not With a
Securities Law Violation, But With a Securities
IN IIE iraiacicccs-censicsecucecouseveiemnaeeies 1]
tr
a. No Secondary Liability for Nondisclosure
Should Exist Absent a Duty to Make Dis-
closure. No Such Duty Can Be Predicated
Solely on Knowledge of Another's Breach
Page
of Duty, nor Merely on a Marital or Other
Relationship With Such a Person ............ 12
b. Absent an Independent Duty to Act, Inaction
Cannot Give Rise to Liability. Nor Should
Secondary Civil Liability to All the World
Be Imposed for Failure to **Blow the Whis-
tle’’ on Another's Nondisclosure, Absent an
Intent to Deceive. Manipulate or Defraud
15
c. Secondary Civil Liability to All the World
Should Not Be Imposed Absent Proof of a
Causal Connection Between the Nondisclo-
sure and Any Damages to Plaintiffs ........ 16
3. The Court of Appeals Has Further Expanded the
Reach of § 10(b) and Rule 10b-5 by Extending
the Potential Class of Plaintiffs Far Beyond the
Limits Recognized by This or Any Other Court
4. A Defendant Has a Basic Due Process Right to
Know in Advance of Trial Who and What She
Is to Defend Against. This Right Is in Significant
Part Protected by Rule 23. Federal Rules of Civil
Procedure. The Extraordinary Procedural Irreg-
ularities in the Management of Class Issues, In-
cluding the District Court's Refusal to Permit
Petitioner to Present Evidence Negating Class-
Based Assumptions, Denied Petitioner Due Proc-
I NE a. arian tsdiaedauaveneneanbeierabeseuieia 20
EERIE LORS A PCR RSE RAEI TES
.
INDEX TO APPENDIX
Page
Opinion of the United States Court of Appeals for the
PI SI wiv sccsacevicsicussizstcistewssecens App. p. 1
Judgment of United States District Court, Southern Dis-
RE BE IIE Giincctvicnvccsvscnsnccusescductanareswiened 29
Amendment to Judgment ............sccsscssevccsevereveses 34
Constitutional Provisions, Statutes and Regulations In-
vi
TABLE OF AUTHORITIES
Cases Page
Abed v. A. H. Robins Co., 693 F.2d 847 (9th Cir.
1982), cert. denied, 74 L.Ed.2d 1015 (1983)
Admiralty Fund v. Hugh Johnson & Co., 677 F.2d 1301
PR WIND as se vega cxuenavacansmenciaxeiarandssananents 10
Admiralty Fund v. Jones, 677 F.2d 1289 (9th Cir. 1982)
Nxt cUL uaa Wecee cts ems einae cea eaa ou ie acess hCard beaeice beatin 10
Admiralty Fund v. Tabor, 677 F.2d 1297 (9th Cir. 1982)
gma: Upeaee carer as canes a iaasaunancbsnseuty eva cresscinecenens 10
Affiliated Ute Citizens v. United States, 406 U.S. 128
PENT Te rea dhh dats densnt eetesticueeckuedavesaoiaee 12
An Intern. Inv. Trust v Cornfeld, 619 F.2d 909 (2d
ED Be es Acer ne RoR P EE Oy Re AAR SOI 15
Avala v. United States, 550 F.2d 1196 (9th Cir. 1977),
COUR. RU. AID UR. DRS CUFT) a iiisccevececicnssenes 21
Benoay v. Decker, 517 F.Supp. 490 (E.D. Mich. 1981)
Mane ate TRUE TEAS SaE eeadt coxeeaerUveates bexaiuaebts 10
Blackie v. Barrack, 524 F.2d 891 (9th Cir. 1975), cert.
Gemind 479 U.S. SIG (ISTO) cc ccccessvccscccsssccvceess 24
Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723
SPD ertaaarstcr ork sesiiedes de askttness pHerelentacaneie ih; ae
Bonime v. Doyle, 416 F.Supp. 1372 (S.D. N.Y. 1976)
aff'd 556 F.2d 554 (2d Cir.), cert. denied 434 US.
PN eae db cys tcaniensasasastiaen bin comdcien ys kaxe 17
Brouillette v. Board of Dir. of Merged Area IX, etc.,
be ee 2) eee 21
Byrnes v. Faulkner, Dawkins & Sullivan, 550 F.2d 1303
WU Oe Lcednds wars sdiriscisesassienelacmiannnedened 16
Chiarella v. United States, 445 U.S. 222 (1980)
Aaueiedth sarah ope vntisibaadiamedusbeesscaietceieinns it,
Vil
Page
Christoffel v. E. F. Hutton & Co., Inc., 588 F.2d 665
ye Re MD | Baler Bri 0 ots heen Penn onto er mii prer 10
Dirks v. S.E.C., 681 F.2d 824 (D.C. Cir.), cert. granted
Coe kt) ee eee 14, 15
Edwards & Hanly v. Wells Fargo Securities, etc., 602
F.2d 478 (2d Cir. 1979), cert. denied 444 U.S. 1045
RSE Ries sak cock iru uleiunnecadtnaceonsecssvaivanenceasasvanss 17
Elkind v. Liggett & Myers, Inc., 635 F.2d 156 (2d Cir.
POs hate uatah ivan een bonccnineenssauiscatcianuesisincnes 18
Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976)
as Nekears nah.cpewamiensnen aude: ia eerie tees 9,10, 11, 12
Fridrich v. Bradford, 542 F.2d 307 (6th Cir. 1976),
cert. denied 429 U.S. 1053 C1977) ...<0csceevenseners 17
Gap Stores Securities Litigation, In re, 457 F.Supp.
ERP CUR aes Male, COED cavechinesvdsccacsvcceteerdccaviess 10
General Time Corporation v. Talley Industries, Inc.,
403 F.2d 159 (2d Cir. 1968) cert. denied 393 U.S.
Ue CPD aoa sadaes it chuvcis vans iapecisuapseunses 14, 15
Gladstone Realtors v. Bellwood, 441 U.S. 91 (1979)
a ssniesedp hi RU UN v eidediten vic Arete etn ARAN Ta PRA Neyer 18
Goldberg v. Kelly, 397 U.S. 254 (1970) .............04. 21
Greene v. McElroy, 360 U.S. 474 (1959) ............ 21
Hansverry Vv. Lee, 311 U.S. 32 (1940) ....ccscccsecceses 20
Harmsen v. Smith, 542 F.2d 496 (9th Cir. 1976)
Ledvapes airs sab nebueadabehe ee car iaan Sbeae eaeeaaeaeeebanan aa a» an
Herman & MacLean v. Huddleston, __ U.S. __, 74
RM PRED via dochnsvcexsbenstansnpincivacnons 9, 15
J. Truett Payne Co. v. Chrysler Motors Corp., 451 U.S.
DPI GMIRED saccieeins vi cebcdsssevenniatsulss ciipistactiaiiaes 17
Kotteakos v. United States, 328 U.S. 750 (1945) ..... 19
Vill
Page
Landy v. Federal Deposit Insurance Corporation, 486
F.2d 139 (3d Cir. 1973), cert. denied 416 U.S. 960
PRIME i ciieuiicnukavescatisouruskcceadcanaenuclanneenes 17
Libby, McNeill, and Libby v. City Nat. Bank, 592 F.2d
ee Ce PED 5 ailcvasaceacaxdurscilecendabeaieen 21
Marx & Co., Inc. v. Diners’ Club, Inc., 550 F.2d 505
(2d Cir.), cert. denied 434 U.S. 861 (1977) ......... 24
Memphis Light, Gas & Water Dis. v. Croft, 436 U.S.
DPI $a dip tieiraesicat bon caeesnndaetvaeesannharen ene cau 21
Miller v. Schweickart, 413 F.Supp. 1062 (S.D.N.Y.
UII von vas cu ucuateeenctec ab sbenendis swe coniatieuenl 17
Mills v. Electric Auto-Lite Co., 396 U.S. 375 (1970)
Ee SPO RRO Fee aE MENC TH: MONA BRN MErd Posie TEE Mea mA Fy 16
Nat. Ass'n. of Regional Medical Programs v. Mathews,
551 F.2d 340 (D.C. Cir. 1976), cert. denied 431 U.S.
BP RETA neck ih caciasasbssadiaccasnusae iasecaneas 20
Preiser v. Newkirk, 422 U.S. 395 (1975) ............... 18
Reeder v. Mastercraft Electronics Corporation, 363
ee ee Be ee 8) errr eel Pennine 24
Rochez Bros., Inc. v. Rhoades, 527 F.2d 880 (3d Cir.
Sa IO EAL POR BA De OR Am eLnpti efuratte Rtas i Bk 10
SEC v. Murphy, 626 F.2d 633 (9th Cir. 1980) ........ 10
Sirota v. Solitron Devices, Inc., 673 F.2d 566 (2d Cir.),
cert. denied 74 L.Ed.2d 170 (1982) ...............008. 24
Steffel v. Thompson, 415 U.S. 452 (1974) v.00... 18
Touche Ross & Co. v. Redington, 442 U.S. 560 (1979)
TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438
RI sa paegin tic uae wpine wedecnn cocdon ees baled cena 24
Unicorp Fin. Corp. v. First Union, etc., 515 F.Supp.
BP ae SU TIED tices eideeeanetenivarnscaanacapions 24
ix
Page
United States v. Cohen, 518 F.2d 727 (2d Cir.), cert.
ne 24
Wilson v. Comtech Telecommunications Corp., 648 F.2d
ee idacsyscndecscccccscrcccees 19
Wolff v. McDonnell, 418 U.S. 539 (1974) ............. 21
Constitution
United States Constitution, Fifth Amendment ...... 2; 25
Rules
Federal Rules of Civil Procedure, Rule 23 ...... ii, 2, 20
Federal Rules of Civil Procedure, Rule 23(c)(1) ....... 20
Statutes
Securities and Exchange Commission Rule 10b-5 (17
C.F.R. § 240.10b-5) ......... i: a, 3, 0, 6, 7, 9,
DR UeREE mi anuneven ens: mame, 82, to, 16, 19, 22, 25
Securities Exchange Act of 1934, Sec. 10(b) (15 U.S.C.
CE a. a, oy o, ©, 7,
pedddamesecaus mem ee, ea, 6, 15, 16, 19, 21, 22, 25
Securities Exchange Act of 1934, Sec. 20(a) (15 U.S.C.
os sci escncccscscscecececes 2
Securities Exchange Act of 1934, Sec. 28(a) (15 U.S.C.
Cee cli ceneassncsccccccccccceces 2
United States Code, Title 12, Sec. 94 ................... 3
United States Code, Title 15, Sec. 78aa ................. 3
United States Code, Title 15, Sec. 78bb(a) ............. 16
United States Code, Title 15, Sec. 77v(a) .............. 3
United States Code, Title 28, Sec. 1254(1) ............. 2
United States Code, Title 28, Sec. 1331 ................ 3
United States Code, Title 28, Sec. 1337 ........0000.... 3
Page
Treatises
Fischel, Secondary Liability Under Section 10(b) of the
Securities Act of 1934, 69 Cal.L.Rev. 80 (1981)
Mullaney, Theories of Measuring Damages in Security
Cases and the Effects of Damages on Liability, 46
PONE A BOY. SPF CIPI vecvasisrsseyosnpeiccecspousaen 17
eee
IN THE
Supreme Court of the United States
October Term, 1982
HELEN SMITH,
Petitioner,
VAY
FRED H. HARMSEN, ef al.,
Respondents.
PETITION FOR WRIT OF CERTIORARI
TO THE UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT.
Petition’
Petitioner, Helen Smith, respectfully prays that a Writ of
Certiorari issue to review the judgment and opinion of the
United States Court of Appeals for the Ninth Circuit entered
in this proceeding on December 1, 1982.
*Parties to the proceedings below: Named plaintiffs in the underlying
action were Fred H. Harmsen, Ken Hansen, Samuel Rosenberg and
James P. Young, suing individually and on behalf of a class certified
(to pursue alleged violations of the National Bank Act) as including
‘all persons and entities, excluding the defendant shareholders, who
were beneficial owners of United States National Bank common stock
on October 18, 1973... ."’ (CR 246.)
By a single opinion, the Court of Appeals decided the several appeals
arising out of the lower court judgment: No. 80-5097 brought by Pe-
titioner herein, No. 80-5098 brought by C. Arnholt Smith, Carol Smith
Shannon and Philip A. Toft, and No. 80-5099 brought by John A. Smith
and First National Finance Corporation.
Several othe defendants were not represented at trial and/or defaulted
prior to trial; thus judgment was entered against a number of other
parties who took no appeals; these were: M. J. Coen, U.S. Holding
Company. San Diego Padres and First California Company. (CR 1081,
1103.)
a aes
Opinions Below.
The Opinion of the Court of Appeals is published at 693
F.2d 932, and is reproduced in the Appendix hereto at pages
1-28.
Jurisdiction.
The judgment sought to be reviewed was filed and entered
on December |, 1982. Petitioner's petition for rehearing
was denied and her suggestion for rehearing en banc rejected
on March 3, 1983. Petitioner’s motion for stay of mandate
pending application for writ of certiorari was granted on
March 17, 1983 and issuance of the mandate was thereby
stayed until June 1, 1983, and, upon the filing of the within
Petition, until disposition by this Court. This Court has
jurisdiction under 28 U.S.C. § 1254(1).
Constitutional Provisions, Statutes and Regulations
Involved.
The follow.ng constitutional provisions, statutes and rules
are involved in this case and set forth in the Appendix hereto
at pages 35-39;
1. Securities Exchange Act of 1934, Sec. 10(b) (15
U.S.C. § 78j(b))
Securities and Exchange Commission Rule 10b-5
(17 C.F.R. § 240.10b-5)
3. Securities Exchange Act of 1934, § 20(a) (15
U.S.C. § 78t(a))
4. Securities Exchange Act of 1934, § 28(a) (15
U.S.C. § 78bb(a))
5. Due Process Clause of the Fifth Amendment to
the United States Constitution
6. Rule 23, Federal Rules of Civil Procedure.
tw
at, as
Statement of the Case.
1. Jurisdiction in the Court of First Instance.
Jurisdiction and venue of the District Court for the South-
ern District of California were invoked under 12 U.S.C.
§ 94 and 28 U.S.C. §§ 1331 and 1337 with respect to al-
leged violations of the National Bank Act, under 15 U.S.C.
§ 78aa with respect to alleged violations of § 10(b) of the
Securities Exchange Act of 1934 and Rule 10b-5 enacted
thereunder,’ and under the District Court’s pendent juris-
diction with respect to certain state law claims.
2. Summary of Underlying Facts.
In October 1973, the Comptroller of the Currency de-
clared United States National Bank of San Diego (*‘USNB”’)
insolvent, and the bank was placed in receivership. C. Arn-
holt Smith headed and was majority shareholder of USNB.
Petitioner Helen Smith, an independently wealthy woman,
had married Mr. Smith in July of 1968.
Among the uncontradicted facts are: Petitioner was never
an officer, director or employee of USNB; she did not attend
meetings of the bank directors or any of its committees (CR
1036, p. 18; RT 7060 [stipulated facts]); she was not an
attorney, accountant, consultant or otherwise involved in
USNB’s financial affairs, nor could she have been involved
in the preparation or dissemination of annual reports, proxy
statements, letters to shareholders or other documents issued
‘The pretrial order of the District Court erroneously cites 15 U.S.C.
§ 77v(a) as governing jurisdiction and venue for purposes of alleged
violations of the Securities Exchange Act of 1934 and Rule 10b-5 (CR
1036, p. 18), whereas the correct statutory provision is 15 U.S.C.
§ 78aa. To be precise, it should be noted that the jurisdiction of the
District Court was originally premised upon alleged violations of the
National Bank Act. Following certification of the plaintiff class, how-
ever, plaintiffs (respondents herein) amended their complaint to allege
violations of the Securities Exchange Act of 1934, thereby invoking
the District Court's jurisdiction under 15 U.S.C. § 78aa. (App., p. 14.)
<li,
by USNB. (See, e.g., RT 2092, 2544-45, 2928, 2946-49,
3638, 4525, 5166-68, 5189-90.)
Petitioner's limited relations with USNB were as follows:
she was a depositor of USNB and from time to time owned
relatively small amounts of USNB stock. She had three loans
from USNB, two fully secured conventional loans and one
unsecured business loan, each under prevailing terms and
interest rates.* Beginning in 1969 she performed certain
interior decorating services for the bank. (CR 1036, p. 19.)
At all relevant times, USNB’s annual reports and other
public disclosures were prepared by legal and accounting
personnei and bank officials pursuant to standards promul-
gated by the Comptroller of the Currency. (See, e.g., RT
3463, 3468, 3562-63, 5168-69, 5202-18, 5228.) Petition-
er’s services for the bank and her unsecured business loan
were properly reflected in USNB’s books and specifically
referenced in USNB’s proxy statements for 1972 and 1973.
(See, e.g., Pl. Exh. 94; HS Exh. 73; RT 2373-88, RT 7060-
61 [stipulated facts].° When the FDIC became USNB’s re-
ceiver, it reviewed and approved all of Petitioner's trans-
“On December 30, 1970, Petitioner, whose deposits with USNB
(including certificates of deposit) then exceeded $1,000,000, obtained
a $500,000 one-year business loan; interest of $47,000 was prepaid
then, as it was when the loan was subsequently renewed at a reduced
level. (E.g., RT 2331-36, 2366-74, 2377-81; Pl. Exh. 416-A, HS Exh,
56.) Because Petitioner prepaid interest on her unsecured loan, some
USNB documents reflected ‘zero interest.’ Plaintiffs transformed this,
in argument, into ‘‘no interest loans,’’ despite the uncontradicted tes-
timony of the representative of the FDIC that USNB’s records were ‘‘a
little deceptive because it would appear that Mrs. Smith is not paying
interest, where, in fact, she had paid interest.’’ (RT 2373; see HS Exh.
56.)
In November 1971 and July 1972, Petitioner obtained fully secured
real estate loans on real property investments for, respectively, $84,000
and $137,000. (CR 1036, pp. 19-20; RT 7061 [stipulated facts].)
‘The bank's annual reports for these years reported extensions of
credit to directors, officers, principal shareholders and their associates
exceeding $35,000,000, (PI. Exh. 94, HS Exh. 73.)
=
actions with the bank. None of Petitioner's loans or other
transactions with USNB had ever been criticized by bank
examiners. (RT 2257-59, 2351-52; Pl. Exhs. 169, 170.)
3. Procedural History.
Shortly after USNB was placed in receivership, two sep-
arate class action suits were filed. These two suits primarily
alleged violations of the National Bank Act by C. Arnholt
Smith and other officials of USNB. They were consolidated.
A class was certified of all beneficial owners of USNB stock
at the time it was closed (excluding defendants). (CR 246.)
On a prior interlocutory appeal by the Federal Deposit In-
surance Corporation (*‘FDIC’’), USNB’s receiver, the Ninth
Circuit Court of Appeals (Judge Hufstedler, dissenting) per-
mitted the action to proceed, with limitations, rejecting the
contention that only the FDIC could pursue on behalf of the
bank the claims asserted individually by plaintiffs. See
Harmsen v. Smith, 542 F.2d 496 (9th Cir. 1976).
Thereafter, the complaint was amended to include § 10(b)
and Rule 10b-5 causes of action, C. Arnholt Smitn being
the alleged primary violator, Petitioner and others being
charged with aiding and abetting and other theories of sec-
ondary liability. Petitioner was granted summary judgment
on the National Bank Act claims (CR 1040); therefore, the
allegations under § 10(b) and Rule 10b-5 were the sole basis
of federal jurisdiction regarding her.
By the time of trial, C. Arnholt Smith was the only
remaining defendant charged with violations of the National
Bank Act. Nevertheless, the action proceeded under the
original class certification under the National Bank Act
(owners of USNB shares), including pendent California
claims seeking punitive damages, this despite protestations
by Petitioner and other defendants that (a) there was not a
proper class of plaintiffs as to them (purchasers and sellers
-
of USNB shares), and (b) no named plaintiff had standing
to sue her because all of them had acquired their USNB
stock prior to the earliest alleged primary § 10(b) violation
allegedly linked to Petitioner.
The trial was bifurcated. Neither of the two named plain-
tiffs who testified asserted any individual grievance against
Petitioner, nor did any other member of the class of share-
holders (much less a representative of purchasers) do so.
(CR 551, 556, 566, 588, 1017, 1040.)
The action against Petitioner was ostensibly premised on
allegations she had, by her silence, assisted a **fraud on the
market’’ perpetrated by nondisclosure of material facts in
USNB’s public reports regarding her transactions with
USNB.° Petitioner's dealings with USNB, however, even
had they somehow been improper (which they were not),
to the extent they were not specifically disclosed by USNB,
would not have been material to the average investor ac-
cording to plaintiffs’ own evidence. (RT 9181-83.)’ More-
over, the district court itself warned plaintiffs’ counsel at
the close of the liability phase of plaintiffs’ case that there
was no evidence Petitioner had any knowledge of any al-
leged nondisclosure regarding her transactions with USNB.
(RT 6185-86.)
Legal limitations on plaintiffs’ suit under the National
Bank Act, the exclusive authority of the FDIC to pursue
claims on behalf of USNB, and the requirements of § 10(b)
and Rule 10b-5 were ultimately lost in the trial proceedings.
‘The jury was instructed solely on an ‘‘omissions"’ theory of primary
§ 10(b) liability. (See RT 6062-63, 6312.)
The district court prohibited Petitioner's expert from testifying that,
based on his study of actual behavior of the stock market involving
USNB stock, any alleged nondisclosure regarding Petitioner's relations
with USNB would not have significantly altered the total mix of in-
formation available to the average reasonable investor, i.e., it was not
material. (RT 5832-35, 5883-85.)
a tine
At the end, plaintiffs’ counsel urged the jury to act on a
‘“*gut level’’ feeling that ‘‘something wrong was done
here . . . [w]hatever you want to call it, aiding and abetting,
conspiracy, controlling person.’’ (RT 6608.) According to
plaintiffs’ counsel, ** ‘[{I]t’s when you put the last drop in
that the cup overflows.’ Ladies and Gentlemen, what is the
last drop here? Are we going to say it was J. A. Smith?
Are we going to say it was Mrs. Smith? What was it? Who
really caused the Bank to fail?’’ (RT 6572.)
In the first phase of the proceedings, the jury found Pe-
titioner liable on secondary theories of aiding and abetting,
conspiracy and controlling person and several related state
counts. (CR 1081.) In the damages phase, it fixed her li-
ability at over $6,200,000 based on the estimated value of
all USNB stock which was transferred or issued on or after
March 1, 1971, plus $750,000 in punitive damages on the
State law counts. (CR 1103.)
4. The Court of Appeals Opinion.
The Court of Appeals deemed it necessary to consider
only a single basis of secondary liability under § 10(b) and
Rule 10b-5, i.e., aiding and abetting. The Court duly noted
Petitioner’s contention that such liability does not exist,
further noted the doubt and criticism levelled at such ‘‘add-
on’’ theories of liability, and noted that this Court’s most
recent holdings suggest that the statutory scheme provides
the sole source of civil liability and should not be embel-
lished by common law theories of liability. The Court of
Appeals virtually invited this Court’s review, holding that
there is such liability because *‘the Supreme Court has not
yet seen fit to follow that suggestion.’ (App., p. 20.)
The Court of Appeals proceeded to affirm such liability
on the part of Petitioner without regard to the requisites for
civil liability established by this Court's holdings. To the
—
contrary, the Court of Appeals expressly repudiated the
contention that no liability could be imposed absent a duty
to disclose as held in Chiarella v. United States, 445 U.S.
222 (1980).* The Court of Appeals, having found it unnec-
essary to identify any duty by Petitioner to disclose apart
from one premised merely on her knowledge of her own
relations with USNB, similarly found it unnecessary to iden-
tify (a) any material nondisclosure of facts by Petitioner or
assisted by her, (b) any conduct by Petitioner in connection
with the purchase or sale of securities, (c) any intent by
Petitioner to deceive, manipulate or defraud, or (d) any
damages caused by any nondisclosures which Petitioner al-
legedly assisted by her omission to make public announce-
ment of her transactions with USNB.
‘Despite Petitioner's repeated insistence that no such duty existed
(see, e.g., AOB 46-47, ARB 22-23), the opinion of the Court of Appeals
addresses the issue only with respect to appellants Shannon and Toft.
(App., pp. 20-21.)
po ‘on
REASONS FOR GRANTING REVIEW.
1. THIS COURT SHOULD NOW ADDRESS THE FUNDAMEN-
TALLY IMPORTANT ISSUE IT HAS EXPLICITLY
RESERVED, NAMELY, WHETHER CIVIL LIABILITY
UNDER § 10(b) AND RULE 10b-5 MAY BE IMPOSED ON
THE BASIS OF THE COMMON LAW THEORY OF AIDING
AND ABETTING.
If, for historical reasons, it is now too late for this Court
to consider whether any private right of action is implied
under § 10(b), now is precisely the time to address an equally
important issue this Court has explicitly reserved, namely,
‘‘whether civil liability for aiding and abetting is appropriate
under the section and the Rule.’’ Ernst & Ernst v. Hoch-
felder, 425 U.S. 185, 191-192, n. 7 (1976); see also Herman
& MacLean v. Huddleston, __ U.S. —_, 74 L.Ed.2d 548,
553, n. 5 (1983) [*‘While several courts of appeals have
permitted aider and abettor liability ... we specifically
reserved this issue in Ernst & Ernst v. Hochfelder’’|. In
this case, the issue is squarely presented and is dispositive.
This case dramatically illustrates the potential for add-on
theories of secondary liability to swallow this Court’s pain-
staking articulation of the rationale and scope of civil lia-
bility under § 10(b) and Rule 10b-5.
This Court has repeatedly stressed that the issue of lia-
bility under § 10(b) and Rule 10b-5 must be determined by
relevant statutory language, legislative history and the stat-
utory structure of the securities laws, not by court-created
notions of pubiic policy. E.g., Touche Ross & Co. v.
Redington, 442 U.S. 560 (1979). As a result, numerous
courts (including another panel of the Ninth Circuit Court
of Appeals) and commentators have suggested or opined
that aiding and abetting and other common law theories of
—_ on
secondary liability have no place under § 10(b) and Rule
10b-5.°
The Court of Appeals in the instant case abjured the
analysis mandated by this Court’s decisions, expressly leav-
ing it to this Court, stating (App., p. 20): **[T]he Supreme
Court has not yet seen fit to follow that suggestion. . . . In
the absence of any authority or compelling reasons for hold-
ing that aider and abettor liability no longer exists, we hold
that it remains a viable part of securities regulation.”
Thereby, the Court of Appeals held, for the first time since
this Court noted this as an open question, that aiding and
abetting is a viable basis for civil liability under § 10(b) and
Rule 10b-5 simply because it has been previously assumed
to exist. Thus, yet again, a new branch of civil liability, of
potentially much vaster scope than the ‘‘judicial oak’’ from
*See, e.g., Fischel, Secondary Liability Under Section 10(b) of the
Securities Act of 1934, 69 Cal.L.Rev. 80 Se alg Admiralty Fund vy.
Hugh Johnson & Co., 677 F.2d 1301, 1311, n. 12 (9th Cir. 1982)
[‘*Aiding and abetting and other ‘add-on’ eons of liability have been
justified by reference to the broad policy objectives of the securities
acts... . (€) The Supreme Court has rejected this justification for an
expansive reading of the statutes and instead prescribed a strict we
construction approach to determining liability under the acts. . .
(Professor Fischel) argues in fact that Ernst & Ernst v. Hochjeider.
supra, implicitly holds that aiding and abetting liability does not exist
as an area of liability distinct from liability that could be imposed for
a direct violation of the section and rule’’]; Admiralty Fund v. Tabor,
677 F.2d 1297, 1299, n. 2 (9th Cir. 1982) [noting, **the status of implied
secondary liability under the securities laws is in doubt’’]; Admiralty
Fund v. Jones, 677 F.2d 1289, 1294-1295, n. 4 (9th Cir. 1982) [**We
note the doubtful nature of both (aider and abettor and the participant
theory relied upon in SEC v. Murphy, 626 F.2d 633 (9th Cir. 1980))
in light of recent Supreme Court cases that prescribe a strict statutory
construction approach to the securities acts and reject their expansion
with tort and criminal theories’’]; Benoay v. Decker, 517 F.Supp. 490,
495 (E.D.Mich. 1981) [“‘itis . . . doubtful that a claim for ‘aiding and
abetting’ or ‘conspiracy’ will continue to exist under 10(b)""]; /n re Gap
Stores Securities Litigation, 457 F.Supp. 1135, 1144 (N.D.Cal. 1978)
[‘*Recent decisions . . . raise questions about the continued utility of
aiding or abetting as a separate theory of liability’’]. And cf., Christoffel
v. E. F. Hutton & Co., Inc., 588 F.2d 665 (9th Cir. 1978); Rochez
Bros., Inc. v. Rhoades, 527 F.2d 880 (3d Cir. 1975) [rejecting respondeat
superior as common law basis for liability under § 10(b)].
|
which it springs, Blue Chip Stamps v. Manor Drug Stores,
421 U.S. 723, 737 (1975), has found judicial endorsement
wholly outside, indeed despite, the statutory scheme. If past
experience is any guide, what is now the law of the Ninth
Circuit will by process of accretion soon be the law of every
circuit, repeating a familiar pattern of unanalyzed expansion
of the securities laws well beyond any foundation in the
Statutory language, history or intent. The Court of Appeals
has effectively invited, one might say challenged, this Court’s
review. Petitioner respectfully urges this Court to accept.
2. BY EXPANDING SECONDARY LIABILITY BEYOND ANY
PRIOR BOUNDS, THE COURT OF APPEALS HAS EFFEC-
TIVELY ELIMINATED PROOF OF THE REQUISITE ELE-
MENTS OF CIVIL LIABILITY UNDER § 10(b) AND RULE
10b-5 AS PREVIOUSLY ESTABLISHED BY THIS COURT,
THUS OPENING VAST NEW VISTAS OF CIVIL LIABILITY
FOR ANYONE EVEN REMOTELY CONNECTED, NOT
WITH A SECURITIES LAW VIOLATION, BUT WITH A
SECURITIES LAW VIOLATOR.
Even assuming that common law theories of secondary
liability can be tacked onto § 10(b) and Rule 10b-5, the
Court of Appeals’ interpretation of the extent of such lia-
bility is in direct conflict with the decisions of this and other
Courts establishing the requisite foundations for liability
under the section and the Rule."” This Court has explicitly
held that liability under § 10(b) and Rule 10b-S5 for a failure
to disclose requires (a) ‘‘a duty to disclose,’’ Chiarella vy.
United States, supra, 445 U.S. 222, 230, *‘in connection
with the purchase or sale’’ of securities, Blue Chip Stamps
v. Manor Drug Stores, supra, 421 U.S. 723; (b) breach of
"Having reserved the fundamental issue, this Court has not yet con-
sidered the elements which might be necessary to establish any such
secondary liability. Ernst & Ernst v. Hochfelder, supra, 425 U.S. at
191-192, n. 7.
—,
this duty with the intent ‘‘to deceive, manipulate, or de-
fraud,’’ Ernst & Ernst v. Hochfelder, supra, 425 U.S. at
193; (c) causing actual and identifiable damages, see Affil-
iated Ute Citizens v. United States, 406 U.S. 128, 154-155
(1972).
The opinion of the Court of Appeals makes secondary
liability for aiding and abetting coextensive with primary
liability, yet effectively eliminates each of the requisite
elements of primary liability.
a. No Secondary Liability for Nondisclosure Should
Exist Absent a Duty to Make Disclosure. No Such
Duty Can Be Predicated Solely on Knowledge of
Another’s Breach of Duty, nor Merely on a Marital
or Other Relationship With Such a Person.
Under the Court of Appeals’ decision, silence with know}-
edge (actual or imputed) of another person’s nondisclosure
in violation of § 10(b) and Rule 10b-5 is, given some con-
nection with the violator, sufficient without more to impose
the same liability as for a primary violation. Hence, ac-
cording to the opinion, for a secondary defendant to invoke
the duty requirement of Chiarella ‘‘blurs the distinction
between primary and secondary violations of section 10(b).”’
(App., p. 20.)
In Chiarella this Court held that silence does not give
rise to liability for a failure to disclose material non-public
information absent a duty to disclose “‘arising from a re-
lationship of trust and confidence. . . .”’ (445 U.S. at 230.)
The Court of Appeals in this case, however, effectively
discards any duty requirement for a secondary violation by
holding that a secondary violator’s duty arises, and is there-
fore simultaneously breached, by knowing assistance of or
participation in a fraudulent scheme, i.e., silence with
knowledge of another's breach of his duty. Obviously, any
=|
time anyone learns of someone else's violation of the se-
curities laws he must also know that a failure to speak, to
publicize his knowledge, will assist the primary violator’s
success; silence with knowledge thus necessarily translates
into ‘‘knowingly provid{ing] substantial assistance in the
fraud’ by failure to blow the whistle. (App., p. 19.)
In the Court of Appeals’ formulation, the only ‘‘in con-
nection with’ required is a connection with an alleged pri-
mary violator, not with the purchase or sale of securities.
Indeed, the opinion describes the duty breached by the pri-
mary violator, C. Arnholt Smith, as one owed to the bank's
shareholders, without regard to any purchase or sale of bank
stock. (App., p. 20.)'' Thus, a secondary violator’s duty is
virtually limitless, arising solely from a connection with a
violator and silence with knowledge of the primary viola-
tor’s conduct. This extraordinary expansion of liability
sweeps in not only C. Arnholt Smith’s wife (and other
family members), but would equally reach attorneys, banks
and other financial institutions, indeed anyone who may
have a connection with a securities law violator, even though
they have no connection with any securities transaction."
Even assuming Petitioner had some reason to believe ‘‘that
potential investors were being deceived by C. Arnholt’’
(App., p. 19) (there is no evidence to that effect), what duty
did Petitioner have to potential investors when she had no
''Mr. Smith was at all times the bank's majority shareholder. The
class of shareholders was not purchasing from him, but in the relatively
thin market for USNB stock.
"This is consistent with the argument of plaintiffs’ counsel, in op-
position to motions for directed verdict and to decertify the class: ‘*The
fact that she [Petitioner] didn’t disclose anything, the fact that she didn't
have an opportunity to disclose anything really means nothing when
we are talking about aiding and abetting. [{] What she is a is aiding
and abetting in the primary act, the primary fraudulent act of violating
the law.” (RT 5585.)
fan tees
relationship whatever with them or with the market? And
as a practical matter, how could she possibly have fulfilled
any such duty?
Dirks v. S.E.C., 681 F.2d 824 (D.C. Cir.), cert. granted
74 L.Ed.2d 506 (1982), where aiding and abetting liability
was upheld in a disciplinary action, makes for dramatic
comparison with this case. In Dirks, a broker-dealer ub-
tained non-market information of the Equity Funding scan-
dal. He tried to interest the Wall Street Journal in the story
but, failing that, saw that his clients were able to act on his
information, In this case, unlike Dirks, Petitioner was not
a broker-dealer nor did she have any connection with the
securities market; she neither did nor stood to profit from
any nondisclosure of her transactions; she had no knowledge
of any major scandal or any seemingly significant ‘‘inside
information.’* Was she supposed to go to the Wall Street
Journal? And report what — that she had two fully secured
conventional loans from USNB, one unsecured business
loan, and was paid for decorating services and furnishings
— all of which was already generally or specifically dis-
closed in public documents?"’
Under the opinion of the Court of Appeals, anyone having
relations with a stock issuer has ‘‘inside information’ re-
garding his own relations, and the duty attending possession
of such ‘‘inside information’’ is not just to ‘‘disclose or
abstain’’ but to disclose on pain of liability to all the world
should the persons responsible for appropriate disclosures
fail to make them. But, see, e.g., General Time Corporation
"Contrary to the Court of Appeals’ opinion (App.. p. 19). Petitioner
never acquired real property from USNB at all (much less at minimal
cost), nor did she receive any loans at ‘‘non-market terms.’* But even
if she had, the question remains on what basis any transaction with a
es Sey am translates into a § 10(b) violation if the corporation fails to
make appropriate disclosures
| os
v. Talley Industries, Inc., 403 F.2d 159, 164 (2d Cir. 1968),
cert. denied 393 U.S. 1026 (1969) [tender offeror does not
violate § 10(b) when it makes preannouncement purchases
because there is no relationship between the offeror and the
seller].
b. Absent an Independent Duty to Act, Inaction Can-
not Give Rise to Liability. Nor Should Secondary
Civil Liability to All the World Be Imposed for Fail-
ure to ‘*Blow the Whistle’? on Another’s Nondis-
closure, Absent an Intent to Deceive, Manipulate or
Defraud.
If a duty to speak arises from the mere possession of non-
market information resulting from a connection with a se-
curities law violator, silence with knowledge, mere inaction,
becomes the sole test for liability under § 10(b) and Rule
10b-5. Cf., ITT, An Intern. Inv. Trust v. Cornfeld, 619 F.22
909, 927 (2d Cir. 1980) [*‘(I)naction can create aider and
abettor liability only when there is a conscious or reckless
violation of an independent duty to act’’]. The scienter re-
quirement stated in Hochfelder (an aiding and abetting case)
i.e., intent to deceive, manipulate or defraud — which in
the Courts of Appeals was downgraded to recklessness, see
Herman & MacLean v. Huddlesion, supra, _— U.S. —_,
74 L.Ed.2d at 553, note 4, — disappears through further
dilution under secondary liability to a simple knowledge
requirement in some circumstances by equating recklessness
with knowledge. See, e.g., Dirks v. S.E.C., supra, 681
F.2d at 844-845 and n. 27.
The consequence of such double and triple dilution of
scienter is painfully evident in this case. Here the district
court stated, at the close of the plaintiffs’ case in the liability
phase of trial, that, if it were necessary to liability for aiding
and abetting to prove Petitioner had knowledge of alleged
a
nondisclosure of her relations with USNB, there was a ‘‘fatal
defect’’ in plaintiffs’ case because ‘‘the record is complete
now, and .. . [t]here is a hiatus in the case as to that.’
(RT 6185-86.) Obviously, Petitioner had knowledge of her
own transactions with USNB but, as the district court cor-
rectly observed, there was no evidence she had knowledge
of any supposed failure on the bank’s part to make disclosure
of these transactions, even assuming she had any reason to
believe further disclosure was necessary. The Court of Ap-
peals, however, was satisfied apparently solely on the
strength of her knowledge of her own transactions that she
had sufficient *‘scienter’’ for multi-million dollar liability.
On this theory, Hochfelder’s exhaustive analysis of the
scienter required for § 10(b) and Rule 10b-5 liability is
utterly meaningless.
c. Secondary Civil Liability to All the World Should
Not Be Imposed Absent Proof of a Causal Connec-
tion Between the Nondisclosure and Any Damages
to Plaintiffs.
Under the Court of Appeals’ construction of secondary
liability, civil liability becomes a devastatingly punitive con-
sequence of one person’s failure to reveal another's breach
of duty by nondisclosure. But civil liability is supposed to
be compensatory, not punitive. Damages for a violation of
§ 10(b) and Rule 10b-5 are limited to actual damages prox-
imately caused by the violation. 15 U.S.C. § 78bb(a); Byrnes
v. Faulkner, Dawkins & Sullivan, 550 F.2d 1303, 1313 (2d
Cir. 1977); see also Mills v. Electric Auto-Lite Co., 396
U.S. 375, 388-389 (1970).
Few courts have had occasion to analyze the issues of
proximate causation/damages under the section and rule and
virtually none in light of theories of secondary liability. The
Court of Appeals’ opinion in this case, however, endorses
=|
a ‘*but for’’ analysis of both transaction causation and dam-
ages causation, in conflict with the law of other circuits.
See Edwards & Hanly v. Wells Fargo Securities, etc., 602
F.2d 478, 483-485 (2d Cir. 1979), cert. denied 444 U.S.
1045 (1980); Landy v. Federal Deposit Insurance Corpo-
ration, 486 F.2d 139, 163 (3d Cir, 1973), cert. denied 416
U.S. 960 (1974); Fridrich v. Bradford, 542 F.2d 307, 318-
23 (6th Cir. 1976), cert. denied 429 U.S. 1053 (1977),
Bonime v. Doyle, 416 F.Supp. 1372, 1383 (S.D.N.Y. 1976),
aff'd. 556 F.2d 554 (2d Cir.), cert. denied 434 U.S. 924
(1977); Miller v. Schweickart, 413 F.Supp. 1062, 1068
(S.D.N.Y. 1976); see also Mullaney, Theories of Measuring
Damages in Security Cases and the Effects of Damages on
Liability, 46 Ford.L.Rev. 277 (1977). The Court of Appeals
equates an alleged nondisclosure of material facts, which it
presumes affected purchasers’ decisions to acquire USNB
stock, with the presumably total loss of shareholders’ in-
vestment when USNB was closed. (See App., p. 23,
and n. 11.) This creates a rule of automatic damages com-
parable to that recently rejected by this Court in a different
context, J. Truett Payne Co. v. Chrysler Motors Corp., 451
U.S. 557 (1981), and imposes ruinous liability without con-
sideration either of the degree of the party's secondary fault
or the actual damages attributable to it.
This case illustrates the horrendous consequences of a
rule of *‘presumed damages.’’ In this instance plaintiffs’
own expert testified that, even assuming there was some-
thing wrong with Petitioner's transactions with USNB (al-
though nothing was shown to be), it would have had no
appreciable impact on the value of USNB stock, i.e., neither
more detailed disclosure nor its lack affected the value of
USNB stock. (RT 9181-83.) Nevertheless, the jury found
her liable for damages computed by multiplying the full
estimated market price of the stock for a// shares presumed
—18—
to have been purchased after March 1, 1971 — an amount
exceeding $6,200,000 — consistent with the ‘‘last drop in
the cup’’ argument urged by plaintiffs.
One irony of the Court of Appeals’ opinion is that if
Petitioner had actually traded with the presumed knowledge,
instead of doing nothing, her liability would have been
limited to disgorgement of profits.'’ E.g., Elkind v. Liggett
& Myers, Inc., 635 F.2d 156, 168-173 (2d Cir. 1980). In
other words, under the opinion, in a case of ‘insider in-
formation’ liability for insider trading is less than for insider
non-trading, i.e., compliance with a duty to ‘‘disclose
or abstain’’ exposes a person to greater liability than non-
compliance. Surely this cannot be.
3. THE COURT OF APPEALS HAS FURTHER EXPANDED
THE REACH OF § 10(b) AND RULE 10b-5 BY EXTENDING
THE POTENTIAL CLASS OF PLAINTIFFS FAR BEYOND
THE LIMITS RECOGNIZED BY THIS OR ANY OTHER
COURT.
The opinion of the Court of Appeals treats the question
of pleading. (App., pp. 15-16.) Standing, however, is a
jurisdictional requirement and inust exist at every stage of
the proceedings. See Gladstone Realtors v. Bellwood, 441
U.S. 91, 115, n. 31 (1979); Preiser v. Newkirk, 422 U.S.
395, 401 (1975); Steffel v. Thompson, 415 U.S. 452, 459,
n. 10 (1974). Granting that standing is not lost by failure
to prevail on the merits, in this case it was established even
before trial began that the named plaintiffs had acquired
their stock at the latest by early 1968, i.e., before the earliest
alleged act involving Petitioner. (CR 877, pp. 2-3.) Nec-
“Thus. Petitioner might well regret that the court refused an insider
trading instruction (RT 6291-93) since, over the years, Petitioner never
owned more than a few thousand shares of USNB stock on which she
either lost about $10,000 or made a profit of less than $15,000 on all
transactions. (F.g., HS Exh. 48.)
mY oe
essarily, the named plaintiffs (only two of whom testified)
had no grievance with Petitioner. Necessarily, too, the jury
fixed the opening date of liability three years after named
plaintiffs had acquired their stock. (CR 1081, 1103.)
The Court of Appeals, however, replaced the *‘purchaser-
seller’’ and ‘‘in connection with’’ requirements of § 10(b)
and Rule 10b-5 with yet another notion derived, like aiding
and abetting liability, from the common law and criminal
law — that one conspirator is liable for the conduct of other
conspirators committed prior to the time of joining the con-
spiracy —— making liability depend not on conduct in con-
nection with the purchase or sale of securities but on whether
the jury wants to call secondary liability ‘‘conspiracy”’ in-
stead of ‘‘aiding and abetting.’’'* Thus, in a single sweep
the Court of Appeals couples an unprecedented expansion
of standing to sue under § 10(b) and Rule 10b-5 with a
Virtually limitless construction of what conduct may give
rise to liability and then adds the suggestion that liability
may be projected endlessly backwards (or forwards) in time.
Nothing in § 10(b), or Rule 10b-5 or the case law sanctions
such a result. Here, again, the implication is that Petitioner
might have been better off by trading on the non-public
information she allegedly had instead of doing nothing, as
Wilson v. Comtech Telecommunications Corp., 648 F.2d
88, 94-95 (2d Cir. 1981) illustrates. There the court reaf-
“The Court's statement that the jury found all appellants liable for
conspiracy beginning in 1963 or 1968 (App.. p. 16) 1s not accurate.
First, there was simply no evidence linking Petitioner with the other
secondary defendants, each of whom was —— linked toC. Arnholt
Smith, See Kotteakos v. United States, 328 U.S. 750, 772 (1945).
Moreover, plaintiffs’ attorney himself argued that the earliest date Helen
could be found liable for anything was March 1968 (RT 7045), and the
jury in fact fixed the opening date of liability as March 1971. (CR 1081,
1103.) Contrary to the suggestion of the Court of Appeals, this was
hardly an act of largesse on the part of the jury.
a
firmed its prior holdings, stating:
‘‘(I|nsider sellers [are] subject to a duty to disclose
only to those who purchased the stock ‘during the same
period’ as the insiders’ sales. . . . To extend the period
of liability well beyond the time of the insider’ s trading
simply because disclosure was never made could make
the insider liable to all the world. (Citations.) Any
duty of disclosure is owed only to those investors
trading contemporaneously with the insider, non-
contemporaneous traders do not require the protection
of the ‘disclose or abstain’ rule because they do not
suffer the disadvantage of trading with someone who
has superior access to information.’’ (Emphasis added. )
None of the named plaintiffs traded USNB stock contem-
poraneously with any alleged misconduct by Petitioner.
4. A DEFENDANT HAS A BASIC DUE PROCESS RIGHT TO
KNOW IN ADVANCE OF TRIAL WHO AND WHAT SHE
IS TO DEFEND AGAINST. THIS RIGHT IS IN SIGNIFI-
CANT PART PROTECTED BY RULE 23, FEDERAL RULES
OF CIVIL PROCEDURE. THE EXTRAORDINARY PRO-
CEDURAL IRREGULARITIES IN THE MANAGEMENT OF
CLASS ISSUES, INCLUDING THE DISTRICT COURT'S
REFUSAL TO PERMIT PETITIONER TO PRESENT EVI-
DENCE NEGATING CLASS-BASED ASSUMPTIONS, DE-
NIED PETITIONER DUE PROCESS OF LAW.
Virtually all discussion of the constitutional dimensions
of the class action requirements now embodied in Rule 23,
Federal Rules of Civil Procedure focuses on the rights of
absent members of the plaintiff class. See, e.g., Hansberry
v. Lee, 311 U.S. 32, 42 (1940); Nat. Ass'n. of Regional
Medical Programs v. Mathews, 55\ F.2d 340, 345-346
(D.C. Cir. 1976), cert. denied 431 U.S. 954 (1977). These
rules, however, are meant to assure due process for defen-
dants as well, including the rule that the determination of
whether a class shall be certified should be made as soon
=
as practicable after commencement of the action. (Rule
23(c)(1).)
In an adversary proceeding, minimal procedural due proc-
ess requires identification of one’s adversaries and the basis
of their charges, see Brouillette v. Board of Dir. of Merged
Area IX, etc., 519 F.2d 126, 128 (8th Cir. 1975), without
which there is no meaningful opportunity to prepare a de-
fense. See, e.g., Memphis Light, Gas & Water Dis. v. Croft,
436 U.S. 1, 14 (1978); Wolff v. McDonnell, 418 U.S. 539,
564 (1974). Since few rights are more basic to due process
than the right to confront and cross-examine adverse wit-
nesses, see, e.g., Greene v. McElroy, 360 U.S. 474, 496,
n. 25 (1959); Goldberg v. Kelly, 397 U.S. 254, 267 (1970),
a fortiori, the right to confront at least one true adversary
whose claims are typical of the class he represents is patently
essential in this context.'°
While a real plaintiff may be only an inconvenient but
necessary encumbrance for the attorney seeking to pursue
a class action suit, a true, existing representative adversary
is a critical element of due process to the defendant. Simply
put, it is fundamentally unfair to require a person to defend
against a phantom class which, while lacking sufficient sub-
stance to put forward a single individual to confront the
defendant, is accorded sufficient substance to be awarded
a multi-million dollar judgment. The instant action denied
Petitioner the basic right to know who and what she was to
defend against, indeed to know on what basis her presence
“Indeed, the entire case may hinge on certification; in this case, for
example, the named plaintiffs had no individual claims against Petitioner
and, absent proper certification of a class of purchasers of bank stock
under § 10(b), Petitioner should have been dismissed from the action.
See Libby, McNeill, and Libby vy. City Nat. Bank, 592 F.2d 504, 510
(9th Cir. 1978) [rejecting concept of ‘‘pendent party’’ jurisdiction];
Avala v. United States, 550 F.2d 1196, 1198-1200 (9th Cir. 1977),
cert. dism. 435 U.S. 982 (1978) [same].
=.
in the action could be compelled at all. A national class
was certified under the National Bank Act as one of share-
holders, and it remained just this class.'’ No class or subclass
of purchasers was ever framed in terms of § 10(b), the only
jurisdictional basis for Petitioner's presence in the action,
Blue Chip Stamps v. Manor Drug Stores, supra, 421 U.S.
723, this despite all protestations by her and the other sec-
ondary defendants from the beginning to the end of the
proceedings. (See, e.g., RT 19, 52-54, 1567-72, 1600-05,
1614, 1623, 1629-32, 1649-50, 5572-89, 7224-27, 9022-
37, 9914-17.)
As a result, Petitioner faced a multi-million dollar judg-
ment (including punitive damages under California law)
without any opportunity to test any properly certified class
either under § 10(b), the basic source of the court's juris-
diction over her, or under the pendent claims which, it seems
clear, could not properly be pursued on behalf of a nation-
wide class. Abed v. A. H. Robins Co., 693 F.2d 847 (9th
Cir. 1982), cert. denied, 74 L.Ed.2d 1015 (1983). Further,
she was obliged to do so despite the fact none of the named
plaintiffs asserted any grievance against her, and no one
actually or purportedly representing stock purchasers ever
"In Harmsen y. Smith, supra, 542 F.2d 496 (9th Cir. 1976), the
Court of Appeals permitted this action, which was then premised on
alleged violations of the National Bank Act, to proceed over the ob-
jection of the FDIC. Class certification was not before the court, though
it was confident its opinion would make review of the certification
necessary. (/d. at 503.) The certification remained the same, although
following remand the complaint was amended to add a bevy of § 10(b)
and Rule 10b-5 claims and essentially homologous pendent claims against
Petitioner. Having been granted summary judgment on the National
Bank Act claim, Petitioner and the other secondary defendants repeat-
edly asserted (i) named plaintiffs’ lack of standing and (ii) the absence
of an appropriate class or subclass framed in terms of the jurisdictional
basis for the § 10(b) claims, i.e., purchasers or sellers. Blue Chip
Stamps v. Manor Drug Stores, 42\ U.S. 723 (1975).
x
appeared at trial.'* Not surprisingly, even the judgment did
not identify the persons in whose favor it ran.'”
The Court of Appeals treated these events as of no prac-
tical significance. The court concluded that a jury instruction
in the liability phase using the term of art ‘‘in connection
with the purchase or sale of securities,’’ and one in the
damages phase regarding ‘‘purchases’* of stock were the
functional equivalent of an appropriate class certification
(App., p. 15); that there was no reason to exclude out-of-
state shareholders from the California pendent claims (id.,
p. 25); that the judgment could be corrected (id., p. 15) and
people who didn’t belong in the class calculations could be
weeded out later (id., pp. 16-17, 23-24, 26-27).
But even assuming the possibility of such reconstructive
surgery, the real vice of defending against phantom plaintiffs
and the basic issue of due process remain. Petitioner was
forced to defend an action in which, as to her, there was
no true plaintiff, no one who claimed to have been misled
by any alleged nondisclosure regarding her, no one asking
that she be punished for any real or imagined wrongdoing.
The fundamental unfairness inherent in the proceedings
was further compounded by the district court’s refusal to
"The class damages were computed by a Special Master who erro-
neously assumed all shareholders were purchasers, with the exception
of those who were identifiably not purchasers. He sent out over 4,300
questionnaires, only 1,799 of which were returned. Nevertheless, he
assumed these persons were purchasers, and estimated a market price
for their stock. The Special Master estimated up to a 30% margin of
error on his extrapolations which, nevertheless, were translated by the
jury into several million dollars in damages. (See RT 7341-48, 8832-
50, 9432.)
"It appears that plaintiffs’ counsel had lost the opt-out forms returned
in response to notice of the proceedings. (RT 8882.)
"No consideration was given to the fact that during the sorting out
process itself Petitioner may face financial ruin, for example, through
a forced sale of the real property securing the face amount of the
judgment.
a,
permit Petitioner to introduce evidence negating the as-
sumption that she had wronged some class of persons. If a
class action securities case can be tried at all in the absence
of a true class and any true adversaries, substituting in its
place token pleading requirements and presumptions, a de-
fendant is minimally entitled to offer the best evidence avail-
able to negate the charges leveled against her. Thus, where
as here, a case rests on a ‘‘fraud on the market’’ theory,
see Blackie v. Barrack, 524 F.2d 891i (9th Cir. 1975), cert.
denied 429 U.S. 816 (1976), and there is no individual
plaintiff who can or does testify to the materiality of alleged
nondisclosures respecting the defendant, the defendant's only
recourse is to expert testimony. Here Petitioner offered pre-
cisely such expert testimony, /.e., the opinion of an expert
who, based on his study of actual market behavior regarding
USNB stock, would have opined that no alleged nondis-
closure regarding Petitioner’s relations with USNB would
have significantly altered the average reasonable investor's
total mix of information. (RT 5833-35, 5883.) See TSC
Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976)
[defining ‘‘materiality’’]. The Court of Appeals did not
reject the authorities uniformly endorsing the use of such
testimony,”' nor did it suggest any after-the-fact reconstruc-
tion of the proceedings by which to discount it. It simply
did not address the issue at all.”
*'See Marx & Co., Inc. v. Diners’ Club, Inc., 550 F.2d 505, 509
(2d Cir.), cert. denied 434 U.S. 861 (1977); United States v. Cohen,
518 F.2d 727, 737 (2d Cir.), cert. denied 423 U.S. 926 (1975); Unicorp
Fin. Corp. v. First Union, etc., 515 F.Supp. 249, 258 (S.D. Ohio
1981); Reeder v. Mastercraft Electronics Corporation, 363 F.Supp.
574, 579 (S.D.N.Y. 1973). See also Sirota v. Solitron Devices, Inc.,
673 F.2d 566, 577 (2d Cir.), cert. denied 74 L.Ed.2d 170 (1982)
[requiring consideration of actual market behavior].
~The prejudicial effect of excluding this testimony was raised in all
of Petitioner’s briefs, including her petition for rehearing. (AOB, pp.
55-59, ARB, pp. 27-30, Pet. for Rehearing, p. 13.)
—
Implicitly, perhaps, the opinion may be read to mean that
once due process is construed to permit proceedings in which
a defendant may be put to trial without knowing who or
what to defend against, it is not offended by foreclosing the
defendant from making the only defense available.
Conclusion.
This petition raises issues of fundamental and widespread
importance under § 10(b), Rule 10b-5 and the Fifth Amend-
ment. Petitioner respectfully prays that this Court grant re-
view not merely to correct the gross injustice in this case,
but to assure that such injustice does not become the law
of the land.
Respectfully submitted,
JENNINGS, ENGSTRAND & HENRIKSON,
PAUL D. ENGSTRAND,
GEORGE J. BERGER,
Horvitz & GREINES,
E.Luis J. HORVITZ,
ALAN G. MARTIN,
Attorneys for Petitioner.
APPENDIX.
Opinion.
In the United States Court of Appeals for the Ninth Circuit.
Fred H. Harmsen, et al., Plaintiffs-Appellees, vs.
C. Armmholt Smith, et al., Defendants-Appellants. Nos.
80-5097/5098/5099; DC Nos. 73-460-WBE, 74-345-WBE,
Filed: December 1, 1982.
Appeal from the United States District Court for the
Southern District of California. William B. Enright, District
Judge, Presiding. Argued and submitted February 5, 1982.
Before: SKOPIL and SCHROEDER, Circuit Judges, and
Aguilar,* District Judge.
SCHROEDER, Circuit Judge.
This case arose out of the failure of United States National
Bank (USNB) of San Diego and the disintegration of the
financial empire of its former officer, director, and con-
trolling shareholder, C. Arnholt Smith (C. Arnholt). C.
Armholt, in connection with members of his family and the
directors and officers of corporations he controlled, alleg-
edly engaged in continuing fraudulent activities from 1962
until 1973. Specifically, C. Arnholt, with his daughter Carol
Smith Shannon (Shannon), his brother John, his wife Helen,
numerous directors of USNB, and others allegedly materi-
ally misled USNB shareholders about the many illegal trans-
actions in which defendants were engaged. These transac-
tions generally took three forms: (1) misrepresentation of
loan purposes on the books of USNB; (2) granting of loans
in excess of National Bank Act (Bank Act) requirements
and for insufficient collateral; and (3) funneling USNB loans
for undisclosed personal gain.
*Honorable Robert P. Aguilar, United States District Judge, Northern
District of California, sitting by designation.
—
On October 18, 1973, the Comptroller of the Currency
declared USNB insolvent and appointed the Federal Deposit
Insurance Corporation receiver, Subsequently, two class ac-
tions on behalf of minority shareholders were filed against
C. Arnholt and the other USNB directors; Shannon, Helen,
John, and the corporation John controlled, First National
Finance Corporation (FNFC), were also named as defen-
dants, along with Phillip A. Toft (Toft), an officer and
director of Westgate-California Corporation, a major con-
glomerate that included many Smith-controlled businesses.
The two suits were consolidated into the present action.
In June 1974, the FDIC moved to intervene and be sub-
stituted for the minority shareholders. The district court
permitted intervention but ruled that, under the Bank Act,
the minority shareholders had a cause of action in their own
right against the bank directors. We affirmed on interloc-
utory appeal, holding that minority shareholders have a cause
of action under the Bank Act even when the only damage
claimed is the diminution of the value of their shares. Harm-
sen v. Smith, 542 F.2d 496, 499 (9th Cir. 1976) (Harm-
sen I).
In May 1979, all directors of USNB, with the exception
of C. Arnholt, settled, and were dismissed from the case.
A jury trial followed to determine the liability of C. Arnholt,
Helen, Shannon, Toft, John, and FNFC. The trial was bi-
furcated as to questions of liability and damages.
Plaintiffs proceeded in the liability phase of the trial on
three general theories. The first theory, an alleged violation
of section 93 of the National Bank Act,' was tried against
'12 U.S.C. § 93 provides in pertinent part:
(a) If the directors of any national banking association shall
knowingly violate, or knowingly permit any of the officers, agents,
or servants of the association to violate any of the provisions of
this chapter, all the rights, privileges, and franchises of the as-
_
C. Arnholt alone. Second, all defendants were alleged to
have violated section 10(b) of the Securities Exchange Act
of 1934, 15 U.S.C. § 78)(b)’, and SEC Rule 10b-5 pro-
mulgated thereunder, 17 C.F.R. 240.10b-5 (1981)'. Pri-
mary violations were alleged against C, Arnholt; all other
defendants were charged with secondary participation in the
violations. The secondary section 10(b) theories alleged were
‘control person’’ liability under section 20(a) of the Se-
curities Exchange Act, 15 U.S.C. § 78t(a), aiding and abet-
ting liability, and liability for conspiracy to violate section
sociation shall be thereby forfeited. Such violation shall, however,
be determined and adjudged by a proper district or Territorial
court of the United States in a suit brought for that purpose by
the Comptroller of the Currency, in his own name, before the
association shall be declared dissolved. And in cases of such
violation, every director who participated in or assented to the
same shall be held liable in his personal and individual capacity
for all damages which the association, its shareholders, or any
other person, shall have sustained in consequence of such violation,
*Section 10(b) provides:
It shall be unlawful for any person, directly or indirectly, by
the use of any means or instrumentality of interstate commerce
or of the mails, or of any facility of any national securities exchange
(b) To use or employ, in connection with the purchase 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 Commission may prescribe as necessary or appropriate in the
public interest or for the protecton of investors.
‘SEC Rule 10b-5 provides:
It shall be unlawful for any person, directly or indirectly, by
the use of any means or instrumentality of interstate commerce,
or of the mails or of any facility of any national securities exchange,
(a) To = any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit
to state a material fact necessary in order to make the statements
made, in the light of the circumstances under which they were
made, not misleading, or
(c) To engage in any act, practice, or course of business which
operates or would _ as a fraud or deceit upon any person,
in connection with the purchase or sale of any security.
pe eae
10(b). Third, pendent state claims of fraud, conspiracy to
defraud, abuse of control, and conspiracy to abuse control
were tried against all parties.
The jury returned a verdict against C. Arnholt on the
Bank Act claim, the section 10(b) primary claim, the section
10(b) conspiracy claim, and the four pendent state claims.
Helen, Shannon, Toft, John, and "NFC were found liable
for secondary violations of section 10(b) and for pendent
state violations of fraud, conspiracy to defraud, and con-
spiracy to abuse control. No defendant except C. Arnholt
was found liable for direct abuse of control."
After the jury returned its verdicts in the liability phase
of the trial, the district court, pursuant to plaintiffs’ request,
appointed a special master to gather data to be presented to
the jury regarding plaintiffs’ damages. The special master
sent questionnaires to all USNB shareholders requesting
various information, including the date they purchased their
shares. The special master prepared two schedules, one
based on the actual responses and one based on extrapo-
lations from the actual responses. These schedules were
presented to the jury to be considered in its calculation of
‘The nine counts were:
Count | Violation of NBA § 93
Count II § 10(b) primary
Count Ill $ 10(b) controlling person
Count 1V § 10(b) aiding and abetting
Count V § 10(b) conspiracy
Count VI Fraud
Count VII Conspiracy to defraud
Count VIII Abuse of control
Count IX Conspiracy to abuse control
The jury found the defendants liable on the following counts:
C. Arnholt Counts I, Il, V. VI, Vili, 1X
Helen Counts Ill, IV. V, VI. VIL, IX
Shannon Counts Ill, IV, V. VI. VII, IX
Toft Counts IV, V, VI, VII, IX
John Counts IV, VI, VIL, IX
FNFC Counts IV, VI, Vil, IX
ee es
damages. After instructions by the court, the jury awarded
damages of several million dollars on each violation against
each defendant.* Punitive damages were also awarded against
‘The jury awarded damages against each defendant in the following
amounts:
C. ARNHOLT SMITH
Count | $12,298 ,708.11
Count II $12,061,.417.72
Count V $ 8.689.021.25
Count VI $12,061 .417.72
Count VII $11,614,538.21
Count VIII $11,085,494.77
Count IX $10,722,476.62
Punitive Damages
(Counts VI, VII,
VIII, and IX only) $11,000,000.00
HELEN SMITH
Count Ill $ 6.241,170.02
Count IV $ 6,241,170.02
Count V $ 6,241,170.02
Count VI $ 6,241,170.02
Count VII $ 6,241,170.02
Count IX $ 5,858.660.91
Punitive Damages
(Counts VI, VII and
IX only) $ 750,000.00
CAROL SMITH SHANNON
Count Ill $ 6,241,170.02
Count IV $ 6,241,170.02
Count V $ 6,241,170.02
Count V1 $ 6,241,170.02
Count VII $ 6,241,170.02
Count IX $ 5,858,660.91
Punitive Damages
(Counts VI, VII and
IX only) $ 3,000,000.00
PHILIP A. TOFT
Count IV $ 8.689.021.25
Count V $ 8,689,021.25
Count VI $ 8,689.021.25
Count VII $ 8,689.021.25
Count IX $ 8,083,508.79
Punitive Damages
(Counts VI, VII and
IX only) $ 1.00
JOHN A. SMITH
Count IV $11.614,538.21
Count VI $11,614,538.21
Count VII $11,614,538.21
Count IX $10,722,476.62
(footnote continued on following page)
a
each defendant with respect to the state law violations. Upon
motion of the defendants, the court reduced compensatory
damages to the maximum amount for which each defendant
was found liable under any one count, and retained punitive
damages in full.°
Each defendant now appeals and raises a number of is-
sues. Aside from questions concerning the general suffi-
ciency of the evidence, the principal contentions of the
separate defendants can be summarized as follows:
Helen, joined by the other defendants, focuses her ar-
guments on the propriety of the jury verdict against her
under the Securities Exchange Act. As a preliminary matter,
She asks this court to reexamine prior holdings that there
exists a private right of action under section 10(b).
C. Arnholt does not appeal the adverse verdict of over
$12,000,000 for violation of the Bank Act. He does contend,
however, that any liability based on section 10(b) or on the
pendent state claims was improper because section 93 of
the Bank Act provides the exclusive remedy against a bank
director.
All of the defendants, other than C. Arnholt, urge that
they could not have been secondarily liable under section
Punitive Damages
(Counts VI, VII and
IX only) $ 1.00
FIRST NATIONAL FINANCE CORPORATION
Count IV $ 2,861 ,957.38
Count VI $ 2.861 ,.957.38
Count VII $ 2,861 ,957.38
Count IX $ 2,868,933.92
Punitive Damages
(Counts VI, VII and
IX only) $ 1.00
“With respect to C. Amholt, for example, damages as shown in
footnote 5, supra, were reduced to $12,298,708.11 compensatory plus
$11,000,000.00 punitive. Damages awarded against the other defen-
dants were reduced similarly.
ek, aR
10(b) if no primary violation of the same statute was prop-
erly asserted against C. Arnholt. They further argue that if
no federal cause of action existed against them under section
10(b), the court was without jurisdiction to consider the
pendent state law claims. A key jurisdictional issue is, there-
fore, the claimed exclusivity of the Bank Act.
John and FNFC’s principal argument is that the jury was
wrongfully instructed to give conclusive effect to the spe-
cific findings made in a related bankruptcy case, /n re West-
gate-California Corp., No. 74-413 (S.D. Cal. Feb. 9, 1978).
The court there found that John and FNFC had been involved
in fraudulent transactions with USNB. This court recently
reversed that decision. Westgate-California Corp. v. First
National Finance Corp., 650 F.2d 1040 (9th Cir. 1981).
Defendants also assert that the pendent state claims are
wholly derivative and cannot be maintained by the share-
holders themselves. Finally, all defendants also claim
irreguiarities with respect to class certification and the
damages calculation.
I
Preliminary Issues
We begin with the assertion by Helen that this case pre-
sents an appropriate opportunity to ‘‘reexamine’’ the avail-
ability of a private right of action under section 10(b) of the
Securities Exchange Act. We find no such need. The Su-
preme Court has clearly established the right of individual
enforcement under section 10(b) and Rule 10b-5. Ernst &
Ernst v. Hochfelder, 425 U.S. 185, 196, 96 S. Ct. 1375,
1382 (1976); Blue Chip Stamps v. Manor Drug Stores, 421
U.S. 723, 729-30, 95 S. Ct. 1917, 1922-23 (1975); Affil-
iated Ute Citizens v. United States, 406 U.S. 128, 150-54,
92 S. Ct. 1456, 1470-72 (1972); Superintendent of Insur-
ance v. Bankers Life and Casualty Co., 404 U.S. 6, 13 n.9,
a
92S. Ct. 165, 169 (1971). Helen’s suggestion that the recent
Supreme Court decisions in Transamerica Mortgage Ad-
visors, Inc. v. Lewis, 444 U.S. 11, 100 S. Ct. 242 (1979),
and Touche Ross & Co. v. Redington, 442 U.S. 560, 99
S. Ct. 2479 (1979), cast some doubt on the continued va-
lidity of the private right of action under section 10(b) is
not persuasive. Those cases considered private rights of
action under different statutory provisions with different
legislative histories. They do not indicate that section 10(b)
falls short of meeting the test for implying private rights of
action set forth in Cort v. Ash, 422 U.S. 66, 78, 95 S. Ct.
2080, 2088 (1975).
The next issue is the claimed exclusivity of section 93 of
the Bank Act. We address whether pendent state law claims
or section 10(b) claims can be maintained against C. Arnholt
for conduct that also allegedly violates section 93.
The question of the availability of relief under state law
for conduct covered by the Bank Act has not been litigated
often. This court has, however, in the earlier interlocutory
appeal of this case, Harmsen I, supra, considered the issue.
In Harmsen I we stated that
[Pjendent state law claims asserted by the plaintiffs
here must be with respect to causes not authorized by
reason of Section 93. Violations of federal law resulting
in injuries for which shareholders may bring a personal
action under Section 93 must be determined and mea-
sured by federal law. The relief afforded for such vi-
olations is a federal remedy. State law may not afford
a Similar remedy.
542 F.2d at 502. The Harmsen court relied on a much earlier
Statement by the Supreme Court in Chesbrough v. Wood-
worth, 244 U.S. 72, 78, 37 S. Ct. 579, 582 (1917), that
section 93 ‘‘is exclusive and precludes a common-law lia-
bility for fraud and deceit.’’ This conclusion in Chesbrough,
a ae
in turn, was based on the Court's earlier opinion in Yates
v. Jones National Bank, 206 U.S. 158, 27S. Ct. 638 (1907).
The Yates Court concluded that the Bank Act cause of action
must be exclusive as against pendent state claims in order
to shield bank directors from standards of liability that varied
from state to state. /d. at 178, 27 S. Ct. at 645.
We thus follow our earlier conclusion in Harmsen / that,
for purposes of uniformity, state law causes of action are
not allowable if the allegedly wrongful conduct comes within
the scope of the National Bank Act. Liability against
C. Arnholt under the pendent claims cannot be supported
to the extent that the section 93 cause of action was based
on the same conduct. If, on the other hand, the pendent
claims against C. Arnholt were based on conduct outside
the reach of the Bank Act, considerations of uniformity
would not apply, and section 93 would not bar such claims.
The provisions of the Bank Act proscribe specific conduct
and are limited in coverage. See, e.g., 12 U.S.C. §§ 82,
84. See also Harmsen I, 542 F.2d at 501 (section 93 relief
limited to actions proscribed within Chapter 2 of Bank Act).
The complaint alleges, and the record clearly shows that
C. Arnholt was engaged in fraudulent activity that went far
beyond the narrow range of conduct prohibited by the Act.
The district court judge specifically so held in his denial of
defendants’ motion for judgment n.o.v., and we agree. We
thus conclude that the district court acted properly in con-
sidering the pendent claims against C. Arnholt.
An additional defense argument is that, even if section
93 is not the exclusive remedy against C. Arnholt, the dis-
trict court did not properly distinguish between the two types
of conduct and erroneously permitted the jury to consider
evidence of C. Arnholt’s section 93 violations when it con-
sidered liability under the pendent claims. However, de-
fendants never formulated instructions to meet this present
a oon
objection, and we hold that it is waived. United States v.
Burlington Northern, Inc., 500 F.2d 637, 639-40 (9th Cir.
1974). See 9 C. Wright & A. Miller, Federal Practice and
Procedure § 2552 (1971). Although a formal objection to
proposed instructions may not be required when an appellant
has previously made his position sufficiently clear to the
trial court, Kramas v. Security Gas & Oil, Inc., 672 F.2d
766, 769 (9th Cir. 1982); Brown v. Avemco Investment
Corp., 603 F.2d 1367, 1370-75 (9th Cir. 1979), the record
in this case does not reveal that defendants ever advised the
district court of their view that the instruction did not cor-
rectly state the law.
A separate question is whether section 93 of the National
Bank Act restricts our ability to consider the section 10(b)
claims. Harmsen I and the Supreme Court authority on
which that case relied do not require dismissal; allowing a
section 10(b) cause of action would not subject bank direc-
tors to varying standards of liability from state to state.
Moreover, the language of the relevant statutes does not
suggest that the Bank Act provision is exclusive. Section
10(b) of the 1934 Act and Rule 10b-5 make it unlawful for
‘‘any person’ to engage in the conduct therein described.
Congress did not exclude banks from the coverage of section
10(b), although it did specifically exempt banks from several
other provisions of the securities laws. See, e.g., 15 U.S.C.
$§ 77c(a)(2), 711(2); of. 15 U.S.C. § 78c(a)(6). As stated
by the Fifth Circuit in Lehigh Valley Trust Co. v. Central
National Bank, 409 F.2d 989, 993 (Sth Cir. 1969), **[t}hat
Congress made no express general exemption for banks
under the fraud provisions of either the Securities Act of
1933 or the Securities Exchange Act of 1934 indicates that
Congress did not intend any such exemption.’’ Accord Car-
roll v. First National Bank of Lincolnwood, 413 F.2d 353
(7th Cir.), cert. denied, 396 U.S. 1003, 90S. Ct. 552 (1969)
=
(banks subject to provisions of section 10(b)). For its part,
the Bank Act provision does not contain any language lim-
iting the application of other federal laws to conduct within
its reach.
Defendants fail to articulate any reasons for not applying
section 10(b) in this context. The application of section 10(b)
to bank directors burdens them with no duties or respon-
sibilities that conflict with the directives of the Bank Act.
It does impose additional duties or responsibilities, but we
must construe the two potentially overlapping statutes in the
manner that gives effect to each. We rely on the well rec-
ognized principle that ‘‘when two statutes are capable of
co-existence, it is the duty of the courts, absent a clearly
expressed congressional intention to the contrary, to regard
each as effective.’’ Morton v. Mancari, 417 U.S. 535, 551,
94 S. Ct. 2474, 2483 (1974). We therefore find no basis
for holding that C. Arnholt, as a bank director subject to
liability under the Bank Act, was exempted from liability
under the Securities Exchange Act.
The single Supreme Court decision that discusses any
relationship between the National Bank Act and the Secu-
rities Exchange Act is fully consistent with our conclusion.
In Radzanower v. Touche Ross & Co., 426 U.S. 148, 96
S. Ct. 1989 (1976), the Court held that the venue provision
of the Bank Act, 12 U.S.C. § 94, governed venue in a suit
against a national banking association for violation of the
Securities Exchange Act. Although the focus of the Court
in Radzanower was on the language and history of the venue
provisions, the issue of venue would not have been consid-
ered at all had the Court felt that the Securities Exchange
Act cause of action was improper because a national bank
could be ued only under the Bank Act. We thus hold that
there was no error in allowing causes of action under both
section 10(b) of the Securities Exchange Act and section 93
rs |, am
of the Bank Act.
Because we hold that section 93 of the Bank Act is not
an exclusive federal remedy, and that there was no error in
allowing plaintiffs to proceed against C. Arnholt for primary
violations of section 10(b) or for alleged violations of state
law (pendent claims), the remaining preliminary challenges
are necessarily decided. It is unnecessary to consider the
other defendants’ argument that no secondary section 10(b)
violations can properly be asserted unless a primary 10(b)
violation is properly asserted. It is also clear that, because
both the primary and secondary 10(b) claims were proper,
there was an independent federal jurisdictional basis for the
court to consider the pendent state claims against the other
defendants. United Mine Workers v. Gibbs, 383 U.S. 715,
725, 86 S. Ct. 1130, 1138 (1966).
II
Pendent Claims
A. Plaintiffs’ Standing Under State Law to Assert Pendent
Claims
The defendants argue that the pendent claims asserted by
the plaintiffs are, under California law, derivative claims
which could not have been brought on the plaintiffs’ own
behalf but only on behalf of the bank.’ The leading Cali-
fornia case on a stockholder’s right to sue in an individual
capacity is Jones v. H. F. Ahmanson & Co., | Cal.3d 93,
460 P.2d 464, 81 Cal. Rptr. 592 (1969). Chief Justice
Traynor’s opinion in that case recognized the general rule
that there is no individual right of action for conduct of
majority shareholders and directors which decreases the value
‘It is clear that a derivative claim could only have been brought against
USNB by the FDIC. Harmsen |, 542 F.2d at 500-01 n.2. See Landy
v. Federal Deposit Insurance Corporation, 486 F.2d 139, 146-48 (3d
Cir. 1973), cert. denied, 416 U.S. 960, 94 §. Ct. 1979 (1974).
|
of the corporation’s stock. It went on to hold, however, that
minority shareholders could assert a cause of action for
injury to themselves, as opposed to injury to the corporation
or injury incidental to the corporation’s. /d. at 107, 460
P.2d at 471, 81 Cal. Rptr. at 599. The decision stressed the
duty of majority shareholders to refrain from using their
power to benefit themselves at the expense of the minority
shareholders. /d."
In this case the district court considered this standing
question in light of applicable California authority; !t con-
cluded that the duty allegedly violated here was a duty to
the shareholders separate from the duty to the bank and that
the claimed injury was to the shareholders as individuals.
In addition, the court carefully instructed the jury that it
should consider only individual injury to the shareholders,
i.e., injury separate from any injury to the bank and not
incidental to the bank’s injury.
We conclude that the district court did not err in its ap-
plication of California law to the question of the standing
of the shareholders to bring the pendent claims. The share-
holders were allegedly damaged in that they were induced
to buy and hold stock which was worthless and which they
would have known was worthless had they been aware of
the defendants’ misdeeds. The shareholders’ injury is thus
greater than the mere diminution of the value of their stock,
for which only the corporation or a shareholder acting de-
‘California courts have consistently applied the Ahmanson analysis
to suits brought by individual shareholders, See, e.g., Smith v, Tele-
Communications, Inc., 134 Cal. App. 3d 338; 184 Cal. Rptr. 571 (1982)
(minority shareholder action based on fraud upheld as individual suit);
Crain v, Electronic Memories and Magnetics, 50 Cal. App. 3d 509,
123 Cal. Rptr. 419 (1975) (same). Cf. Truestone, Inc. v. Travellers
Insurance Company, 55 Cal. App. 3d 168, 127 Cal. Rptr. 386 (1976)
(suit for diminution of value of shares allowed because not incidental
to injury to corporation—third party tortfeasor had independent duty to
individual shareholders. )
pat’ See
rivatively may normally seek recovery. The injuries here
are properly characterized as ‘‘separate individual dam-
ages.’’ Sherman v. British Leyland Motors, Ltd., 601 F.2d
429, 440 n.13 (9th Cir, 1979).
B. Sufficiency of the Evidence—Pendent Claims
Defendants argue that there was insufficient evidence to
support the jury’s verdict on fraud, conspiracy to defraud,
and conspiracy to abuse control. The principal contention
is that plaintiffs failed to show that the defendants’ involve-
ment in concealed transactions had any material bearing on
the purchase of shares. The record does contain expert opin-
ion on the materiality of the concealed transactions. This
Opinion testimony was based on the undisclosed nature of
the transfers between family-controlled entities, as well as
on the size of the transactions. The record contains ample
evidence of a conspiracy to misuse C. Arnholt’s controlling
position. Helen cannot logically maintain that because the
jury refused to find that she herself abused control, it could
not find that she conspired with C. Arnholt in connection
with his abuse. The jury verdicts were supported.
Ill.
Class Certification and Related Issues
A. Class certification
Early in this litigation, before plaintiffs asserted any sec-
tion 10(b) cause of action, the district court, pursuant to
Fed. R. Civ. P. 23(b)(3), certified a class consisting of
USNB shareholders as of October 18, 1973, the date the
receiver was appointed. The section 10(b) claims were added
to the class complaint after this court’s decision in Harmsen
I, supra.
The defendants correctly argue that only purchasers or
sellers of stock have standing to bring a section 10(b) action,
oem |
Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723,
754-55, 95 S. Ct. 1917, 1934-35 (1975), and that the class
certification should have been modified to include pur-
chasers rather than shareholders. However, the erroneous
denomination of the certified class was of no practical con-
sequence; the instructions of the district court in the liability
phase of the trial expressly required that the jury find against
defendants on the section 10(b) and Rule 10b-5 claims only
if plaintiffs established that defendants’ conduct was ‘‘in
connection with the purchase or sale of securities.’’ In ad-
dition, in the damages phase of the trial, the jury was spe-
cifically instructed to find damages based on purchases of
stock. Given the district court's specific and unambiguous
instructions to the jury that only purchasers of stock could
recover, appellants did not suffer any prejudice because the
trial court failed formally to certify a sub-class of purchasers.
Defendants also complain that the district court erro-
neously failed to comply with Rule 23(c)(3) because the
judgment did not describe the members of the class to whom
they were liable. The present deficiency in the judgment
has not prejudiced defendants and can easily and appropri-
ately be corrected. On remand from this court, the district
court shall enter judgment in accordance with Rule 23. See
Newman vy. Prior, 518 F.2d 97, 101 (4th Cir. 1975); Young
v. Katz, 447 F.2d 431, 435 (Sth Cir. 1971).
B. 10(b) Standing of class representatives
Helen, Shannon, and Toft all contend that plaintiffs lack
standing to pursue section 10(b) claims against them because
the two named plaintiffs who testified at trial both purchased
their shares before 1968; the jury found that this was the
earliest year in which these defendants were actually in-
volved in the securities law violations. Plaintiffs correctly
respond that standing must be determined from the pleadings
—_
rather than from the liability actually imposed.
The pleadings in this case establish plaintiffs’ standing.
The Constitution's ‘‘case or controversy’’ requirement (U.S.
Const. art. 3, § 2) with respect to standing is met when
plaintiffs allege that they have suffered some injury as a
result of defendants’ illegal conduct. Linda R.S. v. Richard
D., 410 U.S. 614, 617, 93S. Ct. 1146, 1148 (1973). See
also Dupree v. United States, 559 F.2d 1151, 1153 (9th
Cir. 1977). Plaintiffs here alleged a series of securities vi-
olations and a conspiracy that caused them damages. De-
fendants may be liable for all the actions of their co-
conspirators, even those that occurred before the particular
defendants joined the conspiracy. United States v. Saa-
vedra, 684 F.2d 1293 (9th Cir. 1982); United States v.
Traylor, 656 F.2d 1326, 1337 (9th Cir. 1981). See also In
re Equity Funding Corp., 416 F. Supp. 161, 180 (C.D.
Cal. 1976). Moreover, the factual issues denominated in
the pretrial order in this case clearly covered the defendants’
participation as aiders and abettors and as conspirators for
a period beginning in 1960. The jury found all appellants
liable for conspiracy beginning in 1963. The jury was further
instructed at the damage phase that it could hold each de-
fendant liable for all damages which accrued during the
conspiracy period.
The jury chose, however, to assess damages against each
defendant (other than C. Arnholt) for the period the jury
found that each was actually involved in C. Arnholt’s de-
ceptions. In this way, the jury found Helen, Shannon, and
Toft liable only to purchasers who bought their shares after
1968; the named plaintiffs are therefore not able to recover
from these defendants.
This result does not mean, however, that the named plain-
tiffs lacked standing. These plaintiffs had standing to pursue
the action in the first instance. Standing ordinarily does not
Be,
depend upon the merits of a plaintiff's contentions; the re-
quirement is based upon a separate determination that the
plaintiffs have made ‘‘allegations of demonstrable, parti-
cularized injury.’’ Warth v. Seldin, 422 U.S. 490, 508, 95
S. Ct. 2197, 2210 (1975). As we have stated, ‘‘failure of
proof as to the named plaintiffs would not bar maintenance
of the class action or entry of judgment awarding relief to
the members of the class.’’ Gibson v. Local 40, Supercar-
goes & Checkers, Etc., 543 F.2d 1259, 1263 (9th Cir. 1976)
63 [sic]. See also East Texas Motor Freight System v. Rod-
riquez, 431 U.S. 405, 406 n.12, 97 S. Ct. 1891, 1898
(1977), where the Court, citing Franks v. Bowman Trans-
portation Co., 424 U.S. 747, 752, 96 S. Ct. 1251, 1258
(1976), stated that **[p]rovided the initial certification was
proper and decertification not appropriate, the claims of the
class members would not need to be mooted or destroyed
because subsequent events or the proof at trial had under-
mined the named plaintiffs’ individual claims.’’ All plain-
tiffs had standing to pursue their section 10(b) claims against
the defendants.
C. Adequacy of Class Representation
A different question is presented with respect to whether
the named plaintiffs were appropriately certified as adequate
class representatives under Rule 23(a). A district court's
determination as to adequacy of representation will be over-
turned only if the district court abused its discretion. Pat-
terson v. Schlesinger, 625 F.2d 262 (9th Cir. 1980); Clark
v. Watchie, 513 F.2d 994 (9th Cir. 1975). There was no
abuse of discretion in this case. Insofar as the defendants
argue that the named representatives are not typical of the
class members who purchased shares later, their position is
contrary to Blackie v. Barrack, 524 F.2d 891, 902, 911
(9th Cir. 1975), cert. denied, 429 U.S. 816, 97 S. Ct. 57
pn. Te
(1976). The suit was properly conducted as a class action.
IV
Sufficiency of the Evidence—Section 10(b) Claims
Each defendant was found liable for at least one secondary
violation of section 10(b) of the Securities Exchange Act.
Helen, Shannon, Toft, John, and FNFC were found liable
under an aiding and abetting theory. C. Arnholt, Helen,
Shannon, and Toft were found to have conspired to violate
section 10(b). Helen and Shannon were found secondarily
liable as control persons of a primary section 10(b) violator.
The district court limited compensatory damages to the
greatest amount assessed under any one count. Because the
amounts awarded under the separate section 10(b) secondary
counts were identical (and equal to or larger than the amounts
awarded under the pendent claims), we need only sustain
one secondary violation of section 10(b) as to each defendant
in order to sustain the judgment.” We conclude that all
defendants were properly found liable as aiders and abettors.
The elements of a cause of action for aiding and abetting
under section 10(b) are: (1) the existence of an independent
primary wrong; (2) actual knowledge by the alleged aider
and abettor of the wrong and of his or her role in furthering
it; and (3) substantial assistance in the wrong. /nvestors
Research Corp. v. SEC, 628 F.2d 168, 178 (D.C. Cir.),
cert. denied, 449 U.S. 919, 101 S. Ct. 317 (1980); IT v.
Cornfeld, 619 F.2d 909, 922 (2d Cir. 1980); Monsen v.
Consolidated Dressed Beef Co., 579 F.2d 793, 799 (3d
"Because C. Arnholt does not appeal the adverse verdict under section
93 of the Bank Act, and damages awarded against C. Arnholt under
the Bank Act count were greater than damages awarded under any other
count, the judgment against him can therefore be sustained without
addressing his conspiracy liability under 10(b). His violation of 10(b)
is, of course, relevant to consideration of the other defendants [sic]
secondary liability.
=
Cir.), cert. denied, 439 U.S. 930, 99 S. Ct. 318 (1978);
Rochez Brothers, Inc. v. Rhoades, 527 F.2d 880, 886 (3d
Cir. 1975); Woodard v. Metro Bank of Dallas, 522 F.2d
84 (Sth Cir. 1975); In re Gap Stores Securities Litigation,
457 F. Supp. 1135, 1143-44 (N.D. Cal. 1978); /n re Equity
Funding Corp., 416 F. Supp. at 180. See Ruder, Multiple
Defendants in Securities Law Fraud Cases: Aiding and
Abetting, Conspiracy, In Pari Delicto, Indemnification, and
Contribution, 120 U. Pa. L. Rev. 597, 627-38 (1972).
The first element is satisfied by the primary violation of
section 10(b) by C. Arnholt. His fraudulent loans, material
omissions, nondisclosures, and positive misrepresentations
clearly constituted violations of section 10(b) and Rule
10b-5. The jury was properly instructed on the elements of
a 10(b) and 10b-5 cause of action, and there is ample record
evidence to support these violations.
The existence of the second and third elements as to
Helen, Shannon, and Toft is also supported by the record.
Although Helen testified that she never discussed USNB
with C. Arnholt, the record shows that Helen had numerous
business dealings with USNB, including transactions in
which she received loans at non-market terms and acquired
real property at minimal cost. There is sufficient evidence
from which the jury could conclude that she knew that
potential investors were being deceived by C. Amnholt. Taken
in the light most favorable to the plaintiffs, the evidence
also adequately supports the jury’s finding that Helen know-
ingly provided substantial assistance in the fraud. See /IT,
619 F.2d at 923-28; Monsen, 579 F.2d at 799-801; cf.
Investors Research Corp., 628 F.2d at 178.
Helen asks us to declare that there can be no liability
premised on aiding and abetting a violation of section 10(b).
Such a result has been suggested as a possible consequence
of the United States Supreme Court decisions in Touche
a Ue
Ross & Co. v. Redington, 442 U.S. 560, 99 S. Ct. 2479,
61 L.Ed.2d 82 (1979) and Ernst & Ernst v. Hochfelder,
425 U.S. 185, 96 S. Ct. 1775, 47 L.Ed.2d 668 (1976). See
Securities & Exchange Comm. vy. Seaboard Corp., 677 F.2d
1301, 1311 a.12 (9th Cir. !982) (dictum); Fischel, Sec-
ondary Liability under § lO(b) of the Securities Act of 1934,
69 Cal. L. Rev. 80 (1981). However, the Supreme Court
has not yet seen fit to follow that suggestion. Further, other
circuits have stated that aider and abettor liability under
section 10(b)(5) continues to exist. See Dirks v. SEC, 681
F.2d 824 (D.C. Cir. 1982); Sirota v. Solitron Devices, Inc.,
673 F.2d 566 (2d Cir.), cert. denied, 51 U.S.L.W. 3281
(U.S. Oct. 12, 1982) (No. 82-236); Stokes v. Lokken, 644
F.2d 779, (8th Cir. 1981); Monsen v. Consolidated Dressed
Beef Co., 579 F.2d 793 (3d Cir.), cert. denied, 439 U.S.
930, 99 S. Ct. 318 (1978). Our own decision in Strong v.
France, 474 F.2d 747 (9th Cir. 1973) discusses the methods
of establishing aider and abettor liability. In the absence of
any authority or compelling reasons for holding that aider
and abettor liability no longer exists, we hold that it remains
a viable part of securities regulation.
Shannon and Toft also argue that aider and abettor liability
cannot be applied to them because they were under no duty
to disclose to USNB shareholders. Chiarella v. United Staies,
445 U.S. 222, 100 S. Ct. 1108 (1980). This contention
blurs the distinction between primary and secondary vio-
lations of section 10(b). While C. Arnholt’s duty to disclose
arises from his position in the bank and his relationship to
the shareholders, /d. at 227-28, 100 S. Ct. at 1114, the
secondary violater’s duty arises from *‘knowing assistance
of or participation in a fraudulent scheme.’* Strong v. France,
474 F.2d 747, 752 (9th Cir. 1973) (quoting Anderson v.
Francis 1. duPont and Co., 291 F. Supp. 705, 709
a, | oe
(D. Minn. 1968)).'° The record clearly shows that the jury
was presented with sufficient evidence surrounding trans-
actions involving both Shannon and Toft from which it could
find knowing assistance or participation.
Vv
The Westgate Instructions
The district court instructed the jury to give conclusive
effect to certain findings made in the Westgate California
Corporation bankruptcy proceedings regarding John’s in-
volvement in fraud, including a finding that John was *‘an
integral part of the fraud involving Westgate California Cor-
poration and the United States National Bank . . . .”’ This
court, however, after the trial in this case, reversed the
Westgate bankruptcy decision, noting that *‘the record as
presented to us is inadequate to support a determination that
J.A. Smith behaved inequitably.’’ Westgate-California Corp.
v. First National Finance Corp., 650 F.2d 1040, 1044 n.1
(9th Cir. 1981). We now know, therefore, that the Westgate
findings were not entitled to the conclusive effect that the
jury was instructed to give them, and that the instruction
was erroneous. Butler v. Eaton, 141 U.S. 240, 242, 11
S. Ct. 985, 986 (1891) (9th Cir. 1980) [sic]; Restatement
(Second) of Judgments § 16, comment c (1982) (when a
later judgment is based upon an earlier judgment which is
set aside or reversed, **|t}he court should then normally set
aside the later judgment’’).
“Other cases involving aider and abettor liability have also recognized
that such liability exists even when the secondary violator owes no duty
to the plaintiffs. See, e.g.. Sirota, 673 F.2d at 575 (existence or non-
existence of duty on part of aider and abettor only relates to degree of
scienter needed to prove violation—less scienter suffices when duty
present); //T, 619 F.2d at 927 (same); Monsen, 579 F.2d at 800 (con-
scious aiding and abetting liability not predicated on existence of duty).
am, ; ene
The plaintiffs correctly point out that the record never-
theless contains evidence which would independently sup-
port the verdict against John and FNFC. The problem is,
however, that it is impossible to evaluate what the jury might
have done, had it not been instructed to give conclusive
weight to the ‘Westgate findings. We recently held that an
erroneous instruction in a civil case was harmless error
where there was ample evidence for the jury’s conclusion.
We stated:
An erroneous ruling which relates to the substantial
rights of a party is grounds for reversal unless it affir-
matively appears from the whole record that it was not
prejudicial. McCandless v. United States, 298 U.S.
342, 347-48, 56 S. Ct. 764, 766, 80 L.Ed. 1205 (1936).
This is especially true of an error in jury instructions.
Fillippon v. Albion Vein Slate Co., 250 U.S. 76, 82,
39 S. Ct. 435, 437, 63 L.Ed. 853 (1919).
Chancellier v. Federated Dept. Stores, 672 F.2d 1312, 1316
(9th Cir. 1982). Applying that standard, we cannot hold
that the error here is harmless. The verdict against John A.
Smith and FNFC must therefore be reversed.
VI
Damages
Damages were determined by the jury in a proceeding
separate from the determination of liability. Each defendant
claims a number of errors in the damages phase of the trial.
Defendants first argue that the calculation of damages
was speculative. Defendants are correct in asserting that the
plaintiff in a securities fraud action has the burden of proving
that damages flowed from the alleged injury. Rochez Broth-
ers v. Rhoades, 527 F.2d 891, 894 (3d Cir. 1975). See Mills
v. Electric Auto-Lite, 396 U.S. 375, 388 (1969) (*‘damages
should be recoverable only to the extent they can be shown’’).
=
Although damages need not be proved to a mathematical
certainty, ‘‘sufficient facts must be introduced so that a court
can arrive at an intelligent estimate without speculation or
conjecture.’’ 527 F.2d at 895. See also LeLandais & Com-
pany v. MDS Atron, 543 F.2d 421, 424 & n.5 (2d Cir.),
cert. denied, 429 U.S. 1062, 97 S. Ct. 786 (1976) (failure
to adequately show damages prevents recovery).
In this case, a special master, appointed by the trial judge,
sent questionnaires to USNB shareholders requesting var-
ious information, including the date they purchased their
shares. Forty-two percent of the questionnaires were re-
turned. From the information provided, the special master
prepared schedules based both upon the actual responses
and upon extrapolations from them.
We are persuaded that the procedures used by the trial
court do not constitute reversible error. The special master’s
report was intended to provide information from which the
jury could calculate injury to the plaintiff class as a whole.
The questionnaires, which included information about dates
of share purchases, sufficiently served this purpose. Further,
as noted above, the jury was specifically instructed to find
damages based upon purchases of stock. The jury was in-
structed that plaintiffs were required to prove that damages
were suffered as ‘‘a proximate result of the alleged mis-
leading statements or omission, and the purchase of stock
in reliance to [sic] that.*"'' It may well be that not all class
Proof of each plaintiff's reliance on the misrepresentations or omis-
sions is not a prerequisite to recovery. As we stated in Blackie v.
Barrack, 524 F.2d 891, 905 (9th Cir. 1975), cert. denied, 429 U.S.
816, 97 S. Ct. 57 (1976), **|t}he amount of damages is invariably an
individual question and does not defeat class action treatment... .
Individual questions of reliance ure likewise not an impedement |sic|—
subjective reliance is not a distinct element of proof of 10b-5 claims
Further, if omissions or nondisclosures meet the standard of mate-
riality to a reasonable investor, see TSC Industries, Inc. v. Northway,
Inc., 426 U.S. 438, 449, 96S. Ct. 2126, 2133 (1976); Zweig v. Hearst
Corp., 594 F.2d 1261. 1266 (9th Cir. 1979), causation and reliance
can be assumed. Affiliated Ute Citizens v. United States, 406 U.S. 128,
(footnote continued on following page)
aa, ae
members will make claims against the defendants. If there
are excess damage funds after distribution, the district court
should consider any feasible methods of returning that ex-
cess, with appropriate interest, to defendants.
Shannon and Toft argue that the procedure was fatally
defective because the damages were not awarded with re-
spect to the specific time periods for which the various
defendants were found liable. This argument has no basis
in fact. The jury was provided with damages forms which
specifically indicated the beginning and ending dates of each
defendant's liability as determined in the liability phase of
the trial. The jury was well aware of the time frame of each
defendant’s liability.
Defendants next argue that no damages can be awarded
for conduct after 1968 because plaintiffs’ expert testified
that USNB stock was worthless as of that date. This ar-
gument misconstrues the basis for defendants’ liability. De-
fendants were found liable for failing to disclose material
information which would have affected an investor’s de-
cision whether to purchase USNB stock. The worthlessness
of USNB stock actually evidences the effect of this failure;
damages were, in fact, created by the non-disclosures.
Defendants’ final argument on compensatory damages is
that the district court improperly included certain share-
holders in the plaintiff class. These allegedly improper class
members were all non-California purchasers, the Franklin
National Bank and the Westgate California Insurance Com-
pany. Each of the challenged members will be treated in
turn.
153-54. 92 S. Ct. 1456, 1472 (1972); Blackie, 524 F.2d at 906
With respect to the pendent claims, defendants do not contend that
a showing of reliance was necessary, and, if so, that it was lacking in
this case.
Prior to the district court’s instructions on damages, de-
fendants argued that the class eligible for recovery on the
pendent claims should not include out-of-state purchasers.
Their theory was that non-California purchasers should not
be permitted to recover for causes of action based on Cal-
ifornia law. The district court denied defendants’ motion
because the issue, raised for the first time some six years
after the inception of the suit, had not been introduced in
a timely manner.
Even assuming that the district court erroneously denied
defendants’ motion on grounds of untimeliness, defendants
have not demonstrated grounds for barring the out-of-state
plaintiffs from obtaining recovery on the pendent claims.
The district court would have been required to apply the
substantive law of the state in which it sits, including choice-
of-law rules. Gee v. Tenneco, Inc., 615 F.2d 857, 861 (9th
Cir. 1980). Defendants have failed to show, as required by
California law, that the law of other states relating to the
pendent claims is significantly different from California’s
and, more importantly, that the interests of other states
would be impaired by application of Californa law to these
non-resident plaintiffs. /d.; Offshore Rental Co. v. Conti-
nental Oil Co., 22 Cal.3d 157, 164-66, 583 P.2d 721, 725-
27, 148 Cal. Rptr. 867, 871-73 (1978); Hurtado v. Superior
Court, 11 Cal.3d 574, 579-80, 522 P.2d 666, 669, 114 Cal.
Rptr. 106, 109 (1974). There appears no other reason to
exclude the out-of-state purchasers from participating in
pendent claims arising from conduct in California.
Franklin National Bank was the pledgee of USNB stock.
Defendants argue that a pledge of stock is not a ‘*purchase
or sale’’ for purposes of section 10(b) and Rule 10b-5.
Plaintiffs rely on Rubin v. United States, 449 U.S. 424, 101
S. Ct. 698 (1981), which held that a pledge constitutes an
‘offer or sale’’ for purposes of section 17(a) of the Secu-
_,” va
rities Act of 1933, 15 U.S.C. § 77q(a).
Defendants have offered no persuasive reason why a
pledge of shares of stock should not similarly satisfy the
purchase or sale requirement of section 10(b) and Rule
10b-5. We think this result flows logically from Rubin. Cf.
Marine Bank v. Weaver, 455 U.S. 551, ——, 102 S. Ct.
1220, 1222 n.2 (1982) (Rubin held that *‘a pledge of stock
is equivalent to a sale for the purposes of the antifraud
provisions of the federal securities laws’’). As the Court
stated in Rubin:
The economic considerations and realities present when
a lender parts with value and accepts securities as col-
lateral security for a loan are similar in important re-
spect to the risk an investor undertakes when purchas-
ing shares. Both are relying on the value of the securities
themselves, and both must be able to depend on the
representations made by the transferor of the securities,
regardless of whether the transferor passes full title or
only a conditional and defeasible interest to secure
repayment of a loan.
449 U.S. at 431, 101 S. Ct. at 702 (footnote omitted). This
language fully supports our conclusion that Franklin Na-
tional Bank, even though it had less than a complete interest
in the pledged shares, should be able to remain in the plain-
tiff class and recover damages for violations of section 10(b)
and Rule 10b-5.
The same result is not appropriate for Westgate California
Insurance Company. C. Arnholt was the controlling share-
holder of that company. Defendants argue that it would be
inequitable for a company controlled by the central defen-
dant in a lawsuit to recover as a member of the plaintiff
class. We agree. All defendant shareholders were expressly
excluded from the plaintiff class. Although Westgate was
not a defendant, we think the same principle should apply
a, a
to an entity that is so closely related to a defendant. Westgate
should not recover damages. On remand, the district court
should consider whether the inclusion of Westgate" in class
schedules on damages measurably effected [sic] the amount
of damages awarded and whether a corresponding reduction
in damages is appropriate.
Finally, Shannon, Toft, and Helen argue that the punitive
damages awards were excessive. We cannot agree. This
court will not overturn an award of punitive damages ‘‘un-
less it appears that the jury was influenced by passion or
prejudice.’’ Glovatorium, Inc. v. NCR Corporation, No.
81-4453, slip op. at 3688 (9th Cir. Aug. 20, 1982); Moore
v. Greene, 431 F.2d 584, 593-94 (9th Cir. 1970). Neither
the amount of punitive damages awarded in relation to the
compensatory damages nor any other evidence indicates that
the jury was influenced by passion or prejudice. The jury
was correctly instructed that punitive damages should only
be awarded if the jury believed that the defendants acted
with malice. The term malice was correctly defined. The
award of punitive damages will not be disturbed.
Vil
Conclusion
The judgments against all defendants except John and
FNFC are affirmed. The judgments against John and FNFC
are reversed.
The district court must design and execute a claims pro-
cedure consistent with this opinion. As recognized by the
"John’s argument on this issue refers to shares held by Westgate Life
Insurance Co., a separate entity from Westgate California Insurance
Co. The record shows that the inclusion of shares held by Westgate
California Insurance Co. was called into question during examination
of the special master, and we assume that these shares are the subject
of the present dispute. Westgate California Insurance Co. owned over
41,000 shares of USNB.
ee
district court’s amendment to judgment, amounts already
paid by settling defendants are to be offset. The class of
eligible plaintiffs will not include Westgate California
Insurance Company.
Affirmed in part; Reversed in part; Remanded.
=
Judgment.
United States District Court, Southern District of
California.
Fred H. Harmsen, Ken Hansen, Samuel Rosenberg and
James P. Young, et al., Plaintiffs, vs. C. Arnholt Smith,
et al., Defendants. Consolidated Civil Actions Nos. 73-
460-E and 74-345-E.
Filed: January 2, 1980.
The claims of named plaintiffs FRED H. HARMSEN,
KEN HANSEN, SAMUEL ROSENBERG and JAMES P.
YOUNG, and of the class which they represent, against
defendants C. ARNHOLT SMITH, HELEN SMITH,
CAROL SMITH SHANNON, PHILIP A. TOFT, M. J.
COEN, JOHN A. SMITH, FIRST NATIONAL FINANCE
CORPORATION, U. S. HOLDING COMPANY, SAN
DIEGO PADRES and FIRST CALIFORNIA COMPANY,
came on for jury trial on August 6, 1979 for the liability
phase, and, before the same jury, on December 6, 1979 for
the damage phase. The issues having been duly tried, and
the jury having rendered its liability verdict on October 12,
1979 and its damage verdict on December 21, 1979,
IT IS HEREBY ORDERED, ADJUDGED AND DE-
CREED that judgment is as follows:
1. As to defendant C. ARNHOLT SMITH, judgment
against said defendant and in favor of the named plaintiffs
and the class which they represent, on the following counts
and in the following amounts:
Count | $12,298 ,708.11
Count I $12,061 ,417.72
Count V $ 8,.689,021.25
Count VI $12,061 417.72
Count VII $11,614,538.21
Count VIII $11,085 494.77
|
Count IX $10,722,476.62
Punitive
Damages
(Counts VI,
VII, VIII and
IX only) $11 ,000,000.00
2. As to defendant HELEN SMITH, judgment against
said defendant and in favor of the named plaintiffs and the
class which they represent, on the following counts and in
the following amounts:
Count III $ 6,241,170.02
Count IV $ 6,241,170.02
Count V $ 6,241,170.02
Count VI $ 6,241,170.02
Count VII $ 6,241,170.02
Count IX $ 5,858 ,660.91
Punitive
Damages
(Counts VI,
VII and IX
only) $ 750,000.00
3. As to defendant CAROL SMITH SHANNON, judg-
ment against said defendant and in favor of the named plain-
tiffs and the class which they represent on the following
counts and in the following amounts:
Count Ill $ 6,241,170.02
Count IV $ 6,241,170.02
Count V $ 6,241,170.02
Count VI $ 6,241,170.02
Count VII $ 6,241,170.02
Count IX $ 5,858 ,660.91
=
Punitive
Damages
(Counts VI,
VII and IX
only) $ 3,000,000.00
4. As to defendant PHILIP A TOFT, judgment against
said defendant and in favor of the named plaintiffs and the
class which they represent on the following counts and in
the following amounts:
Count IV $ 8,689,021.25
Count V $ 8,689,021.25
Count VI $ 8,689,021.25
Count VII $ 8,689,021.25
Count IX $ 8,083,508.79
Punitive
Damages
(Counts VI,
VII and IX
only) $ 00
5. As to defendant M. J. COEN, judgment against said
defendant and in favor of the named plaintiffs and the class
which they represent on the following counts and in the
following amounts:
Count III $ 6,241,170.02
Count IV $ 6,241,170.02
Count V $ 8,689,021.25
Count VI $ 6,241,170.02
Count VII $ 8,689,021.25
Count IX $ 8,083 ,508.79
Punitive
Damages
(Counts VI,
VII and IX
only)
$ 3,000,000.00
a
6. As to defendant JOHN A. SMITH, judgment against
said defendant and in favor of the named plaintiffs and the
class which they represent on the following counts and in
the following amounts:
7.
Count |V $11,614,538.21
Count VI $11,614,538.21
Count VII $11,614,538.21
Count IX $10,722,476.62
Punitive
Damages
(Counts VI,
VII and IX
only) $ 1.00
As to defendant FIRST NATIONAL FINANCE
CORPORATION, judgment against said defendant and in
favor of the named plaintiffs and the class which they rep-
resent on the following counts and in the following amounts:
8.
Count IV $ 2,861 ,957.38
Count VI $ 2,861.957.38
Count VII $ 2,861 ,957.38
Count IX $ 2,868,933.92
Punitive
Damages
(Counts VI,
VII and IX
only) $ 1.00
As to defendant U. §. HOLDING COMPANY, judg-
ment against said defendant and in favor of the named plain-
tiffs and the class which they represent on all counts in the
amount of $12,298,708.11 in compensatory damages, and
$1.00 in punitive damages.
9.
As to defendant SAN DIEGO PADRES, judgment
against said defendant and in favor of the named plaintiffs
a,
and the class which they represent on all counts in the
amount of $12,298,708.11 in compensatory damages, and
$1.00 in punitive damages.
10. As to defendant FIRST CALIFORNIA COM-
PANY, judgment against said defendant and in favor of the
named plaintiffs and the class which they represent on all
counts in the amount of $12,298,708.11 in compensatory
damages, and $1.00 in punitive damages.
11. As to all defendants, judgment against all defen-
dants and in favor of the named plaintiffs and the class
which they represent for the costs of suit herein.
Dated 1/2/80.
/s/ William B. Enright
WILLIAM B. ENRIGHT
Judge, U.S. District Court
ee
Amendment to Judgment.
United States District Court, Southern District of
California.
Fred H. Harmsen, et al., Plaintiffs, v. C. Arnholt Smith,
et al., Defendants. Civil Nos. 73-460-E, 74-345-E.
Filed: January 16, 1980.
Upon motion of defendants, the court hereby amends its
Judgment in this case, entered January 4, 1980, to add the
following concluding paragraph:
‘The liability of each defendant is no greater than the
largest sum such defendant has been found liable for
as to any one count, plus the amount of any punitive
damages for that particular defendant. Any payment
by any defendant shall reduce by like amount the amount
of liability of every other defendant, except punitive
damages which are the sole responsibility of the par-
ticular defendant against whom punitive damages have
been assessed.”’
This paragraph shall be deemed to be incorporated into the
judgment entered January 4, 1980.
It is so ordered.
DATED: January 16, 1980.
/s/ William B. Enright, Judge
WILLIAM B. ENRIGHT, Judge
United States District Court
Copies to:
Plaintiffs
Defendants
= =
Constitutional Provisions, Statutes and
Regulations Involved.
Securities Exchange Act of 1934, Sec. 10(b) (15 U.S.C.
§ 78j(b))
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 facility
of any national securities exchange —
(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.
Securities and Exchange Commission Rule 10b-5 (17 C.F.R.
§ 240.10b-5)
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 facility
of any national securities exchange,
(a) to employ any device, scheme or artifice to
defraud
(b) to make any untrue statement of a material fact
or to omit to state a material fact necessary in order
to make the statements made in the light of the
circumstances under which they were made, not
misleading, or
(c) to engage in any act, practice or course of busi-
ness which operates or would operate as a fraud or
deceit upon any person,
in connection with the purchase or sale of any security.
=— =
Securities Exchange Act of 1934, Sec. 20(a) (15 U.S.C.
§ 78t(a))
(a) Every person who, directly or indirectly, con-
trols any person liable under any provision of this chap-
ter 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 in-
directly induce the act or acts constituting the violation
or cause of action.
Securities Exchange Act of 1934, Sec. 28(a) (15 U.S.C.
§ 78bb(a))
(a) The rights and remedies provided by this chap-
ter shall be in addition to any and all other rights and
remedies that may exist at law or in equity; but no
person permitted to maintain a suit for damages under
the provisions of this chapter shall recover, through
satisfaction of judgment in one or more actions, a total
amount in excess of his actual damages on account of
the act complained of... .
Fifth Amendment to the United States Constitution.
No person shall be . . . deprived of life, liberty, or
property, without due process of law... .
Rule 23, Federal Rules of Civil Procedure
Rule 23, Class Action.
(a) Prerequisites to a Class Action. One or more
members of a class may sue or be sued as representative
parties on behalf of all only if (1) the class is so nu-
merous that joinder of all members is impracticable,
(2) there are questions of law or fact common to the
class, (3) the claims or defenses of the representative
parties are typical of the claims or defenses of the class,
and (4) the representative parties will fairly and ade-
7x, am
quately protect the interests of the class.
(b) Class Actions Maintainable. An action may be
maintained as a class action if the prerequisites of sub-
division (a) are satisfied, and in addition:
(1) the prosecution of separate actions by or against
individual members of the class would create a risk of
(A) inconsistent or varying adjudications with re-
spect to individual members of the class which would
establish incompatible standards of conduct for the party
opposing the class, or
(B) adjudications with respect to individual mem-
bers of the class which would as a practical matter be
dispositive of the interests of the other members not
parties to the adjudications or substantially impair or
impede their ability to protect their interests; or
(2) the party opposing the class has acted or refused
to act on grounds generally applicable to the class,
thereby making appropriate final injunctive relief or
corresponding declaratory relief with respect to the class
as a whole; or
(3) the court finds that the questions of law or fact
common to the members of the class predominate over
any questions affecting only individual members, and
that a class action is superior to other available methods
for the fair and efficient adjudication of the contro-
versy. The matters pertinent to the findings include:
(A) the interest of members of the class in individually
controlling the prosecution or defense of separate ac-
tions; (B) the extent and nature of any litigation con-
cerning the controversy already commenced by or
against members of the class; (C) the desirability or
undesirability of concentrating the litigation of the
claims in the particular forum; (D) the difficulties likely
to be encountered in the management of a class action.
(c) Determination by Order Whether Class Action
to be Maintained; Notice; Judgment; Actions Con-
= =
ducted Partially as Class Actions.
(1) As soon as practicable after the commencement
of an action brought as a class action, the court shall
determine by order whether it is to be so maintained.
An order under this subdivision may be conditional,
and may be altered or amended before the decision on
the merits.
(2) In any class action maintained under subdivision
(b)(3), the court shall direct to the members of the class
the best notice practicable under the circumstances,
including individual notice to all members who can be
identified through reasonable effort. The notice shall
advise each member that (A) the court will exclude
him from the class if he so requests by a specified date;
(B) the judgment, whether favorable or not, will in-
clude all members who do not request exclusion; and
(C) any member who does not request exclusion may,
if he desires, enter an appearance through his counsel.
(3) The judgment in an action maintained as a class
action under subdivision (b)(1) or (b)(2), whether or
not favorable to the class, shall include and describe
those whom the court finds to be members of the class.
The judgment in an action maintained as a class action
under subdivision (b)(3), whether or not favorable to
the class, shall include and specify or describe those
to whom the notice provided in subdivision (c)(2) was
directed, and who have not requested exclusion, and
whom the court finds to be members of the class. -
(4) When appropriate (A) an action may be brought
or maintained as a class action with respect to particular
issues, or (B) a class may be divided into subclasses
and each subclass treated as a class, and the provisions
of this rule shall then be construed and applied
accordingly.
(d) Orders in Conduct of Actions. In the conduct of
actions to which this rule applies, the court may make
a
appropriate orders: (1) determining the course of pro-
ceedings or prescribing measures to prevent undue rep-
etition or complication in the presentation of evidence
or argument; (2) requiring, for the protection of the
members of the class or otherwise for the fair conduct
of the action, that notice be given in such manner as
the court may direct to some or all of the members of
any step in the action, or of the proposed extent of the
judgment, or of the opportunity of members to signify
whether they consider the representation fair and ad-
equate, to intervene and present claims or defenses, or
otherwise to come inw the action; (3) imposing con-
ditions on the representative parties or on intervenors;
(4) requiring that the pleadings be amended to eliminate
therefrom allegations as to representation of absent per-
sons, and that the action proceed accordingly; (5) deal-
ing with similar procedural matters. The orders may
be combined with an order under Rule 16, and may
be altered or amended as may be desirable from time
to time.
(e) Dismissal or Compromise. A class action shall
not be dismissed or compromised without the approval
of the court, and notice of the proposed dismissal or
compromise shall be given to all nie bers of the class
in such man..er as the court directs.
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.