Petition — Moss v. Newman

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FILED

83-959 DEC 8 1963

No. 83- ALEXANDER L. STEVAS,

IN THE

Supreme Court of the Gnited States

OCTOBER TERM, 1983

MICHAEL E. Moss,

Petitioner,

Vv.

JAMES M. NEWMAN,

Respondent.

PETITION FOR A WRIT OF CERTIORARI TO

THE UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

HERBERT E. MILSTEIN*

STEVEN J. TOLL

KouN, MILSTEIN, COHEN & HAUSFELD

1776 K Street, N.W., Suite 708

Washington, D.C. 20006

(202) 293-7110

RosBeRT N. KAPLAN

RICHARD J. KILSHEIMER

KAPLAN, KILSHEIMER & FOLEY

122 East 42nd Street

New York, New York 10168

(212) 687-1980

Counsel for Petitioner

*Counsel of Record

PRESS OF BYRON 8. ADAMS PRINTING, INC., WASHINGTON, D.C. (202) 347-6203

QUESTION PRESENTED

1. Did the Court of Appeals err in concluding that a

misappropriation of material nonpublic information does

not give rise to a private claim for relief under Section

10(b) of the Securities Exchange Act of 1934 by sellers of

securities against purchasers who bought on the basis of

the misappropriated information?

PARTIES TO THE PROCEEDING BELOW

Petitioner and plaintiff-appellant below is Michael E.

Moss. Respondent and defendant-appellee below is

James M. Newman. Morgan Stanley, Inc. was also a

defendant and an appellee but is not made a respondent in

this petition. Adrian Antoniu and E. Jacques Courtois,

Jr., were also named as defendants in the district court.

TABLE OF CONTENTS

Page

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STATUTES AND REGULATIONS INVOLVED .............5- 2

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REASONS FOR GRANTING THE WRIT ..........-00eeee0: 10

I. The Decision Below Rejects The Logical Application

of the “Misappropriation” Theory as Set Forth in the

Chiarella Dissent and my eyo Denies a Private

Claim for D s in a Civil Case Against Those

Whose Criminal Liability for the Same Conduct Has

Already Been Established .................00 10

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4 7

TABLE OF AUTHORITIES

CASES: Page

v. ; S.

a ee oe ae

Chiarella v. United States, 445 U.S. 222 (1980) .... passim

Dirks v. SEC, 77 L.Ed.2d 911 (1983) .............. 13, 15

Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976) .... 15

Herman & MacLean v. Huddleston, _ U.S. —_, 103

S.Ct. 683, 74 L.Ed.2d 548 (1983) ............... 15

In re Cady Roberts & Co., 40 SEC 907 (1961) ........ 15

O’Connor & Associates v. Dean Witter Reynolds, Inc.,

529 F. Supp. 1179 (S.D.N.Y. 1981) ............ 15, 16

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

G50: FBG FEB BS Cor, 10TE).. cScacistges cccvecdvce 16

United States v. Naftalin, 441 U.S. 768 (1979) ....... 15

United States vy. Newman, Docket No. 82-1273, Order

-—_ 2/8/83, cert. denied, 52 U.S.L.W. 3227 (Oct. 3, P

United States v. Newman, 664 F.2d 12 (1981) ... 4, 18, 14

STATUTES AND REGULATIONS:

Securities Exchange Act of 1934, § 10(b), 15 U.S.C.

NL va biG 0s 0's chuene's oo vb hn tineemanene passim

Sy RM MMOLE) Shaves ccticakncvvce cheek Weadan ‘2

ek do se 8 Pere ee ee passim

OTHER AUTHORITIES:

ALI Federal Securities Code § 1703 (Proposed Official

BUTE aisha nr cdcctpasin bbe ce eteaenenees ol 16

Brudney, /nsiders, Outsiders and Informational Advan-

tages Under the Federal Securities Laws, 93 Harv.

Ree, SD CATON: 2 osc ccldb phe kh dle sehen Panna 15

H.R. Conf. Rep. No. 94-229, 94th Cong., 1st Sess. 91

GPE oC b.nve dc o-0p0 0 6hMceein tae + Pbk he iS eat 14

Langevoort, Insider Trading and the Fiduciary Princi-

ple: A Post-Chiarella Restatement, 70 Cal. L. Rev. 1

CIDE Bove ccvecopcosccstewibasanbseknehenate

Table of Authorities Continued

Page

Note, Trading on Confidential Information - Chiarella

Takes sony wot United States v. Newman, 56 St.

enya SOU RD COED lacs xen es scares cGa weses 13

Phillips, Insider Trading Liability After Dirks, Vol. 16,

; — of Securities Regulation 841, September 28, ‘

Recent Developments, 27 Vill. L. Rev. 1329 (1982) .. 13

EA? SE a i ee Pee gr iy ie on Le

6 Er ta 4 Se a ee BE A ANS BER. pa ee Oe ae

IN THE

Supreme Court of the Gnited States

OCTOBER TERM, 1983

No. 83-

MICHAEL E. Moss,

Petitioner,

JAMES M. NEWMAN,

Respondent.

PETITION FOR A WRIT OF CERTIORARI TO

THE UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

Petitioner Michael E. Moss prays that a Writ of Cer-

tiorari issue to review the judgment of the United States

Court of Appeals for the Second Circuit entered in this

case.

OPINIONS BELOW

The United States Court of Appeals for the Second

Circuit affirmed dismissal of petitioner’s complaint

brought pursuant to Section 10(b) of the Securities Ex-

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

and Rule 10b-5 promulgated thereunder, 17 C.F.R.

§ 240.10b-5, for damages suffered as a result of respon-

dent Newman’s trading in securities on the basis of mis-

appropriated material nonpublic information. The opin-

ion of the Court of Appeals has not been officially re-

ported. It is reported at [Current] CCH Fed. Sec. L.

Rptr. {¢ 99,478 (2d Cir. 1983). It is set forth in the Appen-

dix (“App.”) at la-36a. The opinion of the United States

District Court for the Southern District of New York is

reported at 553 F. Supp. 1347 (S.D.N. Y. 1983) and is set

forth at App. 37a-65a.

JURISDICTION

Jurisdiction to review the September 9, 1983 decision

of the Court of Appeals is vested in this Court by 28

U.S.C. § 1254(1).

STATUTES AND REGULATIONS INVOLVED

Section 10(b) of the Exchange Act, 15 U.S.C. § 78j(b),

provides in pertinent part:

It shall be unlawful for any person, directly or

indirectly, by the use of any means or in-

strumentality of interstate commerce or of the mails,

or of any facility of any national securities exchange

(b) Touse or employ, in connection with the pur-

chase or sale of any security registered on a national

securities exchange or any security not so reg-

istered, any manipulative or deceptive device or con-

trivance in contravention of such rules and regula-

tions as the Commission may prescribe as necessary

or appropriate in the public interest or for the protec-

tion of investors.

Rule 10b-5 of the Securities Exchange Commission

(“S.E.C.”), 17 C.F.R. § 240.10b-5, provides:

It shall be unlawful for any person, directly or

indirectly, by the use of any means or in-

strumen — 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) Tomake any untrue statement ofa 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

business which operates or would operate as a fraud

or deceit upon any person, in connection with the

purchase or sale of any security.

STATEMENT OF THE CASE

This case presents, in a civil context, the “misappropri-

ation” issue expressly left undecided by this Court in

Chiarella v. United States, 445 U.S. 222 (1980)—namely,

whether liability may be based upon the misappropriation

by an individual and two co-conspirators of material non-

public information concerning unannounced tender

offers, which was used by the conspirators to trade in

securities of the companies involved for their own

pecuniary benefit.’

This action was brought following the indictment, trial

and criminal conviction in July 1982 of respondent, James

M. Newman, before the United States District Court for

‘In his dissent in Chiarella which involved a criminal conviction,

Chief Justice Burger argued for the adoption of the “misappropri-

ation” theory of liability. 445 U.S. at 239-245. Justice Brennan, in his

concurring opinion, agreed with the theory, but found that it had not

been presented to the jury. 445 U.S. at 239. Justice Blackmun, with

whom Justice Marshall joined in dissent, agreed with much of what

the Chief Justice stated about the “misappropriation” theory. 445

U.S. at 245. Justice Powell, writing for the Court, specifically held

. that, since the “misappropriation” theory had not been presented to

the jury, it would not be considered. 445 U.S. at 235-236. Justice

Stevens, in his concurring opinion, agreed that the issue should not

be addressed in the circumstances presented. 445 U.S. at 238.

the Southern District of New York, of conspiracy, seven

counts of violations of Section 10(b) and Rule 10b-5 (in-

cluding one count involving the identical transaction pre-

sented in this action), and seven counts of mail fraud.’

Newman, a former stockbroker, was sentenced to a term

of imprisonment of one year and a day and fined $10,000.

His conviction was affirmed by the Second Circuit Court

of Appeals. United States v. Newman, Docket No. 82-

1273, Order dated 2/8/83; certioreri was recently denied

by this Court, 52 U.S.L.W. 3227 (Oct. 3, 1983).

This action was commenced in August 1982 by petition-

er Michael E. Moss on his own behalf and on behalf of a

class of persons who sold shares of Deseret Pharmaceuti-

cal Company (“Deseret”) stock on November 30, 1976.

The Amended Complaint alleges that the individual de-

fendants, Newman, Antoniu and Courtois’, undertook

and carried on a scheme and conspiracy to trade in the

securities of various companies on the basis of material

nonpublic information concerning proposed tender offers,

all in violation of Section 10(b) of the Exchange Act (15

U.S.C. § 78j(b)), and Rule 10b-5 promulgated thereunder

(17 C.F.R. § 240.10b-5).

Defendants were specifically charged with purchasing

Deseret stock on November 30, 1976 after acquiring

knowledge of the imminent joint announcement of a ten-

der offer for Deseret shares by Warner-Lambert Com-

? Initially, the district court dismissed the indictment against New-

man, but the Second Circuit reversed. United States v. Newman, 664

F.2d 12 (2d Cir. 1981).

3 Antoniu had pled guilty to a criminal information based upon his

role in the scheme, and was sentenced to a three month term of

imprisonment. Courtois, who was indicted with Newman, was a

fugitive who has recently been extradited to the United States.

pany (“Warner-Lambert”). This knowledge was acquired

by Courtois as an employee in the mergers and acquisi-

tions department at Morgan Stanley, Inc., an investment

bank retained to evaluate the proposed transaction.

Courtois passed this information to Antoniu (a former

Morgan Stanley employee), who, pursuant to the con-

spiracy, instructed Newman to purchase Deseret shares

immediately. Subsequently, the tender offer at a pre-

mium was announced and the conspirators reaped a hand-

some profit.

The Deseret transaction was not the first one of this

kind for these conspirators. At Newman’s criminal trial

Antoniu testified at length concerning the formation and

conduct of their scheme. In fact, the “leak” about Deseret

was only one in a series of similar transactions extending

over a period in excess of three years.

Early in 1973, Antoniu, who was then employed in the

coporate finance department of Morgan Stanley, and

Newman, a broker-dealer, resolved to form a “part-

nership.” In brief, Newman was to supply capital and

make investments in stocks “recommended” by Antoniu.

These recommendations, however, were based upon non-

public information learned by Antoniu in the course of his

employment at Morgan Stanley of proposed tender offers

prior to their public announcement. When the offers were

announced, the market price of the target company’s

stock would rise, and Newman would sell his shares,

splitting the profits with Antoniu.

This pact was first tested in 1973 with a stock known as

Certainteed. Antoniu learned through his employment at

Morgan Stanley, that a company known as Saint Gobain

Pont Mousson was considering a tender offer for controll-

ing ownership in Certainteed. Thereafter, a public an-

nouncement of the Saint Gobain tender offer for Certain-

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inside ote 4%

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teed was made. Newman sold the stock at a considerable

profit.

Later in 1973, Antoniu learned, during the course of his

employment at Morgan Stanley, of a proposed takeover

of a company named Funk Seeds by Ciba/Geigy. Morgan

Stanley was acting as investment banker in the transac-

tion. As before, Antoniu instructed Newman to buy

shares of the target, which were sold at a profit after the

announcement of the tender offer.

Throughout the spring and summer of 1974, Noth

American Phillips Company was considering a tender

offer for all of the shares of Magnavox. Antoniu learned of

this situation during the course of his employment at

Morgan Stanley and instructed Newman on several occa-

sions to purchase Magnavox stock. A tender offer was

announced at $8 per share, but Antoniu told Newman to

hold the shares pending a later announcement. Shortly

thereafter, there was a second announcement which in-

creased the offering price to $9 per share. Newman then

sold the Magnavox stock at a profit.

In the fall of 1974, Antoniu learned during the course of

his employment at Morgan Stanley of a proposed tender

offer by Standard Oil of Indiana for all of the shares of

Occidential Petroleum. He followed the progress of this

proposal and instriicted Newman to purchase Occidental

stock on several occasions. When the tender offer was

announced, the price of Occidental stock increased and

Newman sold his shares. The conspirators realized a

profit although the takeover attempt was ultimately un-

successful.

In December 1975, Antoniu was told that his services

were no longer required at Morgan Stanley. In May 1976,

he was employed by Kuhn Loeb & Co., Inc. in its mergers

and acquisitions department.

In the interim, Antoniu recruited defendant Courtois,

who was employed in the mergers and acquisitions de-

partment of Morgan Stanley, to join the scheme. Thence-

forth, when Courtois learned of proposed takeovers, he

passed the information to Antoniu, who in turn instructed

Newman to purchase shares of the various target com-

panies. Profits on those transactions were split three

ways.

Courtois’ first contribution to the scheme was a tip in

1975 to buy Pan Ocean Oil stock, based upon information

that he obtained at Morgan Stanley of an impending

takeover attempt. He contacted Antoniu who instructed

Newman to buy the shares. Thereafter, in April 1976,

Marathon Oil Company announced a tender offer for all of

Pan Ocean at a price of $18 per share. Newman sold the

stock and the profits were split among the conspirators.

In early 1976, Courtois learned during his employment

at Morgan Stanley that a company known as Ventron was

a target and tipped this information to Antoniu. As be-

fore, Antoniu told Newman to buy. Thereafter, a tender

offer for Ventron by a foreign buyer was announced and

the stock was sold at a profit.

In the summer of 1976, Courtois learned during the

course of his employment at Morgan Stanley that North-

rup King was the target of Sandoz. He tipped this in-

formation to Antoniu and urged that an immediate pur-

chase of Northrup King stock be made. Newman bought

10,000 shares at $92—10 per share and sold them at a

profit after the tender offer was announced. However,

there were certain antitrust problems in connection with

the takeover. Courtois later told Antoniu that these prob-

lems had been resolved and that another purchase should

be made. At Antoniu’s direction, Newman again bought

Northrup King stock. Soon thereafter a public announce-

ment was made that the antitrust obstacle had been over-

come and that the tender price was $19.40 per share.

Again, Newman sold, realizing a second profit on the

same takeover.

The conspirators’ next transaction concerned the

negotiated takeover of Deseret by Warner-Lambert, the

transaction at issue here. The criminal transcript in-

dicates that Deseret and Warner-Lambert had, over

some months, discussed the acquisition by Warner-

Lambert of all of the outstanding shares of Deseret

through a tender offer. Morgan Stanley was retained by’

Warner-Lambert on or about November 23, 1976 to ev-

aluate the desirability of such a negotiated acquisition and

to recommend an appropriate price per share for the

tender offer.

During the course of this evaluation, representatives of

Morgan Stanley apparently met directly with representa-

tives of Deseret, and Morgan Stanley received informa-

tion directly from officers of Deseret.‘

On or about November 30, 1976, Courtois contacted

Antoniu and informed him of the upcoming tender by

Warner-Lambert for Deseret stock. Antoniu immediate-

ly telephoned Newman who purchased a substantial

amount of Deseret shares at about $28 per share. It was

on that day that plaintiff Moss and the class, unaided by

foreknowledge of the tender offer, sold their Deseret

shares.°

‘In fact, a Morgan Stanley list of the participants in “Project

Cross” (Morgan Stanley’s code name for the transaction between

Warner-Lambert and Deseret) includes several Deseret officers.

5On November 30, 1976, 143,000 shares of Deseret stock were

traded on the New York Stock Exchange. In contrast only 5,000

shares were traded on November 29, 1976.

On December 1, 1976, one day later, trading in Deseret

shares was suspended at Deseret’s request and was not

resumed until after the announcement on December 7,

1976 of the offer, at a price of $38 per share, by Warner-

Lambert for Deseret stock. Subsequently, Newman ten-

dered his shares and reaped a substantial profit.

The Amended Complaint seeks damages from the indi-

vidual defendants as a result of their violation of Section

10(b) of the Exchange Act and Rule 10b-5 in connection

with the Deseret transaction.

In September 1982, defendant Newman moved to dis-

miss the Amended Complaint for failure to state a claim

under Rule 12(b)(6), Fed.R.Civ.P. Shortly thereafter

(October 1982), and before issued was joined, defendant

Morgan Stan’ filed its motion to dismiss under Rule

12(b)(6), or fo: summary judgment under Rule 56, Fed. R-

.Civ.P.

The District Court granted defendants’ motions by

decision dated January 10, 1983, holding, inter alia, that:

(1) plaintiff could not state a claim against Newman under

the securities laws relying on Chiarella v. United States,

445 U.S. 222 (1980); and (2) plaintiff could not state a claim

against, and that summary judgment should be granted

for, Morgan Stanley upon the theories of liability prof-

fered. App. 37a-65a.

The Second Circuit affirmed the dismissal of the

Amended Complaint. The Court held that the individual

defendants owed no duty to Moss and the selling share-

holders because the information had not come from in-

siders of Deseret (App. 20a):

The defendants in this case—Courtois and his tip-

pees Antoniu and Newman—owed no duty of dis-

closure to Moss. In working for Morgan Stanley,

neither Courtois nor Newman was a traditional

‘corporate insider,’ and neither had received any con-

fidential information from the target Deseret. In-

stead, like Chiarella and Dirks, the defendants were

‘complete stranger[{s] who dealt with the sellers [of

Deseret stock] only through impersonal market

— Chiarella v. United States, 445 U.S. at

The Second Circuit also rejected petitioner’s argu-

ment, based upon the Chief Justice’s dissent in Chiarella,

that the misappropriation of nonpublic information by the

individual defendants is sufficient for the imposition of

liability under Section 10(b) and Rule 10b-5 (App. 22a-

23a):

In effect, plaintiff's ‘misappropriation’ theory

would grant him a windfall recovery simply to dis-

courage tortious conduct by securities pur-

chasers... .

* * #

We find that plaintiffs ‘misappropriation’ theory

clearly contradicts the Supreme Court’s holding in

both Chiarella and Dirks and therefore conclude

that the complaint fails to state a valid section 10(b)

or rule 10b-5 cause of action.

REASONS FOR GRANTING THE WRIT

1. The Decision Below Rejects The Logical Application Of

The “Misappropriation” Theory As Set Forth In The

Chiarella Dissent And Improperly Denies A Private Claim

For Damages In A Civil Case Against Those Whose Crimi-

nal Liability For The Same Conduct Has Already Been

Established

This petition presents, in a private civil action context,

the “misappropriation” issue expressly left undecided in

Chiarella v. United States, 445 U.S. 222 (1986).° This

Court in Chiarella held that mere possession of nonpublic

information does not give rise to a duty to disclose or

abstain, and that under the circumstances presented,

there was no duty to disclose where the person trading on

inside information “was not [the corporation’s] agent. . .

was not a fiduciary, [or] was not a person in whom the

sellers [of the securities] had placed their trust and confi-

dence.” Chiarella, 445 U.S. at 232, 235.

The majority in Chiarella noted the alternative argu-

ment offered by the United States to support Chiarella’s

conviction:

It argues that petitioner breached a duty to the

acquiring corporation when he acted upon informa-

tion that he obtained by virtue of his position as an

employee of a a em: by the corporation.

The breach of this duty is said to ss a conviction

under § 10(b) for fraud perpetrated upon both the

scquiring corporation and the sellers. (emphasis add-

445 U.S. at 235-36. The Court specifically stated that it:

need not decide whether this theory has merit for it

was not submitted to the jury.

* « x

[W]e will not speculate upon whether such a duty

existed, whether it has been breached, or whether

such a breach constitutes a violation of § 10(b). [foot-

note omitted]

445 U.S. at 236-37.

6 This “misappropriation” theory is defined by Chief Justice Bur-

ger in his dissent in Chiarella (445 U.S. at 240):

. . . @ person who has misappropriated nonpublic information

has an absolute duty to diselsnn hak information or to refrain

from trading.

This so-called “misappropriation” theory was discussed

by Chief Justice Burger in his dissent in Chiarella. He

found that the general rule of disclosure which is premis-

ed on the existence of a fiduciary or confidential rela-

tionship “should give way when an informational advan-

tage is obtained, not by superior experience, foresight, or

industry, but by some unlawful means.” 445 U.S. at 240.

As he explicitly stated:

I would read § 10(b) and Rule 10b-5 to encompass

and build on this principle: to mean that a person who

has misappropriated nonpublic information has an

absolute duty to disclose that information or to re-

frain from trading.

445 U.S. at 240.

Justice Brennan, who concurred in the majority opin-

ion because he believed the “misappropriation” theory

had not been presented to the jury, expressed his agree-

ment with the theory. 445 U.S. at 239.’ Justice Stevens,

who also concurred in the majority opinion, noted that the

Court correctly did not address the “misappropriation”

theory and that respectable arguments could be made in

support of either position. 445 U.S. at 238. He further

stated: “I think the Court wisely leaves the resolution of

7 Further, in the dissenting opinion of Justice Blackmun, joined by

Justice Marshall, which rejected the reasoning of the majority, it was

noted that they agreed with much of what was said in that part of

Chief Justice Burger’s dissenting opinion that adopted the

“misappropriation” theory. 445 U.S. at 245. As Justice Blackmun

stated:

The fact that petitioner Chiarella ined, or, to use the

Chief Justice’s word, ante, at 245, 63 L.Ed.2d, at 367, ‘stole,’

information concerning pending tender offers certainly is the

most dramatic evidence that petitioner was guilty of fraud.

445 U.S. at 245-46.

this issue for another day.” Jd. We respectfully urge that

this day is now at hand. This petition seeks a determina-

tion of the validity of the “misappropriation” theory in a

private civil damage action under § 10(b) of the Exchange

Act. The application of the “misappropriation” theory as

set forth in Chiarella requires resolution in the context of

a private civil action for damages by sellers of securities

against persons who purchased the same securities based

on misappropriated material nonpublic information.* This

issue has a significant impact on the fair and efficient

operation of the securities markets, the confidence and

integrity investors have in those markets, and the ability

of investors to recover damages against those who misuse

information for their own pecuniary benefit.

The validity of the “misappropriation” theory has been

questioned in the criminal context, with the Second Cir-

cuit having found the theory applicable. United States v.

Newman, 664 F.2d 12 (1981). Commentators have writ-

ten extensively on the “misappropriation” theory, some

raising questions as to its rationale and application. See,

e.g., Note, Trading on Confidential Information—

. Chiarella Takes an Encore: United States v. Newman,

56 St. John’s L. Rev. 727 (1982); Recent Developments,

27 Vill. L. Rev. 1329 (1982). One securities lawyer recent-

ly wrote that the rationale of Dirks v. SEC, 77 L.Ed. 2d

911 (1983) squarely contradicts the “misappropriation”

theory. See Phillips, /nsider Trading Liability After

Dirks, Vol. 16, Review of Securities Regulation 841,

September 28, 1983. But see Langevoort, Insider Trad-

® Under this Court’s decision in Blue Chip Stamps v. Manor Drug

Stores, 421 U.S. 723 (1975), petitioner and the class of sellers he seeks

to represent, are the only persons with standing to pursue a claim for

damages under Section 10(b).

ing and the Fiduciary Principle: A Post-Chiarella Re-

statement, 70 Cal. L. Rev. 1, 52 (1982) (misappropriation

theory would bring the law back close to the fairness-

based theories that began the federal law of insider trad-

ing, while avoiding an ad hoc approach to determining

liability). The issue presented here needs resolution, es-

pecially since much of the present focus of securities law

regulation revolves around insider trading and its impact

on the marketplace.

Adoption of the “misappropriation” theory is necessary

to avoid a breach of the protections offered by and the

very purposes of the Federal securities laws. Without

adoption of this theory, persons in the shoes of Newman

and Newman’s cohorts in the massive fraudulent scheme

described above, and even more vividly by the Second

Circuit in United States v. Newman, supra, 664 F.2d at

117 (conduct of the “connivers” who “purloined” confiden-

tial information), would be immunized from civil liability.

The holding of the Court below effectively permits those

like Newman who have no direct relationship with the

company whose shares are traded, to profit by trading on

stolen information. Many persons could unjustly enrich

themselves at the expense of investors who participate in

and rely on the integrity of the marketplace.’ Such a

*The ability of such persons to unjustly enrich themselves is a

paramount concern because it defeats one of the basic purposes of the

antifraud provisions of the Federal securities laws—‘“to assure that

dealing in securities is fair and without undue preference or advan-

tages among investors” HR Conf. Rep. No. 94-229, 94th Cong., Ist

Sess. 91 (1975), Chiarella, supra, 445 U.S. at 241 (dissent of Chief

Justice Burger). As the Chief Justice recognized, trading on the basis

of misappropriated nonpublic information “quite clearly serves no

useful function except [the trader’s] own enrichment at the expense

of others.” 445 U.S. at 241. The “others” include investors like

petitioner who are trading in the market with the expectation that

there is not undue preference or advantages among investors.

,. ae

result would undermine the efficiency and fairness of the

Federal securities laws—and would remove a large ele-

ment of investor trust and confidence in the integrity of

the securities markets. See Brudney, /nsiders, Outsiders

and Informational Advantages Under the Federal

Securities Laws, 93 Harv. L. Rev. 322, 334-337 (1979).

Limitation of the “misappropriation” theory to the

criminal context would be an overly restrictive and im-

proper interpretation of the antifraud provisions of the

Federal securities laws whose essential purposes, as this

Court has repeatedly recognized, are to protect in-

vestors. See, e.g., Herman & MacLean v. Huddleston,

—— U.S. —_, 103 S.Ct. 683, 692, 74 L.Ed.2d 548, 561

(1983); United States v. Naftalin, 441 U.S. 768, 774

(1979); Ernst & Ernst v. Hochfelder, 425 U.S. 185, 196

(1976). See also In re Cady Roberts & Co., 40 SEC 907,

910-11 (1961).

The “misappropriation” theory espoused by Chief Jus-

tice Burger in Chiarella rests on the premise that a

person misappropriating nonpublic information has an

absolute duty to disclose that information prior to trading

or to refrain from trading. The duty to disclose is owed to

shareholders and public investors. See, Dirks v. SEC, 77

L.Ed.2d 911, 929 (1983); In re Cady Roberts & Co., 40

SEC 907, 911, 913-14 (1961). It is those public investors

who sustained injury as a result of Newman’s trading,

and for whom a private cause of action is implied under

Section 10(b)—both to compensate those persons injured

by fraud and to augment the enforcement mechanisms of

the Federal securities laws. Herman & MacLean v. Hud-

dleston, supra, ___ U.S. —__, 108 S.Ct. at 689-90, 692,

74 L.Ed.2d at 558-59, 561; O’Connor & Associates v.

Dean Witter Reynolds, Inc., 529 F. Supp. 1179, 1188

(S.D.N.Y. 1981).

Petitioner Moss is a perfect example of an investor who

has been damaged by Newman’s trading on the basis of

misappropriated material nonpublic information concern-

ing the proposed tender offer. If the information Newman

possessed had been disclosed to a reasonable investor, he

or she would not have sold his or her Deseret shares at $28

per share but rather would have held those shares and

exchanged them in the $38 per share tender offer. Peti-

tioner’s damages flow directly from the failure to disclose

this material information. See Shapiro v. Merrill Lynch

Pierce Fenner & Smith, Inc., 495 F.2d 228, 238-41 (2d

Cir. 1974). O’Connor & Associates, supra, 529 F. Supp.

at 1186-88.

‘© Further, liability for the misappropriation or conversion of in-

formation finds support in the proposed Federal Securities Code

prepared by the American Law Institute under the direction of

Professor Louis Loss. See Chiarella, supra, 445 U.S. at 242 n. 3

(dissent of Chief Justice Burger). The Code provides a civil cause of

action to investors against those violating the insider trading provi-

sions. See ALI Federal Securities Code § 1703 (Proposed Official

Draft 1978).

CONCLUSION

For the reasons set forth above, certiorari should be

granted to review the judgment of the Court of Appeals.

Respectfully submitted,

HERBERT E. MILSTEIN*

STEVEN J. TOLL

KOHN, MILSTEIN, COHEN & HAUSFELD

1776 K Street, N.W., Suite 708

Washington, D.C. 20006

(202) 293-7110

—and—

ROBERT N. KAPLAN

RICHARD J. KILSHEIMER

KAPLAN, KILSHEIMER & FOLEY

122 East 42nd Street, Suite 4000

New York, New York 10168

(212) 687-1980

Counsel for Petitioner

*Counsel of Record

APPENDIX

[CORRECTED COPY]

UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

No. 1281—August Term, 1982

(Argued May 19, 1983 Decided September 9, 1983)

Docket No. 83-7120

MICHAEL E. Moss,

Plaintiff-Appellant,

—)—

MORGAN STANLEY INC., E. JACQUES CouRTOIS, JR.,

ADRIAN ANTONIU, and JAMES M. NEWMAN,

Defendants,

MORGAN STANLEY INC. and JAMES M. NEWMAN,

Defendants-Appellees.

Before:

MANSFIELD, MESKILL and KEARSE,

Circuit Judges.

Appeal from the judgment entered in the United States

District Court for the Southern District of New York,

Pollack, J., granting defendants’ motions to dismiss for

failure to state a claim and motion for summary judg-

ment on the grounds that (1) plaintiff’s complaint failed

to state a cause of action for damages under section 10(b)

of the Securities Exchange Act of 1934, 15 U.S.C.

§ 78j(b) (1976), or rule 10b-5, 17 C.F.R. § 240.10b-5

(1982); (2) because the individual defendants were free

from liability for securities fraud, their employer could

not be held derivatively liable as a “controlling person”

under section 20(a) of the Securities Exchange Act of

1934, 15 U.S.C. § 78t(a) (1976); and (3) plaintiff’s com-

plaint failed to state a claim for damages under the

Racketeer Influenced and Corrupt Organizations Act, #

U.S.C. §§ 1961 ef seg. (1976°& Supp. III 1979).

Affirmed.

——

RICHARD J. KILSHEIMER, New York, New

York (Robert N. Kaplan, Kaplan, Kil-

sheimer & Foley, New York, New York,

Herbert E. Milstein, Steven J. Toll, Kohn

Milstein Cohen & Hausfeld, Washington,

D.C., of counsel), for Plaintiff-Appel-

lant.

ARTHUR F. MATHEWS, Washington, D.C. (An-

drew B. Weissman, Thomas W. White,

Wilmer, Cutler & Pickering, Washington,

D.C., of counsel) for Defendant-Appel-

lee James M. Newman.

HENRY L. KING, New York, New York (Ar

thur F. Golden, James L. Kerr, Davis

Polk & Wardwell, New York, New York,

of counsel), for Defendant-Appellee

Morgan Stanley Inc.

Daniel L. Goelzer, General Counsel, Ja-

cob H. Stillman, Associate General

Counsel, Rosalind C. Cohen, Assistant

General Counsel, Paul Gonson, Solicitor,

Robert Mills, Elliot M. Pinta, Securities

and Exchange Commission, Washington,

D.C., Amicus Curiae.

MESKILL, Circuit Judge:

This appeal spotlights two issues of significance for the

litigation of federal securities fraud claims: (1) whether a

shareholder who unwittingly sold stock of a ‘“‘target’’

company on the open market prior to public announce-

ment of a tender offer has a cause of action for damages

under section 10(b) of the Securities Exchange Act of

1934, 15 U.S.C. § 78j(b) (1976) (the 1934 Act), and rule

10b-5, 17 C.F.R. § 240.10b-5 (1982) promulgated there-

under against a person who purchased ‘“‘target’’ shares on

the basis of material nonpublic information which he

acquired from the tender offeror’s investment adviser;

and (2) whether this same unwitting shareholder can

recover treble damages under the Racketeer Influenced

and Corrupt Organizations Act, 18 U.S.C. §§ 1961 ef

seq. (1976 & Supp. III 1979) (RICO), on the ground that

he was injured by an unlawful ‘‘enterprise’’ conducting a

**pattern of racketeering activity’’ comprised of ‘‘fraudu-

lent’’ securities transactions.

The district court held that the shareholder failed to

state a cause of action under both the 1934 Act and

RICO. We agree for the reasons stated below.

Affirmed.

BACKGROUND

The chain of events that culminated in this action

began in the latter months of 1976 with tender offer

discussions between Warner-Lambert Company (Warner)

and Deseret Pharmaceutical Company (Deseret). On No-

vember 23, 1976 Warner retained the investment banking

firm of Morgan Stanley & Co. Incorporated, a subsidiary

of Morgan Stanley Inc. (Morgan Stanley), to assess the

desirability of acquiring Deseret, to evaluate Deseret’s

stock and to recommend an appropriate price per share

for the tender offer.

Oné of the individual defendants in this action, E.

Jacques Courtois, Jr., was then employed by Morgan

Stanley in its mergers and acquisitions department. In

that capacity Courtois acquired knowledge of Warner’s

plan to purchase Deseret stock. On November 30, 1976

Courtois informed defendant Adrian Antoniu, an em-

ployee of Kuhn Loeb & Co., of the proposed tender offer

and urged him to purchase Deseret stock. Antoniu in turn

informed James M. Newman, a stockbroker, that Warner

intended to bid for Deseret. Pursuant to an agreement

with Antoniu and Courtois, Newman purchased 11,700

shares of Deseret stock at approximately $28 per share for

his and their accounts. Newman also advised certain of

his clients to buy Deseret stock.

Trading was active in Deseret shares on November 30,

1976, with approximately 143,000 shares changing hands.

Michael E. Moss, the plaintiff in this action, was among

the active traders, having sold 5,000 shares at $28 per

share. On the following day, December |, 1976, the New

York Stock Exchange halted trading in Deseret stock

pending announcement of the tender offer. Trading re-

mained suspended until December 7, 1976 when Warner

publicly announced its tender offer for Deseret stock at

$38 per share. Newman and the other defendants ten-

dered their shares to Warner and reaped a substantial

profit.

On August 5, 1982 Moss commenced this action on his

own behalf and on behalf of the class of investors who

sold stock in Deseret on November 30, 1976.' He con-

tended that ‘‘members of the class have been substantially

damaged in that they sold Deseret stock prior to the

public announcement of the Warner tender offer at prices

substantially below that offered by Warner.’’ J. App. at

11. The amended complaint stated three causes of action:

(1) Moss sought to recover damages from Newman for

allegedly violating section 10(b) of the 1934 Act and rule

10b-5 thereunder by purchasing Deseret shares with

knowledge of the imminent tender offer and without

disclosing such information to Deseret shareholders;* (2)

! The parties agreed to delay consideration of class certification until

30 days following the district court’s disposition of defendants’

12(b)(6) motions. Moss v. Morgan Stanley Inc., 82 Civ. 5182

(S.D.N.Y. Dec. 16, 1982) (stipulation and order).

2 In Count | of the amended complaint, Moss alleged that Courtois

and Antoniu, as well as Newman, violated section 10(b) and rule

10b-5. Moss also alleged that all three individual defendants violated

section 14(e) of the 1934 Act, 15 U.S.C. § 78n(e) (1976), and rule

14e-3, 17 C.F.R. § 240.14e-3 (1982). Judge Pollack found that the

section 14(e) claim was without merit and plaintiff has not challenged

this finding. Judge Pollack also dismissed the section 10(b) claim

Moss sought to recover damages from Morgan Stanley on

the ground that as a ‘‘controlling person’’ under section

20(a) of the 1934 Act, 1S U.S.C. § 78t(a) (1976), Morgan

Stanley should be derivatively liable for Courtois’

wrongdoing;’ and (3) pursuant to RICO, 18 U.S.C.

§ 1964(c) (1976), Moss sought to recover treble damages

from Newman on the ground that he engaged in ‘‘at least

two acts of fraud in connection with the purchase and

sale of securitics and as such represent a pattern of

racketeering activity within the meaning of RICO.’ J.

App. at 11.

In September 1982 Newman moved pursuant to Fed.

R. Civ. P. 12(b)(6) to dismiss the complaint for failure to

state a claim upon which relief could be granted. Shortly

thereafter, defendant Morgan Stanley filed a rule 12(b)(6)

motion to dismiss, alternatively styled as a Fed. R. Civ.

P. 56 motion for summary judgment, and also requested

attorneys’ fees and costs pursuant to Fed. R. Civ. P. Il.

The United States District Court for the Southern District

of New York, Pollack, J., granted both defendants’

against all defendants and plaintiff has appealed only from the

dismissal of this claim against Newman.

3 Count | also alleged that Morgan Stanley was jointly and severally

liable to appellant for aiding and abetting the primary violations. The

district court dismissed this pori.on of Count | as well as the “control-

ling person” claim under section 20(a) of the 1934 Act, 15 U.S.C.

§ 73t(a) (1976). Plaintiff appeals only from the dismissal of the

“controlling person” claim.

4 Count 2 also alleged that Morgan Stanley violated RICO. Judge

Pollack dismissed the RICO claims against all defendants, but plaintiff

appeals only from the dismissal of the claim against Newman.

In Count 3 of the complaint, plaintiff alleged that all of defendants’

unlawful acts “constitute{d] violations of the applicable principles of

common law fraud” and that defendant Morgan Stanley was “liable

under the doctrine of respondeat superior.” J. App. at 12. The district

court dismissed this count and plaintiff has not appealed.

motions to dismiss, defendant Morgan Stanley’s Rule 56

motion’ and awarded costs to both defendants. Moss v.

Morgan Stanley inc., 553 F.Supp. 1347, 1352 (S.D.N.Y.

1983). Although we disagree with several of the reasons

advanced by the district court for dismissing plaintiff’s

RICO claim, we affirm the judgment dismissing the

complaint and awarding costs to both defendants.°

On September 21, 1982 the parties met with the district court at a

pretrial conference and Morgan Stanley indicated its intention to file a

motion for summary judgment. Judge Pollack specifically stated that

before the hearing on this motion “the plaintiff would be afforded

whatever discovery plaintiff deemed necessary to defend the amended

complaint.” 553 F.Supp. at 1364. Morgan Stanley provided plaintiff

with extensive document discovery and repeatedly asked plaintiff to

designate any witnesses for deposition. /d. Plaintiff did not designate

anyone for deposition. Judge Pollack regarded plaintiff's lack of

initiative as providing:

fair inference in the circumstances on the basis of the affidavits

submitted by Morgan Stanley and their challenging effect and the

background of this case that discovery would demonstrate cogently

the absence rather than the presence of genuine issues of material

fact on either the securities claim or the RICO claim.

Id. Finding that plaintiff had failed to carry his burden, Judge Pollack

granted Morgan Stanley’s summary judgment motion. /d.; see Beal v.

Lindsay, 468 F.2d 287, 291 (2d Cir. 1972).

Plaintiff appeals only from the district court’s grant of summary

judgment dismissing plaintiff's section 20(a) “derivative liability”

claim. 15 U.S.C. § 78t(a) (1976).

Prior to this civil suit, on February 3, 1981, a 27 count criminal

indictment charged Courtois and Newman with committing a series of

criminal violations of 10(b) and rule 10b-5 (including trading on the

Deseret tender offer information), as well as violations of the federal

mail fraud and conspiracy statutes. United States v. Courtois, 81 Cr.

$3 (S.D.N.Y. filed Feb. 3, 1981), as superseded, 82 Cr. 0166 (S.D.N.Y.

filed Mar. 1, 1982). Newman was convicted on seven counts of

securities fraud, seven counts of mail fraud and one count of con-

spiracy. He received a one year jail sentence and a fine of $10,000.

United States v. Newman, No. 82-1273 (2d Cir. Feb. 8, 1983) (un-

published order affirming conviction), petition for cert. filed, 5\

U.S.L.W. 3759 (U.S. Apr. 8, 1983).

Antoniu cooperated with the government and pled guilty to an

Information based on his role in the securities scheme. He was

sentenced to a three month term of imprisonment. Courtois, who was

indicted with Newman, remains a fugitive from justice.

DISCUSSION

I. Section 10(b) Liability’

A. Introduction

It is well settled that traditional corporate ‘‘insiders’’—

directors, officers and persons who have access to confi-

dential corporate information® must preserve the

7 Section 10(b) of the 1934 Act provides:

It shall be unlawful for any person, directly rindecty, Se

¢ or 0

use of any fr epdinrwetongs: posing ha Pasa commerc

: i, o— 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 protection of investors.

15 U.S.C. § 78j(b) (1976).

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 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

operates or would operate as a fraud or eceit upon any person, in

connection with the purchase or sale of any security.

17 C.F.R. § 240.10b-5 (1982). The duty to either disclose or refrain is

traditionally based on subsection (c) of rule 10b-5. However the courts

have never treated the subsections of rule 10b-5 as carrying different

legal consequences. See List v. Fashion Park, Inc., 340 F.2d 457, 462

(2d Cir.), cert. denied, 382 U.S. 811 (1965).

8 Section !6(b) of the 1934 Act defines “insiders” as directors, officers

and 10% beneficial owners. 15 U.S.C. § 78p (1976). However, there is

no definitive test for defining an “insider.” 3 A. Bromberg, Securities

Law, § 7.4(6)(b) at 180-81 & n.169.1 (1969). This Court's initial

confidentiality of nonpublic information that belongs to

and emanates from the corporation.’ Consistent with this

characterization of an “insider” reaffirmed the SEC's view that anyone

who has access to the issuer of stock and thereby obtains nonpublic

information is an “insider” for purposes of the federal securities laws:

The essence of the Rule is that anyone who, trading for his own

account in the securities of a corporation has “access, directly or

indirectly, to information intended to be available only for a

corporate purpose and not for the personal benefit of anyone” may

not take “advantage of such information knowing it is unavailable

to those with whom he is dealing,” i.e., the investing public.

SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 848 (2d Cir. 1968) (en

banc), cert. denied, 404 U.S. 1005 (1971) (quoting /n re Cady, Roberts

& Co., 40 S.E.C. 907, 912 (1961)). Ordinarily, “insiders” include such

corporate figures as directors and vice presidents, persons who have

access to confidential corporate information and therefore owe a duty

to a corporation’s shareholders not to trade on that information. See

Dirks v. SEC, 681 F.2d 824, 835 (D.C. Cir. 1982), rev’d on other

grounds, 51 U.S.L.W. 5123 (U.S. July 1, 1983); O’Connor & Assoc. v.

Dean Witter Reynolds, Inc., 529 F.Supp. 1179, 1184-85 (S.D.N.Y.

1981); Langevoort, /nsider Trading and the Fiduciary Principle: A

Post-Chiarella Restatement, 70 Cal. L. Rev. 1, 19-24 (1982).

9 In addition to distinguishing between “insiders” and “outsiders”

with respect to the “duty of disclosure” under section 10(b) and rule

10b-5, the courts and commentators have also distinguished between

“inside” and “outside” information. “Inside” informat: generally

concerns the internal business affairs of the issuer—assets and earning

power. “Outside” or “market” information is “related solely to the

market for the securities rather than their intrinsic value.” Dirks v.

SEC, 681 F.2d 824, 834 (D.C. Cir. 1982), rev’d, 51 U.S.L.W. 5123

(U.S. July i, 1983).

a In Dirks v. SEC, the D.C. Circuit discussed the importance of the

“character” of information in determining whether non-disclosure of

such information violates section 10(b) of the 1934 Act:

On the one hand, some of the language in the cases finds the

element of unfairness and fraud in conflicts of interest on the part

of traders or their informants who profit at the expense or to the

exclusion of those who have placed trust in them. The contlict of

interest may arise from a traditional fiduciary relationship, as

between a corporate director and the corporation's shareholders, or

a similar relationship of trust, as between employers and employees

or investment bankers and their clients. On the other hand, some of

the cases imply that the securities laws impose a duty to disclose or

refrain from trading based on the nature of the undisclosed infor-

mation. The theory is that all investors should have equal access to

10a

duty, the ‘‘insider’’ musi either disclose nonpublic cor-

porate information or abstain from trading in the securi-

ties of that corporation. See SEC v. Texas Gulf Sulphur

Co., 401 F.2d 833, 848 (2d Cir. 1968) (en banc), cert.

denied, 404 U.S. 1005 (1971); accord Radiation

Dynamics, Inc. v. Goldmuntz, 464 F.2d 876, 890 (2d Cir.

1972) (‘‘The essential purpose of Rule 10b-5 . . . is to

prevent corporate insiders and their tippees from taking

unfair advantage of the uninformed outsiders.’’). The

individual defendants in this case—Courtois, Antoniu

and Newman—having acquired confidential information

_ information that a reasonable investor would consider material to

investment decisions, and that any trade in which only one party

had an opportunity to learn and did learn such information is

inherently unfair.

Id. at 835 (emphasis added) (footnotes omitted). The “[t]ension be-

tween the two theories derives in large part from the conflict between

the two major ideals of the federal securities laws: fairness to all

investors and efficient markets for capital.” /d. at 835 n.14; see

Brudney, /nsiders, Outsiders, and Informational Advantages Under the

Federal Securities Laws, 93 Harv. L. Rev. 322, 333-39 (1979).

This “information” theory of section 10(b) liability has been rejected

by some commentators:

The same information can therefore be either inside or outside

information. A market researcher or columnist who concludes from

published information that a certain company is ripe for a takeover

bid, the person making the tender offer, an employee of the tender

offeror who misuses the information, and even a stock market

specialist or broker who observes preparations for the tender offer,

all use outside market information when they trade in target

securities. By contrast, the target executive who learns of the

impending offer by virtue of his employment uses inside market

information when he trades in target stock. The important factor is

not the type of information, so \ong as it is material, but its source.

Barry, The Economics of Outside Information and Rule 10b-5, 129 U.

Pa. L. Rev. 1307, 1309-10 n.11 (1981) (emphasis added), and most

recently the Supreme Court has laid the issue to rest: “Judge Wright

correctly read our opinion in Chiarella as repudiating any notion that

all traders must enjoy equal information before trading: ‘[T]he ‘infor-

mation’ theory is rejected.’ ” Dirks v. SEC, 51 U.S.L.W. 5123, 5126

(U.S. July 1, 1983). '

+ ote

tal

lla

through Warner’s investment adviser and having no

direct relationship with Deseret, could not be traditional

corporate ‘‘insiders.’’

However, in a number of decisions the Supreme Court

has extended the ‘‘duty of disclosure’’ requirement to

nontraditional ‘‘insiders’’—persons who have no special

access to corporate information but who do have a special

relationship of ‘‘trust’’ and ‘‘confidentiality’’ with the

issuer or seller of the securities. See, e.g., Affiliated Ute

Citizens v. United States, 406 U.S. 128 (1972) (bank

employees who purchased shares in a tribal trust fund

from mixed-blood Ute Indians without disclosing that

there was a secondary market for shares at higher prices

among non-Indians); SEC v. Capital Gains Research

Bureau, Inc., 375 U.S. 180 (1963) (investment adviser

who purchased stock for his own account just before

publishing a recommendation that his clients buy the

stock); see also Zweig v. Hearst Corp., 594 F.2d 1261 (9th

Cir. 1979) (financial columnist); Lewelling v. First Cali-

fornia Co., 564 F.2d 1277 (9th Cir. 1977); Frigitemp

Corp. v. Financial Dynamics Fund, Inc., 524 F.2d 275

(2d Cir. 1975); Flynn v. Bass Brothers Enterprises, 456

F.Supp. 484 (E.D. Pa. 1978). Moss sought to include the

defendants in this category of nontraditional ‘‘insiders’’

and argued that they necessarily violated section 10(b)

and rule 10b-5 by purchasing Deseret stock without pub-

licly disclosing their knowledge of the impending tender

offer. After finding that none of the defendants occupied

a position of ‘‘trust’’ with respect to Moss, the district

court held that none of the defendants owed him such a

‘*duty of disclosure.’’ In light of the Supreme Court’s

decisions in Chiarella v. United States, 445 U.S. 222

(1980), and Dirks v. SEC, 51 U.S.L.W. 5123 (U.S. July

1, 1983), which recently articulated the standard for

12a

analyzing violations of section 10(b) and rule 10b-5, we

agree with the district court’s dismissal of plaintiff’s

federal securities law claim.

B. Chiarella v. United States

In Chiarella v. United States, 445 U.S. 222 (1980), an

employee of a New York financial printer deduced the

identity of corporate takeover targets from the confiden-

tial offering documents prepared by his firm. Without

disclosing his knowledge of the acquiring company’s

plans, Chiarella purchased stock in the target companies

and sold it at a substantial profit immediately after public

announcement of the takeovers. Jd. at 224. He was

indicted and convicted of violating section 10(b) of the

1934 Act and rule 10b-5. A divided Court of Appeals

affirmed the conviction. United States v. Chiarella, 588

F.2d 1358 (2d Cir. 1978) (Meskill, J., dissenting).

The Supreme Court reversed, stating that:

In this case, the petitioner was convicted of violat-

ing § 10(b) although he was not a corporate insider

and he received no confidential information from the

target company. Moreover, the ‘‘market informa-

tion’? upon which he relied did not concern the

earning power or Operations of the target company,

but only the plans of the acquiring company. Peti-

tioner’s use of that information was not a fraud

under § 10(b) unless he was subject to an affirmative

duty to disclose it before trading.

Chiarella v. United States, 445 U.S. at 231 (emphasis

added) (footnote omitted); see Dirks v. SEC, 5\i

U.S.L.W. at 5125. The Court explained that liability for

nondisclosure of material nonpublic market information

under section 10(b) is ‘‘premised upon a duty to disclose

13a

arising from a relationship of trust and confidence be-

tween parties to a transaction.’’ Jd. at 230. Absent an

‘*insider’’ or ‘‘fiduciary’’ relationship with the sellers of

stock, a purchaser has no duty to disclose nonpublic

market information. /d. at 229 (citing with approval

General Time Corp. v. Talley Industries, Inc., 403 F.2d

159, 164 (2d Cir. 1968), cert. denied, 393 U.S. 1026 (1969)

(‘‘We know of no rule of law. . . that a purchaser of

stock, who was not an ‘insider’ and had no fiduciary

relation to a prospective seller, had any obligation to

reveal circumstances that might raise a seller’s demands

and thus abort the sale.’’)); see also Polinsky v. MCA

Inc., 680 F.2d 1286, 1290 (9th Cir. 1982) (‘‘{A] purchaser

of stock who has no fiduciary relationship to the prospec-

tive seller of the stock and who owns less than five

percent of the target companies’ stock has no duty to

disclose circumstances that will insure the purchaser pays

the highest possible price for the stock.’’); Staffin v.

Greenberg, 672 F.2d 1196, 1201-02 (3d Cir. 1982).

The Court concluded unequivocally that Chiarella

owed no duty of disclosure:

[T]he element required to make silence fraudulent—a -

duty to disclose—is absent in this case. No duty

could arise from petitioner’s relationship with the

sellers of the target company’s securities, for peti-

tioner had no prior dealings with them. He was not

their agent, he was not a fiduciary, he was not a

person in whom the sellers had placed their trust and

confidence. He was, in fact, a complete stranger who

dealt with the sellers only through impersonal market

transactions.

Chiarella v. United States, 445 U.S. at 232-33.

l4a

C. Application of Chiarella

In applying Chiarella’s “fiduciary standard” to this

case, Judge Pollack concluded that Newman owed no

“duty of disclosure” to plaintiff Moss and hence could

not be liable for a section 10(b) or rule 10b-5 violation.

553 F.Supp. at 1352-53. We agree. Like Chiarella, both

Courtois and Newman were “complete stranger[s] who

dealt with the sellers [of Deseret stock] only through

impersonal market transactions.” Chiarella v. United

States, 445 U.S. at 232-33. However, in this appeal

plaintiff continues to insist, arguendo, that if civil “liabil-

ity is premised upon a duty to disclose arising from a

relationship of trust and confidence between parties to a

transaction,” then he occupied such a position of “trust”

with respect to the defendants. He suggests three sources

for the defendants’ “duty of disclosure.”

1. United States v. Newman

Moss first argues that because Courtois owed a “fidu-

ciary duty” to his employer, Morgan Stanley, and to

Morgan Stanley’s client, Warner, then Newman (standing

in Courtois’ shoes) owed a separate duty of disclosure to

Deseret shareholders. Plaintiff claims that our decision in

United States v. Newman, 664 F.2d 12 (2d Cir. 1981),

aff'd after remand, Docket No. 82-1273 (2d Cir. Feb. 8,

1983) (unpublished order), petition for cert. filed, 51

U.S.L.W. 3759 (U.S. Apr. 8, 1983), supports this circuit-

ous linking of liability. We disagree.

In Newman we held that Courtois’ and Antoniu’s

securities transactions constituted a breach of their fidu-

ciary duty of confidentiality and loyalty to their employ-

ers (Morgan Stanley and Kuhn Loeb & Co., respectively)

and thereby provided the basis for criminal prosecution

15a

under section 10(b) and rule 10b-5. Indeed, the district

court at Newman’s trial specifically charged the jury that

“the law is clear that Mr. Newman had no obligation or

duty to the people from whom he bought the stock to

disclose what he had learned, and, thus, he could not

have defrauded these people as a matter of law.” J. App.

at 29-30. Nothing in our opinion in Newman suggests that

an employee’s duty to “abstain or disclose” with respect

to his employer should be stretched to encompass an

employee’s “duty of disclosure” to the general public. In

fact, we explicitly limited our holding in Newman by

Stating:

In two instances the targets themselves were cli-

lents of the investment banking firms. The Govern-

ment belatedly suggests that the indictment shou be

construed to allege securities laws violations in these

two instances, on the theory that the defendants, by

purchasing stock in the target companies, defrauded

the shareholders of those companies. Whatever va-

lidity that approach might have, it is not fairly within

the allegations of the indictment, which allege essen-

tially that the defendants defrauded the investment

banking firms and the firms’ takeover clients.

United States v. Newman, 664 F.2d at 15 n.1 (emphasis

added). Thus, the district court was correct in concluding

that “plaintiff cannot hope to piggyback upon the duty

owed by defendants to Morgan Stanley and Warner.

There is no ‘duty in the air’ to which any plaintiff can

attach his claim.” 553 F.Supp. at 1353.

2. “Insider” Trading

Plaintiff’s next attempt to find a source for Newman’s

duty to disclose is to argue that Morgan Stanley and its

abd

l6a

employee Courtois were “insiders” of Deseret and there-

fore owed a duty to Deseret shareholders. Moss asserts

that Morgan Stanley and Courtois were transformed into

“insiders” upon their receipt of confidential information

from Deseret during tender offer negotiations in this

“friendly takeover.” Such an argument fails both as a

matter of fact and law.

First, the complaint contains no factual assertions that

Morgan Stanley or Courtois received any information

from Deseret. Nor does it allege that Newman traded on

the basis of information derived from the issuer or seller

of Deseret stock. Rather, the complaint was premised

solely on the theory that Newman traded on the basis of

information originating from “Warner’s plan to acquire

Deseret stock.” J. App. at 9.

Yet, even if we overlook the complaint’s facial deficien-

cies, plaintiff’s theory fails as a matter of law. In Walton

v. Morgan Stanley & Co., 623 F.2d 796 (2d Cir. 1980), we

held that an investment banker, representing an acquiring

company, does not owe a fiduciary duty to the target

simply because it received confidential information

during the course of tender offer negotiations. In Walton,

Kennecott Copper Corporation retained Morgan Stanley

to advise it about the possible acquisition of Olinkraft,

Inc. In the course of negotiations, Olinkraft furnished

Morgan Stanley with “inside” information which was to

be kept confidential. Although Kennecott ultimately

elected not to bid, Morgan Stanley purchased Olinkraft

shares for its own account based on the “confidential”

information. In rejecting Olinkraft’s claim that Morgan

Stanley violated section 10(b) by breaching a fiduciary

duty owed to Olinkraft, we held that Morgan Stanley had

engaged in arm’s length bargaining with the target.

Morgan Stanley did not become the target’s fiduciary

17a

simply upon receipt of confidential information. We

noted that “we have not found any [cases] that consider[]

one in Morgan Stanley’s position [investment adviser to

the “shark”] to stand in a fiduciary relationship to one in

Olinkraft’s [the target].” /d. at 799; see Dirks v. SEC, 51

U.S.L.W. 5123, 5127 n.22 (U.S. July 1, 1983) (citing

Walton with approval as “[a]n example of a case turning

on the court’s determination that the disclosure did not

impose any fiduciary duties on the recipient of the inside

information”); see generally Frigitemp Corp. v. Financial

Dynamics Fund, Inc., 524 F.2d 275, 278-79 (2d Cir. 1975)

(investment companies that traded on confidential infor-

mation obtained in the course of negotiations for private

placement of debentures owed no duty to the selling

corporation).

Relying on Walton, Judge Pollack properly concluded

that “unless plaintiffs can set forth facts that turn the

negotiations from arm’s length bargaining into a fidu-

ciary relationship, they cannot claim that Morgan Stanley

owed them a fiduciary duty.” 553 F.Supp. at 1355. We

recognize that with only “the complaint and the appel-

lee’s motion to dismiss, we do not have the benefit of

findings of fact about whatever communication occurred

between Olinkraft [Deseret], the potential target, and

Morgan Stanley, the financial advisor to the potential

acquirer: how the communication proceeded, what under-

standings were reached, what assumptions or expectations

the trade’s practice would justify.” Walton v. Morgan

Stanley & Co., 623 F.2d at 798. Yet Moss’ complaint is

patently deficient. It is barren of any factual allegations

thai might establish a fiduciary relationship between

Morgan Stanley and Deseret. The complaint shows only

that Morgan Stanley was retained by Warner and repre-

sented Warner’s interest in the tender offer negotiations

ibaa aa

18a

with Deseret. The district court correctly found that the

complaint did not allege a section 10(b) or rule 10b-5

claim premised on Morgan Stanley’s “insider” status.

3. Broker-Dealer Duty

Plaintiff’s final attempt to establish a cognizable duty

between himself and the defendants is to argue that

Newman violated rule 10b-5 because as a registered bro-

ker-dealer he owed a general duty to the market to

disclose material nonpublic information prior to trading.

Moss relies on the District of Columbia Circuit’s decision

in Dirks v. SEC, 681 F.2d 824 (D.C. Cir. 1982), rev’d, 51

U.S.L.W. 5123 (U.S. July 1, 1983), to support his argu-

ment. Such reliance is misplaced. In Dirks, the SEC

censured a broker-deaier for tipping his clients about

irregularities at Equity Funding Corporation of America

before he publicly disclosed evidence of corporate fraud.

The Circuit Court did not consider whether a broker-

dealer’s nondisclosure of nonpublic information gives rise

to civil liability under section 10(b) or rule 10b-5. In fact,

the D.C. Circuit made clear that a “private action for

damages might raise questions of standing, causation,

and appropriate remedy not pertinent [in Dirks].” 681

F.2d at 839-40 n.19. Moreover, in the Supreme Court’s

recent reversal of Dirks, the Court expressly declined to

consider Judge Wright’s “novel theory” that “Dirks ac-

quired a fiduciary duty by virtue of his position as an

employee of a broker-dealer.” 51 U.S.L.W. at 5128 n.26.

Therefore, neither the D.C. Circuit’s nor the Supreme

Court’s decision in Dirks \ends any support to the plain-

tiff’s argument.

We find nothing in the language or legislative history of

section 10(b) or rule 10b-5 to suggest that Congress

intended to impose a special duty of disclosure on broker-

19a

dealers simply by virtue of their status as market profes-

sionals. Cf. Dirks v. SEC, 681 F.2d 824, 840, 841 & n.21

(D.C. Cir. 1982) (Judge Wright reads the legislative his-

tory of the 1934 Act as providing that “securities profes-

sionals regulated by the Act would owe certain

responsibilities to the public at large as well as to their

clients.”). Indeed, to impose such a duty “could have an

inhibiting influence on the role of market analysts, which

the SEC itself recognizes is necessary to the preservation

of a healthy market.” Dirks v. SEC, 51 U.S.L.W. at 5126

& n.17.

Moreover, in Dirks v. SEC, 51 U.S.L.W. 5123 (U.S.

July 1, 1983), the Supreme Court expressly reaffirmed its

holding in Chiarella that “ ‘{a] duty [to disclose] arises

from the relationship between parties ... and not

merely from one’s ability to acquire information because

of his position in the market.’” /d. at 5126 (quoting

United States v. Chiarella, 445 U.S. at 232-33 & n.14).

The Court reexamined this “duty of disclosure:”

Under certain circumstances, such as where cor-

porate information is revealed legitimately to an

underwriter, accountant, lawyer, or consultant work-

ing for the corporation [Deseret’s advisers], these

outsiders may become fiduciaries of the share-

holders. The basis for recognizing this fiduciary duty

is not simply that such persons acquired nonpublic

corporate information, but rather that they have

entered into a special confidential relationship in the

conduct of the business of the enterprise and are

given access to information solely for corporate pur-

poses. See SEC v. Monarch Fund, 608 F.2d 938, 942

(CA2 1979); In re Investors Management Co., 44 S.

E. C. 633, 645 (1971); Jn re Van Alysine, Noel & Co.,

Vite

s ‘ ” i

ad See we ee a Pe a

20a

43 S. E. C. 1080, 1084-1085 (1969); In re Merrill

Lynch, Pierce, Fenner & Smith, Inc., 43 S. E. C.

933, 937 (1968); Cady, Roberts, 40 S. E. C., at

912. . . . For such a duty to be imposed, however,

the corporation must expect the outsider to keep the

disclosed nonpublic information confidential, and

the relationship at least must imply such a duty.

Id. at 5125 n.14 (emphasis added).

The defendants in this case—Courtois and his tippees

Antoniu and Newman—owed no duty of disclosure to

Moss. In working for Morgan Stanley, neither Courtois

nor Newman was a traditional ‘corporate insider,’’ and

neither had received any confidential information from

the target Deseret. Instead, like Chiarella and Dirks, the

defendants were ‘‘complete stranger[s] who dealt with the

sellers [of Deseret stock] only through impersonal market

transactions.”’ Chiarella v. United States, 445 U.S. at

232-33.

Since Moss failed to demonstrate that he was owed a

duty by any defendant, he has failed to state a claim for

damages under section 10(b) or rule 10b-5.

D. ‘‘Misappropriation’’ Theory of Disclosure

In addition to arguing that he satisfied the Chiarella

‘*duty to disclose’’ standard, Moss alternatively argues

that the district court misread Chiarella. He contends that

Chiarella establishes only that ‘‘a duty to disclose under

§ 10(b) does not arise from the mere possession of non-

public market information.’’ 445 U.S. at 235. Moss urges

us to recognize an exception to Chiareila and allow a

section 10(b) cause of action against any person. who

trades on the basis of nonpublic ‘‘misappropriated’’ in-

formation.

2la

Both Moss and the SEC premise their ‘‘misappropria-

tion’’ theory on Justice Burger’s dissent in Chiarella:

I would read § 10(b) and Rule 10b-5 to encompass

and build on this principle: to mean that a person

who has misappropriated nonpublic information has

an absolute duty to disclose that information or to

refrain from trading.

Id. at 240; see id. at 239 (Brennan, J., concurring) (‘‘a

person violates § 10(b) whenever he improperly obtains or

converts to his own benefit rionpublic information which

he then uses in connection with the purchase or sale of

securities’’). In essence, Moss’ theory is that any person

who ‘‘misappropriates’’ information owes a general duty

of disclosure to the entire marketplace. He asserts that

this Court’s recognition of the ‘‘misappropriation

theory’”’ is necessary to effectuate the remedial purposes

of the securities laws. See generally Herman & MacLean

v. Huddleston, 51 U.S.L.W. 4099, 4101 (U.S. Jan. 24,

1983).

While we agree that the general purpose of the securi-

ties laws is to protect investors, the creation of a new

species of ‘‘fraud’’ under section 10(b) would ‘‘depart[]

radically from the established doctrine that duty arises

from a specific relationship between two parties .. .

{and] should not be undertaken absent some explicit

evidence of congressional intent.’’ Chiarella v. United

States, 445 U.S. at 233. In speaking of the origins of the

concept of ‘‘fraud’’ as embodied in the federal securities

laws, the Supreme Court in Chiarella stated that:

At common law, misrepresentation made for the

purpose of inducing reliance upon the false statement

is fraudulent. But one who fails to disclose material

information prior to the consummation of a trans-

22a

action commits fraud only when he is under a duty to

do so.

Id. at 227-28 (emphasis added).

In effect, plaintiff’s ‘‘misappropriation’’ theory would ,

grant him a windfall recovery simply to discourage tor-

tious conduct by securities purchasers. Yet, the Supreme

Court has made clear that section 10(b) and rule 10b-5

protect investors against fraud; they do not remedy every

instance of undesirable conduct involving securities. /d.

at 232; Santa Fe Industries, Inc. v. Green, 430 U.S. 462,

474-77 (1977). As defendants owed no duty of disclosure

to plaintiff Moss, they committed no ‘‘fraud’’ in purchas-

ing shares of Deseret stock.

Moreover, the Court has refused to recognize ‘‘a

general duty between all participants in market trans-

‘actions to forgo actions based on material, nonpublic

information.’’ Chiarella v. United States, 445 U.S. at

233. Rather, in Chiarella the Court stated that:

[NJeither the Congress nor the Commission ever has

adopted a parity-of-information rule... .

. . . We hold that a duty to disclose under § 10(b)

does not arise from the mere possession of nonpublic

market information. The contrary result is without

support in the legislative history of § 10(b) land

would be inconsistent with the careful plan that

Congress has enacted for regulation of the securities

niarkets. Cf. Santa Fe Industries, Inc. v. Green, 430

U.S. at 479.

Id. at 233, 235 (emphasis added) (footnotes omitted). We

find that plaintiff’s ‘‘misappropriation’’ theory clearly

contradicts the Supreme Court’s holding in both

23a

Chiarella and Dirks and therefore conclude that the

complaint fails to state a valid section 10(b) or rule 10b-5

cause of action.

II. Morgan Stanley’s Derivative Liability

Plaintiff claims that pursuant to section 20(a) of the

Securities Exchange Act of 1934, 15 U.S.C. § 78t(a)

(1976), Morgan Stanley is a ‘‘controlling person’’ who

should be found derivatively liable for the unlawful

securities violations committed by its employees. Section

20(a) provides:

(a) Every person who, directly or indirectly, con-

trols any person liable under aay provision of this

chapter or of any rule or regulation thereunder shall

also be liable jointly and severally with and to the

same extent as such controlled person to any person

to whom such controlled person is liable, unless the

controlling person acted in good faith and did not

directly or indirectly induce the act or acts constitut-

ing the violation or cause of action.

15 U.S.C. § 78t(a) (1976). In considering this claim the

district court noted initially that ‘‘{a]s the claims against

the individuals have been dismissed, Morgan Stanley

cannot be derivatively liable.’’ 553 F.Supp. at 1356. We

agree. Because the section 20(a) claim was correctly dis-

missed on this threshold ground, we need not review the

case law defining section 20(a) derivative liability.

Ill. RICO

A. Introduction

In Count II of the amended complaint, plaintiff Moss

alleged that defendant Newman’s unlawful purchase and ~

24a

sale of Deseret stock constituted a violation of RICO, 18

U.S.C. § 1962(c) (1976), thereby subjecting him to civil

liability under 18 U.S.C. § 1964(c) (1976). The district

court dismissed plaintiff’s RICO claim on the grounds

that the complaint failed to include several allegations

‘*essential’’ to pleading a RICO claim. We affirm the

district court’s dismissal of the RICO count, but do not

endorse the court’s reasons for doing so.'”

B. Threshold Defect in the Complaint

To state a claim for damages under RICO a plaintiff

has two pleading burdens. First, he must allege that the

defendant has violated the substantive RICO statute, 18

U.S.C. § 1962 (1976), commonly known as ‘‘criminal

RICO.”’ In so doing, he must allege the existence of seven

constituent elements: (1) that the defendant (2) through

the commission of two or more acts (3) constituting a

**pattern’’ (4) of ‘‘racketeering activity’’ (5) directly or

indirectly invests in, Or maintains an interest in, or par-

ticipates in (6) an ‘‘enterprise’’ (7) the activities of which

affect interstate or foreign commerce. 18 U.S.C.

§ 1962(a)-(c) (1976). Plaintiff must allege adequately de-

fendant’s violation of section 1962 before turning to the

second burden—i.e., invoking RICO’s civil remedies of

treble damages, attorneys fees and costs. See Bays v.

Hunter Savings Association, 539 F.Supp. 1020, 1023

(S.D. Ohio 1982). To satisfy this latter burden, plaintiff

must allege that he was ‘“‘injured in his business or

lu We recognize that in attempting to delineate the scope of “civil”

RICO, the district court did not have the benefit of our decisions in

United States v. Mazzei, 700 F.2d 85 (2d Cir. 1983), cert. denied, 51

U.S.L.W. 1841 (U.S. May 23, 1983), United States v. Ivic, 700 F.2d 51

(2d Cir. 1983), and United States v. Bagaric, 706 F.2d 42 (2d Cir. 1983),

as well as the Seventh Circuit's well-reasoned decision in Schact v.

Brown, Docket No. 82-2088, slip op. (7th Cir. Apr. 8, 1983).

25a

property by reason of a violation of section 1962.’’ 18

U.S.C. § 1964(c) (1976) (emphasis added). Moss’ com-

plaint fails to carry either pleading burden.

Section 1962

Plaintiff's complaint fails to allege one of the elements

needed to state a violation of section 1962—that defen-

dant Newman engaged in ‘‘racketeering activity.’’ Section

1961(5) defines ‘‘pattern of racketeering activity’’ as at

least two acts of ‘‘racketeering activity’’ occurring within

ten years of each other. 18 U.S.C. §1961(5) (1976).'' In

turn, section 1961(1)(D) defines ‘‘racketeering activity’’

to include ‘‘any offense involving fraud . . . in the sale

of securities.’’ 18 U.S.C. § 1961(1)(D) (Supp. III 1979),"

i" (5) “pattern of racketeering activity” requires at least two acts of

racketeering activity, one of which occurred after the effective date

of this chapter [October 15, 1970] and the last of which occurred

within ten years (excluding any period of imprisonment) after the

commission of a prior act of racketeering activity.

18 U.S.C. § 1961(5) (1976).

2 (1) “Racketeering activity” means (A) any act or threat involving

murder, kidnaping, gambling, arson, robbery, bribery, extortion, or

dealing in narcotic or other dangerous drugs, which is chargeable

under State law and punishable by imprisonment for more than one

year; (B) any act which is indictable under any of the following

provisions of title 18, United States Code: Section 201 (relating to

bribery), section 224 (relating to sports bribery), sections 471, 472,

and 473 (relating to counterfeiting), section 659 (relating to theft

from interstate shipment) if the act indictable under section 659 is

felonious, section 664 (relating to embezzlement from pension and

welfare funds), sections 891-894 (relating to extortionate credit

transactions), section 1084 (relating to the transmission of gambling

information), section 1341 (relating to mail fraud), section 1343

(relating to wire fraud), section 1503 (relating to obstruction of

justice), section 1510 (relating to obstruction of investiga-

tions), section 1511 (relating to the obstruction of or local law

enforcement), section 1951 (relating to interference with commerce,

robbery, or extortion), section 1952 (relating to racketeering), sec-

tion 1953 (relating to interstate transportion of wagering

paraphernalia), section 1954 (relating to unlawful welfare fund

Plaintiff sought to satisfy both the ‘‘pattern’’ and ‘‘rack-

eteering’’ clements of RICO by alleging that ‘‘[d]e-

fendants’ actions as set forth herein in this Complaint

constitute at least two acts of fraud in connection with the

purchase and sale of securities and as such represent a

pattern of racketeering activity within the meaning of

RICO.”’ J. App. at 11. Thus, the complaint clearly relies

on Newman's allegedly ‘‘fraudulent’’ securities trans-

actions with respect to Deseret stock as the predicate acts

of ‘‘racketeering’’ that form the “‘pattern’’ underpinning

plaintiff's RICO claim. Such allegations of fraud would

ordinarily satisfy RICO’s ‘‘racketeering activity’’ plead-

ing prerequisite."’

payments), section 1955 (relating to the prohibition of illegal

gambling businesses), sections 2314 and 2315 (relating to interstate

transportation of stolen property), sections 2341-2346 (relating to

trafficking in contraband cigarettes), sections 2421-24 (relating to

white slave traffic), (C) any aci which is indictable under title 29,

United States Code, section 186 (dealing with restrictions on pay-

ments and loans to labor organizations) or section SOi(c) (relating

to embezzlement from union funds), or (D) any offense involving

fraud connected with a case under title 11, fraud in the sale of

securities, or the felonious manufacture, importation, receiving,

concealment, buying, selling, or otherwise dealing in narcotic or

other dangerous drugs, punishable under any law of the United

States.

18 U.S.C. § 1961(1)(D) (Supp. II 1979) (emphasis added).

3 Although the district court's opinion voices an extreme reluctance to

extend RICO’'s civil remedies to garden variety securities fraud claims,

see $53 F.Supp. at 1361, a number of courts have entertained both civil

and criminal RICO claims premised on common law fraud and

“ordinary” securities fraud violations. For civil cases see, ¢.g.,

USACO Coal Co. v. Carbomin Energy, Inc., 689 F.2d 94, 95-96 (6th

Cir. 1982); Mauriber v. Shearson/American Express, Inc., 546 F.Supp.

391, 395-96 (S.D.N.Y. 1982); Harper v. New Japan Securities Int'l, 545

F.Supp. 1002, 1003 (C.D. Cal. 1982); Maryville Academy v. Loeb

Rhoades & Co., $30 F.Supp. 1061, 1064-65 (N.D. Ill. 1981); Engi v.

Berg, 511 F.Supp. 1146, 1154 (B.D. Pa. 1981); Landmark Savings &

Loan v. Loeb Rhoades, Hornblower & Co., $27 F.Supp. 206 (E.D.

Mich, 1981); United States v. DePalma, 461 F.Supp. 778, 785

(S.D.N.Y. 1978); Farmers Bank v. Bell Mortgage Corp., 482 F.Supp.

27a

However, in section | of this opinion, we held that

plaintiff Moss’ pleadings had failed as a matter of law to

state a claim that Newman had defrauded him in viola-

tion of section 10(b) and rule 10b-5. In affirming the

district court’s grant of Newman’s 12(b)(6) motion to

dismiss, we dismissed plaintiff’s claim of “securities

fraud” from the complaint. In addition, the district

court’s dismissal of plaintiff’s section 14(e), rule 14(e)-3

and common law fraud claims was never appealed.

Therefore, since the complaint contains no valid allega-

tion of “fraud,”"* to underpin the “predicate acts” of

“racketeering,” it necessarily must fail.

With respect to the sufficiency of the “racketeering”

allegations, the district court’s decision in Mauriber v.

Shearson/American Express, Inc., 546 F.Supp. 391

(S.D.N.Y. 1982), is instructive. There the plaintiff alleged

that defendant’s mismanagement of a discretionary bro-

kerage account violated section 10(b) of the Securities

Exchange Act of 1934, 15 U.S.C. § 78j(b) (1976), and

RICO, 18 U.S.C. § 1962(c) (1976). In response to defen-

dant’s Rule 12(b)(6) motion the district court found that

1278, 1279 (D. Del. 1978); for criminal cases see, ¢.g., United States v.

Weisman, 624 F.2d 1118, 1124 (2d Cir.), cert. denied, 449 U.S. 871

(1980); United States v. Pray, 452 F.Supp. 788, 793 (M.D. Pa. 1978).

14 Although RICO provides that “fraud in the sale of securities” may

constitute “racketeering activity,” it supplies neither a definition of

“fraud” nor a reference to other federal laws contemplated in drafting

this “predicate offense.”

The district court did not define “RICO fraud” when it dismissed

plaintiff's complaint. Similarly, we need not decide this complex and

far-reaching question. Following the district court's rejection of plain-

tiffs 14(e) and common law fraud claims, we put to rest any lingering

existence of “fraud” in the instant complaint by rejecting piaintitf’s

section 10(b) and rule 10b-5 claims. Therefore, as neither common law

fraud nor traditional securities fraud underpins plaintiff's RICO

claim, we need not delineate RICO’s definition of “fraud in the sale of

securities.”

v- % o} =

_—e ri i? Wy al

28a

plaintiff had failed to state its section 10(b) fraud claim

with sufficient particularity to meet the pleading require-

ments of Fed. R. Civ. P 9(b). The court further con-

cluded that:

[T]he RICO claim must fail for reasons not advanced

by defendants. In Count II, the complaint alleges a

violation of RICO by vaguely referring back to all of

the preceding paragraphs that constitute the Section

10(b) violation. As earlier stated, the securities fraud

allegations fail in numerous respects to comply with

the specificity requirements of Fed. R. Civ. P. 9(b).

Until such time as plaintiff adequately pleads fraud it

will not be known whether a RICO violation is

properly alleged. As a result, Count II of the com-

plaint is dismissed with leave to replead within 20

days of the date hereof.

Id. at 397 (emphasis added); accord Maryville Academy

v. Loeb Rhoades & Co., 530 F.Supp. 1061, 1070 (N.D.

Ill. 1981) (Court notes that “filing the lawsuits is not

fraud in connection with a securities transaction; thus the

filings are not within the scope of racketeering activity

under the RICO statute.”); see also Van Schaick v.

Church of Scientology, 535 F.Supp. 1125, 1138 (D. Mass.

1982).

The instant complaint suffers from a defect more

fundamental than that found in Mauriber. As plaintiff

has failed to state a valid claim that defendant Newman’s

securities transactions were “fraudulent” violations of

section 10(b) or rule 10b-5, we cannot now conclude that

such acts represent “racketeering activity” sufficient to

support his RICO cause of action. Rather, since our

dismissal of the securities fraud claim so undercut the

existence of any “racketeering activity” in the com-

+",

"Ade

J Be in as ee

29a

plaint,'* we affirm the district court’s dismissal of plain-

tiff’s RICO claim.

In speaking of plaintiff's RICO claim, the district court apparently

believed that “(plaintiff rests his argument that Newman is liable in

treble damages for a violation of RICO on the mere fact that Newman

has been convicted of violating some of the statutes listed in Section

1961.” 553 F.Supp. at 1363 (emphasis added). Conceivably, Newman’s

prior convictions for mail fraud, as well as securities fraud (both

enumerated as racketeering activities within 18 U.S.C. § 1961(1)),

could provide the proof of the predicate acts of “racketeering” that is

presently absent from the complaint.

Although the courts have noted that prior convictions for alleged

predicate offenses are not preconditions to bringing a RICO civil suit,

see, e.g., USACO Coal Co. v. Carbomin Energy, Inc., 689 F.2d 94, 95

n.1 (6th Cir. 1982); United States v. Malatesta, 583 F.2d 748, 757

(1978), aff'd on rehearing, 590 F.2d 1379 (Sth Cir.), cert. denied, 444

U.S. 846 (1979); Glusband v. Benjamin, 530 F.Supp. 240, 241

(S.D.N.Y. 1981); see also State Farm Fire and Casualty Co. v. Estate

of Caton, 540 F.Supp. 673, 675 (N.D. Ind. 1982); Heinold Commodi-

ties, Inc. v. McCarty, $13 F.Supp. 311, 313-14 (N.D. Ill. 1979); Parnes

v. Heinold Commodities, Inc., 487 F.Supp. 645, 647 (N.D. Ill. 1980);

Farmers Bank v. Bell Mortgage Corp., 452 F.Supp. 1278, 1280 (D.

Del. 1978); but see Kleiner v. First National Bank, 526 F.Supp. 1019,

1022 n.2 (N.D. Ga. 1981) (“It may well be that entitlement to the civil

remedy of section 1964 should be conditioned upon a criminal convic-

tion or at least an indictment.”), a growing number of courts have

recognized that a prior criminal conviction on the alleged predicate

offense may exert a collateral estoppel effect on the issue of “rack-

- eteering activity” in pleading a “civil RICO” claim. See Municipality

of Anchorage v. Hitachi Cable, Lid., $47 F.Supp. 633, 644 (D. Ala.

1982) (“Under traditional theories of collateral estoppel, Hitachi's

pleas of guilty to the mail and wire fraud counts estop it from denying

that it engaged in a pattern of racketeering activity. . . .”); Anderson

v. Janovich, 543 F.Supp. 1124, 1127-32 (W.D. Wash. 1982); State Farm

Fire and Casualty Co. v. Estate of Caton, $40 F.Supp. at 682-83; but

see United States v. Malatesta, 583 F.2d at 757 (“Because the United

States was not a party in the state proceedings, it is not collaterally

estopped from proving in the federal prosecutions [RICO] facts that

the state was unable to prove.”). See generaily, Tarlow, RICO: The

New Darling of the Prosecutor’s Nursery, 49 Fordham L. Rev. 165,

266-67 (1980).

However, we need not examine the collateral estoppel effect of

Newman's criminal conviction in this case. Plaintiff's complaint never

mentioned the existerice of Newman's prior criminal conviction, let

alone presented it as proof of “racketeering activities” sufficient to

support the RICO claim.

30a

C. District Court Dismissal of RICO

We now turn to the remaining rationales offered by the

district court to support its dismissal of plaintiff’s RICO

claim. The district court dismissed the RICO claim on the

grounds that plaintiff had failed to allege several elements

essential to pleading such a claim. Most notably, the court

found that the complaint failed to allege (1) the existence

of an “enterprise” and that this “enterprise” was

economically independent from defendants’ “pattern of

racketeering activity,”'® and (2) that the “enterprise,” or

16 The district court also required plaintiff to plead a third allegation:

plaintiff’s injury to be cognizable under RICO must be caused by a

RICO violation and not simply by the commission of a predicate

offense. . . . RICO’s civil remedy provision permits a recovery to

“any person injured in his business or property by reason of a

violation of Section 1962,” . . . that is, where the distinctive RICO

violation contributed to plaintiff's injury, i.e., where the plaintiff

suffered directly a racketeering enterprise injury at the hands of

those sought to be reached by the Organized Crime Control Act of

1970.

$53 F.Supp. at 1361.

In so stating, the district court joined a growing number of courts

that have limited standing under 18 U.S.C. § 1964(c) to those “plain-

tiffs alleging something more, or different, than direct injury resulting

from the predicate acts that constitute the racketeering activity. In-

stead, a plaintiff must allege a commercial or ‘racketeering enterprise’

injury.” Johnsen v. Rogers, 551 F.Supp. 281, 284-85 (C.D. Cal. 1982)

(footnote omitted); see Cenco, Inc. v. Seidman & Seidman, 686 F.2d

449, 457 (7th Cir.), cert. denied, 51 U.S.L.W. 3258 (U.S. Oct. 4, 1982);

North Barrington Development, Inc. v. Fanslow, 547 F.Supp. 207, 211

(N.D. Ill. 1980) (“plaintiff must allege how it was injured competi-

tively by the RICO violation in order to state a cause of action under

§ 1964(c).”); Harper v. New Japan Securities Int'l, 545 F.Supp. 1002,

1007 (C.D. Cal. 1982); Van Schaick v. Church of Scientology, 535

F.Supp. 1125, 1137 (D. Mass. 1982); Landmark Savings & Loan v.

Loeb Rhoades, Hornblower & Co., 527 F. Supp. 206, 208 (E:D. Mich.

1981); see also Commer, Reading the “Enterprise” Element Back into

RICO: Sections 1962 and 1964(c), 76 Nw. U.L. Rev. 100, 125-33

(1981). But see Bennett v. Berg, 685 F.2d 1053, 1059 (8th Cir.),

rehearing en banc denied in part and granted in part (Sept. 16, 1982);

D’lorio v. Adonizio, 554 F.Supp. 222, 231 (M.D. Pa. 1982); Hellenic

Lines Lid. v. O'Hearn, 523 F.Supp. 244, 248 (S.D.N.Y. 1981); see also

3la

any of the defendants, had a tie to “organized crime.” We

do not agree with the district court’s assessment that these

omissions required dismissal of the complaint.

1. Civil RICO

The district court’s opinion is replete with expressions

of concern about the broad scope of civil RICO. The

court began its analysis by noting that “[t]he Racketeer

Influenced and Corrupt Organizations Act, part of the

Organized Crime Control Act of 1970, was designed in a

multifaceted campaign against the pervasive presence of

organized crime infiltrated in American business and

trade,” 553 F.Supp. at 1359, and then cautioned that

“(t]he statutory language and recent Supreme Court and

Second Circuit precedent, if carefully applied, can be

extraordinarily effective in limiting RICO to its intended

scope and filtering out many RICO claims that are just

efforts to claim treble damages for ordinary violations of

criminal or tort laws.” Jd. at 1360. The court continued,

“[t]he sweep of the statute does not embrace ordinary

violators charged in common law fraud actions or federal

securities law violations as the predicate offenses for

RICO relief,” id. at 1361, and finally concluded that

“there is nothing in the legislative history to suggest that

Congress intended to create a private right of action for

Blakey & Gettings, Racketeer Influenced and Corrupt Organizations

(RICO); Basic Concepts—Criminal and Civil Remedies, 53 Temple

L.Q. 1009, 1040-43 (1980); Strafer, Massumi & Skoinick, Civil RICO

in the Public Interest: “Everybody's Darling,” 19 Am. Crim. L. Rev.

655, 689-707 (1982).

The district court subscribed to this interpretation of section 1964(c),

but never explained its understanding of a racketeering enterprise

injury. We need not decide whether such an interpretation is proper

because we find that plaintiff has not satisfied the threshold burden of

showing that he suffered any injury “by reason of” defendants’

unlawful conduct.

32a

treble damages. for violations of substantive statutes by

ordinary business or parties.” /d. at 1361.

We sympathize with the district court’s concerns. How-

ever, it is not the “[judiciary’s] role to reassess the costs

and benefits associated with the creation of a dramati-

cally expansive ... tool for combating organized

crime.” Schact v. Brown, slip op. at 36 (citing United

States v. Turkette, 452 U.S. at 586-87). In this regard we

agree with the author of the Note, Civil RICO: The

Temptation and Impropriety of Judicial Restriction, 95

Harv. L. Rev. 1101, 1120-21 (1982):

Courts should not be left to impose liability based

on their own tacit determination of which defendants

are affiliated with organized crime. Nor should they

create standing requirements that would preclude

liability in many situations in which legislative intent

would compel it. Complaints that RICO may effec-

tively federalize common law fraud and erode recent

restrictions on claims for securities fraud are better

addressed to Congress than to courts.

Although we appreciate the concerns motivating the dis-

trict court to limit RICO’s scope, we believe that the

court misinterpreted the elements essential to pleading a

RICO cause of action.

2. Organized Crime

The district court stated that “application of RICO

should be restricted sharply to organized crime and the

enterprises on which its talons have fastened. Thus,

; courts in the Southern District and elsewhere have held

. that RICO claims for damages could be maintained only

if there was a tie to organized crime.” 553 F.Supp. at 1361

| (citing Noonan v. Granville-Smith, 537 F.Supp. 23, 29

“= 4 we - " ok &

ae! lee! OW PEL Pe —- ie 2, dle weed! od Gi

33a

(S.D.N.Y. 1981); Barr v. WUI/TAS, Inc., 66 F.R.D. 109,

112-13 (S.D.N.Y. 1975); and Waterman Steamship Corp.

v. Avondale Shipyards, Inc., 527 F.Supp. 256, 260 (E.D.

La. 1981)); accord Wagner v. Bear, Stearns & Co., [cur-

rent] Fed. Sec. L. Rep. (CCH) ¢ 99,032 (N.D. Ill. 1982);

City of Atlanta v. Ashland-Warren, Inc., 1982-1 Trade

Cas. (CCH) ¢ 64,527 (N.D. Ga. 1982).

It is true that RICO’s legislative history states that it

was enacted to provide “enhanced sanctions and new

remedies to deal with the unlawful activities of those

engaged in organized crime.” Organized Crime Control

Act of 1970, Pub. L. No. 91-452, 84 Stat. 922, reprinted

in 1970 U.S. Code Cong. & Ad. News 1073; see United

States v. Ivic, 700 F.2d 51, 62 (2d Cir. 1983). The

language of the statute, however, does not premise a

RICO violation on proof or allegations of any connection

with organized crime."

3. The “Enterprise” Element

The district court recognized that section 1962(c) re-

quires plaintiffs to plead that an “enterprise” exists and

that “there must be some nexus between the pattern of

7 Similarly, the Act's legislative history supports a rejection of this

“organized crime” element. During the House debates on RICO,

Congressman Biaggi proposed an amendment that sought to limit the

application of RICO to Mafia and La Cosa Nostra organizations. 116

Cong. Rec. 35,343 (1970). The amendment was vigorously attacked on

constitutional grounds. Congressman Celler objected that such terms

were “imprecise, uncertain, and unclear” and that mere membership in

an organization should not be punished. /d. at 35,343-44 (1970).

Congressman Poff (the bill's sponsor in the House) objected that such

an amendment might violate the Supreme Court's rulings that struck

down statutes which created status offenses, such as Scales v. United

States, 367 U.S. 203 (1961), and Robinson v. California, 370 U.S. 660

(1962). 116 Cong. Rec. 35,344 (1970). Congress rejected the amend-

ment. 116 Cong. Rec. 35,346 (1970); see Cornell Institute on Or-

ganized Crime, Techniques in the Investigation and Prosecution of

Organized Crime 59-105 (G.R. Blakey ed. 1980).

34a

racketeering activity and the enterprise.” 553 F.Supp. at

1363. We agree. Section 1962(c) states: “It shall be unlaw-

ful for any person employed by or associated with any

enterprise . . . to conduct or participate, directly or

indirectly, in the conduct of such enterprise’s affairs

through a pattern of racketeering activity... .” 18

U.S.C. § 1962(c) (1976). “Enterprise” is defined as “any

individual, partnership, corporation, association, or

other legal entity, and any union or group of individuals

associated in fact although not a legal entity.” 18 U.S.C.

§ 1961(4) (1976); see United States v. Turkette, 452 U.S.

576, 581-82 (1981).

Yet, in addition to requiring plaintiff to plead the

existence of this “enterprise,” the district court required

him to allege facts showing that the “enterprise” had an

“independent economic significance from the pattern of

racketeering activity.” 553 F.Supp. at 1363. The district

court concluded that because Morgan Stanley’s and New-

man’s alleged “pattern of activity [was] identical to the

enterprise . . . the plaintiff completely fails to make out

this element [enterprise] of a RICO claim.” /d. This

conclusion cannot stand in light of our recent decisions in

United States v. Mazzei, 700 F.2d 85 (2d Cir. 1983), cert.

denied, 51 U.S.L.W. 3841 (U.S. May 23, 1983), and

United States v. Bagaric, 706 F.2d 42 (2d Cir. 1983).

In United States v. Mazzei we expressly rejected the

Eighth Circuit’s view that the evidence offered to prove

the “enterprise” and “pattern of racketeering” must nec-

essarily be distinct. /d. at 89-90; see Bennett v. Berg, 685

F.2d at 1060; United States v. Anderson, 526 F.2d 1358,

1372 (8th Cir. 1980) (enterprise “to encompass only an

association having an ascertainable structure which exists

for the purpose of maintaining operations directed to-

ward an economic goal that has an existence that can be

35a

defined apart from the commission of the predicate acts

constituting the ‘pattern of racketeering activity.’ ”), cert.

denied, 450 U.S. 912 (1981). Instead, we relied on the

Supreme Court’s decision in Turkette that “proof used to

establish the ‘pattern of racketeering activity’ element

‘may in particular cases coalesce’ with the proof offered

to establish the ‘enterprise’ element of RICO.” United

States v. Mazzei, 700 F.2d at 89 (quoting United States v.

Turkette, 452 U.S. at 583); see United States v. Bagaric,

706 F.2d at 55. In Mazzei a group of individuals—bettors

and Boston College basketball players—conspired ille-

gally to shave points in Boston College basketball games

in order to maximize their gambling proceeds. The “en-

terprise” consisted of the Boston College conspirators

functioning as a “continuing unit, /.e., during the 1978-79

B.C. basketball season” and the “pattern of racketeering

activity” consisted of “ ‘fixing’ nine B.C. basketball

games.” 700 F.2d at 89. We upheld the propriety of

Mazzei’s RICO conviction even though the proof offered

to establish the existence of these two elements had

“coalesced.” Id.; see United States v. Bagaric, 706 F.2d at

55 (“We have upheld application of RICO to situations

where the enterprise was, in effect, no more than the sum

of the predicate racketeering acts.”).

In this case the “enterprise” allegedly consisted of

Courtois’ use of his position at Morgan Stanley to obtain

confidential information about imminent tender offers;

Antoniu’s transmission of tender offer information to

Newman; and Newman’s use of his brokerage abilities to

purchase the “target’s” stock. The criminal indictment of

these individuals reported that their tender offer “en-

terprise” existed for approximately two years. J. App. at

60-62. As previously mentioned, the “pattern of rack-

eteering activity” consisted of Newman’s purchase and

: i

i a

36a

sale of Deseret stock on the basis of the confidential

information about the imminent tender offer. We can see

no logical or practical basis upon which to distinguish

between the enterprise/racketeering relationship of the

illegal gamblers in Mazzei and the enterprise/racketeering

relationship of the securities “schemers” in this case. See

also United States v. Errico, 635 F.2d 152, 156 (2d Cir.

1980) (a network of jockeys and bettors, who joined

together for the single illegal purpose of betting on

“fixed” horseraces, constituted an “enterprise” for the

purposes of RICO), cert. denied, 453 U.S. 911 (1981). We

find that under the standard articulated in Mazzei, the

district court erred in its characterization of RICO’s

“enterprise” and “pattern of racketeering activity” ele-

ments.

Summary

We affirm the district court’s dismissal of plaintiff’s

complaint on the grounds that (1) under Chiarella and

Dirks plaintiff’s inability to show that any defendant

owed him a duty of disclosure precluded a violation of

section 10(b) or rule 10b-5; (2) as the individual defen-

dants were not held liable for violating the federal securi-

ties laws, Morgan Stanley could not be held derivatively

liable under section 20(a) of the 1934 Act; (3) because

plaintiff failed to state a claim under section 10(b) of the

1934 Act that defendant Newman committed fraud in the

sale of securities, the RICO claim—which premises its

“pattern of racketeering activity” on the alleged securities

fraud—must likewise fail; and (4) since plaintiff failed to

allege that his injury was causally connected to defen-

dant’s “unlawful” conduct, his civil RICO claim must be

dismissed.

Affirmed.

37a

UNITED STATES DISTRICT COURT,

S.D. NEW YORK

Jan. 10, 1988

No. 82 Civ. 5182(MP)

MICHAEL E. Moss, Plaintiff,

Vv.

MorGAN STANLEY INc., E. Jacques

Courtois, Jr., Adrian Antoniu, and

James M. Newman, Defendants.

Target corporation shareholder brought action for damages

under securities laws and Racketeer Influenced and Corrupt

Organizations Act in connection with disclosure of information

pertaining to tender offeror’s plan to acquire target corpora-

tion’s stock by employee of investment banker. On motions to

dismiss and for summary judgment, the District Court, Milton

Pollack, J., held that: (1) none of defendants owed plaintiff duty

of disclosure or abstention as required for plaintiff to claim

damages under section of Securities Exchange Act prohibiting

use of manipulative and deceptive devices in the sale of secur-

ities; (2) rule adopted by Securities and Exchange Commission

establishing “disclose or abstain from trading” rule under Wil-

liams Act should not be given retroactive effect; (3) acts of

investment banker’s employee for which plaintiff sought to

impose liability on investment banker were not of same general

nature or similar to authorized conduct so as to impose deriva-

tive liability upon investment banker even if acts were unau-

thorized; (4) no prima facie case of control could be made out

under section of Securities Exchange Act providing for liabil-

ity of controlling persons for acts of controlled parties under

certain circumstances; (5) investment banker could not be held

liable as aider and abettor of defendants; and (6) allegations of

violation of RICO failed to state claims.

Judgment accordingly.

thie, Lda Phat NS iad a

38a

OPINION

MILTON POLLACK, District Judge.

Plaintiff Moss, who seeks to represent the class of all those

who sold shares of Deseret Pharmaceutical Company stock on

November 30, 1976, brings this suit for damages against New-

man, Courtois and Antoniu and Morgan Staniey in the wake of

Newman’s conviction for securities fraud and mail fraud in

connection with a tender offer made for Deseret stock. Moss

asserts claims against Newman, Courtois and Antoniu based

on Sections 10(b) and 14(e) of the Securities Exchange Act of

1934 and the Rules promulgated thereunder, Rule 10b-5 and

Rule 14e-3. In addition, Moss claims that Morgan Stanley is

derivatively liable for these Securities Act violations. Moss

also asserts pendent state law claims of fraud and claims that

Morgan Stanley is liable under the doctrine of respondeat

superior. Finally, Moss asserts that all of the defendants,

including Morgan Stanley have violated the Racketeer In-

fluenced and Corrupt Organizations Act, 18 U.S.C. § 1961, et

seq., and that they are therefore liable for treble damages.

Defendant Newman has moved to dismiss the complaint for

failure to state a claim on which relief can be granted pursuant

to Rule 12(b)(6) of the Federal Rules of Civil Procedure, and

Morgan Stanley has moved to dismiss the complaint under

Rule 12(b)(6) and for summary judgment under Rule 56(b) and

for attorneys’ fees and costs pursuant to Rule 11. For the

reasons appearing hereafter, the motions to dismiss the

amended complaint will be granted.

Summary Of Events

In December 1976, Warner Lambert Company made a cash

tender offer for Deseret Pharmaceuticals Company. On or

about November 23, 1976, Warner engaged the services of

Morgan Stanley, in its capacity as as investment banker, to

advise and assist Warner in its effort to acquire control of

Deseret. Morgan Stanley was to investigate Deseret, evaluate

its stock and recommend a price for Warner to offer Deseret

39a

shareholders in a tender offer. The defendant, E. Jacques

Courtois, Jr., was employed by Morgan Stanley in its Merger

and Acquisition Department. In that capacity, Courtois

obtained knowledge of Warner’s plan.

On or about November 30, 1976, Courtois disclosed to de-

fendant Adrian Antoniu the information pertaining to War-

ner’s plan to acquire Deseret stock. Antoniu was at the time an

employee of Kuhn Loeb & Co., another broker-dealer and

investment banker. Antoniu then disclosed the non-public in-

formation about the planned Warner offering to defendant

James M. Newman, a stockbroker. The latter advised certain

of his customers to buy Deseret stock in anticipation of War-

ner’s tender offer, and purchased Deseret stock for his own

account and others at prices substantially below the price

which Warner offered to Deseret stockholders shortly there-

after.

As a result of these activities, Newman was tried and con-

victed on 15 counts of fraud. Antoniu pleaded guilty. Courtois

was indicted but has not yet been tried as he is presently

believed to be living in South America.

Section 10(b) Claim.

A plaintiff claiming damages under Section 10(b) must estab-

lish the existence of a special relationship by the defendant

with an insider or the plaintiff. Absent this, nondisclosure of

nonpublic market information is not actionable. “The essential

purpose of Rule 10b-5. . . is to prevent corporate insiders and

their tippees from taking unfair advantage of the uninformed

outsiders.” Shapiro v. Merrill Lynch, Pierce, Fenner &

Smith, Inc., 495 F.2d 228, 235 (2d Cir. 1974), quoting Radia-

tion Dynamics, Inc. v. Goldmuntz, 464 F.2d 876, 890 (2d Cir.

1974). Thus, as stated in F rigitemp Corp. v. Financial Dyna-

mics Fund, 524 F.2d 275, 282 (2d Cir. 1975), “the party

charged with failing to disclose market information must be

under a duty to disclose it to the plaintiff.”

In this case, none of the defendants owed plaintiff a duty of

disclosure or abstention. None of the defendants had any tie to

40a

the issuer, Deseret, in whose stock they traded. As Morgan

Stanley was not employed by Deseret but by Warner, neither

Morgan Stanley nor its employees were insiders of Deseret.

Thus, Newman, even if he is viewed as standing in the shoes of

the Morgan Stanley employee, Courtois, when he traded, pur-

chased stock on the basis of information that was obtained from

a source outside the issuer. While the information that led to

the purchase was nonpublic, it was outside not inside informa-

tion.

The argument that defendants did not owe the requisite

duty to the plaintiff is based on Chiarella v. United States, 445

U.S. 222, 100 S.Ct. 1108, 68 L.Ed. 348 (1980), where the

Supreme Court held that an individual who was not an insider

of the issuer in whose stock he traded could not be found to

have violated Section 10(b) based on a theory of the breach of a

duty to the shareholders of the issuer. In Chiarella, supra, the

Court reversed the conviction under Section 10(b) of a printer

who had traded in stock on the basis of non-public information

that he had obtained in the course of his employment. Like the

defendants in the present action, Chiarella was an outsider of

the corporations in whose stock he traded. The Court stated:

(T]he element required to make silence fraudulent—a

duty to disclose—is absent in this case. No duty could

arise from petitioner’s relationship with the sellers of the

et company’s securities, for petitioner had no prior

dealings with them. He was not their agent, he was not a

era: he was not a person in whom the sellers had

placed their confidence.

Id. at 232, 100 S.Ct. at 1117.

The Supreme Court argument compels a finding that New-

man, Courtois and Antoniu cannot be liable to plaintiff for a

violation of Section 10(b). As outsiders of Deseret, they did not

owe the Deseret shareholders any duty of disclosure before

trading. As the Ninth Circuit has recently noted:

A purchaser of stoc’ who has no fiduciary relation to the

prospective seller of the stock and who owns less than 5%

4la

. . . has no duty to disclose circumstances that will insure

that the purchaser pays the highest possible price.

Polinsky v. MCA, Inc., 680 F.2d 1286, 1290 (9th Cir. 1982). As

no duty to disclose or abstain was owed to the Deseret stock-

holders, they have no standing to sue for damages under Sec-

tion 10(b) as the essential element of a breach of a duty owed to

them is absent.

Recognizing that in order to set out a claim for damages

under Section 10(b) one must show that the defendants have

breached a duty owed to the plaintiff, Moss attempts to find a

source that could create a duty owed to him by defendants. One

of these efforts to create a duty to the stocholders of Deseret

focuses on the duty that Courtois owed to Morgan Stanley.

Plaintiff argues that Courtois owed a fiduciary duty to Morgan

Stanley and to Morgan Stanley’s client Warner. He claims that

this duty to Morgan Stanley and its client Warner gave rise toa

separate duty to disclose or abstain that was owed to the

shareholders of Deseret. This argument fails.

It is true that a criminal violation of Section 10(b) can be

based upon the breach of a duty owed to a party other than the

party to the transaction. While the Supreme Court has not

specifically addressed the question, the Second Circuit has

held that criminal violation of Section 10(b) can be based on the

breach of a duty owed to the acquiring corporation or other

party even though no duty is owed to the issuer. United States

v. Newman, 664 F.2d 12 (2d Cir. 1981). In Newman, supra, the

Court reversed the dismissal of the Section 10(b) count against

the defendant Newman of this present action. It held that

Courtois did owe a duty to Morgan Stanley and its client

Warner and that Newman, as Courtois’ tippee, was subject to

this same duty. Thus, as there was a breach of a duty, Section

10(b) liability was possible. It is essential to note, however,

that this case did not find any duty owed to the issuer, Deseret,

or to its stockholders. As Newman, supra, was a criminal

prosecution, this question of privity of the stockholders of

Deseret was not before the Court, and it was not addressed.

42a

Thus, even though there may have been a fiduciary duty to

Morgan Stanley and Warmer in this case, there is no support for

the argument that this dui, transformed itself into a duty

owed to the stockholders of Deseret, as is necessary for a

finding that Moss has a claim for damages under Section 10(b).

A holding that the duty owed to Morgan Stanley and Warner

gives rise to a duty to the stockholders of Deseret would be

wholly inconsistent with the teaching of the Supreme Court in

Chiarella, supra, that a duty to disclose under Section 10(b)

arises out of a relationship of trust and confidence. Jd. 445 U.S.

at 230, 100 S.Ct. at 1115. This relationship must be one be-

tween the parties themselves. Jd. at 231, n. 14, 100 S.Ct. at

1116 n. 14. Thus, plaintiff cannot hope to piggyback upon the

duty owed by defendants to Morgan Stanley and Warner.

There is no “duty in the air” to which any plaintiff can attach his

claim.

Further support for this analysis comes from the following

passage in Chiarella, supra:

We know of no rule of law . . . that a purchaser of stock,

who was not an “insider” and had no fiduciary relation to a

prospective seller, had any obligation to reveal circum-

stances that might raise a seller’s demands and thus abort

the sale. Jd. at 232, n. 14, 100S.Ct. at 1116 n. 14. The duty

to disclose arises from a relationship between the parties.

Here, the defendants were not insiders of Deseret, had no

fiduciary relation with Deseret’s stockholders, and thus

owed them no duty of disclosure. Consequently, there is

no Section 10(b) damage liability of defendants to them.

Plaintiff asserts that the Southern District case of O’Connor

& Associates v. Dean Witter Reynolds, Inc., 529 F.Supp. 1179

(S.D.N.Y. 1981), suggests a different conclusion. Plaintiff

argues that O’Connor, supra, stands for theory that the

fiduciary duty that traders owe to their corporation creates a

separate duty to the investing public to disclose or abstain.

There are several problems with relying on O’Connor, supra.

O’Connor, supra, can be distinguished on its facts. The

plaintiffs there claimed that the information traded upon with-

43a

out disclosure had come from the issuer, the other party to the

merger, or both. While the Court did not specifically state that

its conclusion would differ if the information had not come from

insiders, it did base much of its analysis on the duty of insiders.

Thus, the Court did distinguish Chiarella, supra, by noting

that in O’Connor, supra, the alleged sources of material in-

formation were insiders, This supports a reading of O’Connor,

supra, to apply only to the situation of information leaked from

the issuer. Any other reading of the case would flatly con-

tradict the language in Chiarella, supra, that states that a

duty to disclose arises from a relation between the parties. Jd.

445 U.S. at 231, n. 14, 100 S.Ct. at 1116 n. 14.

Plaintiff points to other alleged sources of a duty to disclose

in addition to the duty to Morgan Stanley and Warner. Plaintiff

claims that the negotiations between Warner and Deseret

established a duty on the part of Morgan Stanley to disclose or

abstain before trading and that this duty arose out of a duty

that Warner owed to Deseret to bargain in good faith. If during

the course of the bargaining leading up to the offer for the

Deseret stock, Warner Lambert received confidential in-

formation from Deseret with the understanding that this in-

formation would be used by Warner only for legitimate corpo-

rate purposes, this could have imposed a duty on Warner not to

abuse the information that it received. Morgan Stanley and its

employees would then have been brought into a trust relation

with Warner and thus could have become subject to the same

duty owed to Deseret. If valid, this argument might allow

plaintiff to prove that Courtois owed the sellers a duty arising

out of the trust relationship of the bargaining process.

The most recent Second Circuit case on the question of the

duty owed by an investment bank to a potential target when it

represents the acquring corporation is Walton v. Morgan

Stanley, 623 F.2d 796 (2d Cir. 1980). Morgan Staniey first

represented Kennecott Copper Corporation while that

corporation was considering the acquisition of Olinkraft. In the

course of these negotiations, Olinkraft gave Morgan Stanley

confidential inside information on the condition that Morgan

dda

Stanley use the information only in connection with its work on

the Kennecott bid and that it then return the information to

Olinkraft. The Kennecott bid did not materialize, but other

companies did make bids for Olinkraft. Morgan Stanley’s

Arbitrage Department then purchased stock in Olinkraft.

Morgan Stanley’s Merger and Acquisitions Department,

aware of the purchases by the Arbitrage Department, then

used the confidential information to convince Johns-Manville

to make a bid for Olinkraft.

Plaintiffs in Walton, supra, sued derivatively, claiming that

Morgan Stanley had breached a fiduciary duty that it owed to

Olinkraft. The Second Circuit rejected this argument. The

Court stated:

Put bluntly, although, according to the complaint, Olin-

"sm nagement placed its confidence in Morgan Stan-

ley not to disclose the information, Morgan Stanley owed

no duty to observe that confidence.

Id. at 799. The Court noted that facts had been presented to it

to indicate that anything but an arm’s length bargaining rela-

tionship had existed between Olinkraft and Morgan Stanley

and Kennecott Copper.

Walton was based upon Delaware law as Olinkraft was a

Delaware corporation. It is not possible to determine from the

complaint and papers whether Deseret is a Delaware corpora-

tion or not. Note, however, that the Second Circuit’s construc-

tion of New York fiduciary law results in a similar result. In

Frigitemp Corp. v. Financial Dynamics Fund, 524 F.2d 275

(2d Cir. 1975), the Court found that no fiducuary duty to a

corporation had been created under New York law on the part

of investment companies that had negotiated with the corpora-

tion regarding the purchase of corporate debt. As the negotia-

tions had been at arm’s length, no fiducuary duty had been

created. The inside information that the investment companies

had acquired could be traded upon.

Thus, unless plaintiffs can set forth facts that turn the

negotiations from arm’s length bargaining into a fiduciary rela-

45a

tionship, they cannot claim that Morgan Stanley owed them a

fiduciary duty. The plaintiffs assert that the following facts

show that there was a fiduciary relationship:

1. The parties to the tender offer had negotiated for

some time prior to the announcement.

2. Morgan Stanley had obtained some of its information

directly from Deseret.

3. Deseret requested that trading in its stock be sus-

pended upon the offer, thus showing that it wished the

offer to proceed in an orderly manner.

These facts do not indicate any more of a duty on the part of

Morgan Stanley than was present in Walton, supra, where

there had been negotiations and a specific request by the

target not to reveal the information. As the Second Circuit

found that Morgan Stanley owed the target no duty in Walton,

supra, this Court finds that no duty existed here.

Plaintiff also argues that Newman, as a registered broker-

dealer breached an additional duty, that of market professional

to the market. Plaintiff relies on Dirks v. S.E.C., 681 F.2d 824

(D.C. Cir. 1982), cert. granted, ___ U.S. —__, 103 S.Ct. 371,

74 L.Ed.2d 506 (1982), for this theory. While it is true that

Dirks, supra, did note that brokers-dealers were subject to

duties not imposed on the general public, this case cannot

support an argument that the breach of a duty to the market

creates a private cause of action. First, Dirks, supra, was an

action to censure a broker-dealer. There was no discussion of

what created a duty to disclose or abstain so as to give rise to

Section 10(b) damage liability. Second, the information that

Dirks failed to make publicly available before he passed it on to

clients was inside information received from sources at the

issuer.

Plaintiff has failed to state a claim on which relief may be

granted under Section 10(b) of the Securities Exchange Act. In

order to obtain damages for a violation of this Section, a plain-

tiff must show that a duty to disclose or abstain was owed by

the defendants and that it has been breached. Plaintiff has not

46a

shown any duty owed to him by the defendants. They were

the parties. The only duty owed by defendants was that to

Morgan Stanley and to Warner. Any effort to create a duty to

plaintiff out of this duty contradicts the Supreme Court

requirement that the duty giving rise to a violation of Section

10(b) arises out of a relationship between the parties.

Section 14(e) Liability.

Plaintiff also claims that Newman violated Section 14(e) of

the Securities Exchange Act. Newman has moved to dismiss

that complaint arguing that Rule 14e-3, which was adopted by

the Securities and Exchange Commission on September 12,

1980, was the first effort by the Securities and Exchange

Commission to make his actions illegal. As the actions involved

in this litigation took place before the adoption of the Rule,

Newman claims that his conduct did not violate Section 14(e).

Rule 14e-3 should not be given retroactive effect. The SEC

Release accompanying Rule 14e-3 suggests that the SEC

viewed the rule as altering the interpretation of Section 14(e)

and as prospective in effect. Tender Offer Fraud Rule, 1934

Act Release No. 17120, Fed.Sec.L. Rep. [CCH] 4 82,646. This

Release stated that “Rule 14e-3 establis/es a ‘disclose or ab-

stain from trading’ rule under the Williams Act,” id. at 83,453

(emphasis added). Also, the Release stated that the Rule

would be effective thirty days after the publication of the

Release in the Federal Register. /d.

This language supports the finding that Rule l4e-3 was

altering the interpretation of Section 14e-3 was altering the

interpretation of Sectin 14(e) and creating new liability. Before

the adoption of the Rule, Section 14(e) could not cover the acts

of defendants. The District Court that dismissed the indict-

ment of Newman, United States v. Courtois, Fed.Sec.L. Rep.

[CCH] 198.024 at 91,-292 (S.D.N.Y. 1981) rev’d on other

sub. nom. United States v. Newman, 664 F.2d 12 (2d “

Cir. 1981), noted that before Rule 14e-3 was adopted in 1980,

- S oe $

OO Ee br had. Bs a -

De eee ee ieee le) ie eee 4 ere a ae ee et ee

47a

the Williams Act had no “cure” for the problem of individuals

trading on the basis of non-public information that a tender

offer would be made.

Thus, as Rule 14e-3 cannot be given retroactive effect and as

the Williams Act as interpreted before the Rule’s adoption did

not cover Newman’s, Courtois’ or Antoniu’s acts, the Section

14(e) claim must be dismissed.

Derivative Liability Of Morgan Stanley.

Plaintiff asserts that Morgan Stanley is liable derivatively

for the Securities Acts violations of the individual defendants

on theories of respondeat superior, aiding and abetting, and

control person liability under Section 20(a) of the Securities

Exchange Act, 15 U.S.C. § 78t(a). As the claims against the

individuals have been dismissed, Morgan Stanley cannot be

derivatively liable. Yet, it should be noted that the arguments

that Morgan Stanley could be liable for any Section 10 or 14

violation are completely devoid of merit. Even if the underly-

ing claims did state a claim on which relief might be granted

against the individual defendants, they would fall as against

Morgan Stanley.

Respondeat Superior.

Plaintiff asserts that the common law doctrine of respondeat

superior makes Morgan Stanley derivatively liable for the acts

of its employee, Courtois. Plaintiff claims that the acts of an

employee that are of the same general nature as, or sufficiently

similar to, the authorized conduct will be adequate to impose

derivative liability even if the acts are unauthorized. While it is

correct that unauthorized acts can fall within the scope of

employment and thus subject the employer to liability, the acts

of Courtois cannot be so categorized.

As Judge Lasker noted in O’Connor, supra at 1194:

Ijnsider trading and tipping cannot ordinarly [be] said to

within the course of employment. An e who

ride oh the Nats of manalenioal dpodieten

48a

tips cannot be said to act as an employee in the transaction.

. . . [AJn employee who trades on the basis of inside in-

formation or who tips such information must normally be

viewed as on a frolic of his own.

This analysis applies to Courtois. Like the employee in

O’Connor, supra, the only link between the tip and the em-

ployment duties was that the latter constituted the source of

the tip. The illegal trading did not take place on or use the

facilities of the employer. No one dealing with the employee

could have thought that the acts were authorized by the em-

ployer. The mere fact that the business of Morgan Stanley

relates to securities generally is not sufficient to convert the

acts of Courtois into acts within the scope of employment or

acts similar in nature to authorized conduct. It is especially

worthy of note that Courtois was employed in the Mergers and

Acquisitions Department of Morgan Stanley. His usual re-

sponsibilities related to the analysis of potential targets and

the structuring of deals, not to the purchase and sale of secur-

ities for his own or for anyone else’s account. Thus, the acts for

which the plaintiff seeks to impose liability on Morgan Stanley

were not of the same general nature or at all similar to autho-

rized conduct.

The cases that plaintiff cites do not alter this conclusion. All

of those cases involved acts that the employee undertook in his

official capacity or that were the same type of activity usually

undertaken. For example, in Lewis v. Walston & Co., 487 F.2d

617 (5th Cir. 1973), a broker’s acts were attributed to the

employer as the broker had been dealing with the customers of

the employer as its representative, thereby performing acts

“commonly done” by brokers. Jd. at 623.

Finally, plaintiff asserts that the fact that the illegal act of

Courtois was foreseeable should make Morgan Stanley liable.

Plaintiff relies on Bushey v. United States, 398.F.2d 167 (2d

Cir. 1968), for this test. In Bushey, supra, the employer, the

United States, was held liable for the actions of a drunken

seaman who destroyed a drydock as it was foreseeable that

such damage would occur. The Second Circuit, however, was

ee ee mn

49a

explicit in limiting its holding to situations in which there was

some relation between the act of the employee and the activi-

ties of the enterprise. /d. at 172. Here, Courtois’ actions had no

relation to Morgan Stanley, as demonstrated above. Thus,

under the Bushey, supra, test, Morgan Stanley is not

derivatively liable for the acts of Courtois.

Section 20(a) Liability.

Section 20(a) of the Securities Exchange Act, 15 U.S.C.

§ 78t(a), provides that controlling persons can be liable for the

acts of controlled parties under certain circumstances. This

Section states:

Every person who, directly or indirectly, controls any

person liable under any provision of this chapter or of any

rule or regulation thereunder shall also be liable jointly

and severally with and to the same extent as such con-

trolled person to any person to whom such controlled

rson is liable, unless the controlling person acted in good

ith and did not directly or indirectly induce the act or

acts constituting the violation or cause of action.

There is some uncertainty as to the construction of this

Section in the Second Circuit. In Lanza v. Drexel & Co., 479

F.2d 1277, 1299 (2d Cir.1973) (en banc), the Second Circuit

stated that before liability could be extended to a controlling

person under Section 20(a), there must be a showing of “culp-

able participation” by the party to be held liable. This test was

followed in Gordon v. Burr, 506 F.2d 1080, 1085-86 (2d

Cir. 1974). If it were clear that the Second Circuit is still follow-

ing the test set forth in Lanza, supra, it would be proper to

dismiss the claims on this ground against Morgan Stanley.

There is no allegation of any act by Morgan Stanley that even

approaches culpable participation, or even participation of any

kind at all. Yet, the Second Circuit in Marbury Management,

Inc. v. Kohn, 629 F.2d 705 (2d Cir.), cert. denied, 449 U.S.

1011, 101 S. Ct. 566, 66 L.Ed.2d 469 (1980), suggested that

under certain circumstances inadequate supervision of em-

50a Pa

ployees may result in Section 20(a) liability. Thus, the Court

stated that:

While the precise standard of supervision required of

broker-dealers to make good the good faith defense of

Section 20(a) is uncertain, where, as in the present case,

the erring salesman completes the transactions through

the employing brokerage house and the brokerage house

receives a commission on the transactions, the burden of

proving good faith is shifted to the brokerage house . . .

and requires it to show at least that it has not been negli-

gent in supervision . . . and that it has maintained and

enforced a reasonable and proper system of supervision

and internal control over sales personnel.

Id. at 716.

All that Marbury Management, supra, does to the Section

20(a) test is allow plaintiff to make out a prima facie case of

control by a showing that the employee acted in the scope of his

employment. Thus, in Savino v. E.F. Hutton, 507 F.Supp.

1225 (S.D.N.Y. 1981), the Court stated that a prima facie

showing of control could be made out by a showing that the

employer had the means of control of the employee or that

there was some control by status. As Courtois was operating

outside of the scope of his employment, there is no relationship

between the parties to give Morgan Stanley control by status

of Courtois with respect to the acts in question. Thus, no prima

facie case of control can be made out under Section 20(a).

Aiding and Abetting Liability. :

There is also no liability on the part of Morgan Stanley as a ¢

result of plaintiff's argument that Morgan Stanley is liable as

an aider and abettor of the defendants in this action. The

Second Circuit test for aiding and abetting liability has recent-

ly been set forth by the Second Circuit in JJT, an International ’

Investment Trust v. Cornfeld, 619 F.2d 909 (2d Cir.1980). The M

following must be shown before a defendant can be found to =

| have aided and abetted: he

; 1. The existence of a securities law violation by the pri- RN

mary party. ~

5la

2. Knowledge of this violation by the aider and abettor.

3. Substantial assistance by the aider and abettor in the

achievement of the primary violation.

The requirement of knowledge was further developed as fol-

lows:

When it is impossible to find any duty of disclosure, an

alleged aider-abettor should be found liable only if scienter

of the high “conscious intent” variety can roved.

Where some special duty of disclosure exists, then liability

should be possible with a lesser degree of scienter.

Id. at 922. The requirement of substantial assistance has been

defined to cover inaction by the defendant in certain limited

circumstances. Liability will attach when there is clear evi-

dence cf some degree of scienter and a “conscious and specific

motivation for not acting” or when there is a conscious or

reckless violation of an independent duty to act. Jd. at 927.

Neither the second nor the third element of the aiding and

abetting test is satisfied in this case. As Morgan Stanley had no

duty of disclosure to anyone, the knowledge requirement can

be met only if there is some conscious intent on the part of

Morgan Stanley. No such allegation is made. All that plaintiff

asser’'s is that Morgan Stanley may have been reckless. In

addition to their failure to state any fact that can support a

finding of recklessness as a matter of law, this argument failsas _

there can be no satisfaction of the second element of the com-

plaint without a higher degree of scienter than recklessness.

There is also no allegation that can support a finding of

substantial assistance. Plaintiff makes no claim that Morgan

Stanley had any motivation at all for not acting. As matter of

law there was no violation of any independent duty owing to

plaintiff to act.

Thus, the attempt to find Morgan Stanley derivatively liable

as an aider or abettor fails completely.

52a

RICO Claims.

A. Morgan Stanley.

Plaintiffs Count II in the amended complaint charges Mor-

gan Stanley, Inc. with culpability under the Racketeer In-

fluenced and Corrupt Organizations Act, 18 U.S.C. § 1964(c).

The allegations of the amended complaint for this bold

charge are the following:

Morgan Stanley rendered advice and assistance to Warner

Lambert Company for a tender offer by it for Deseret stock

({ 9). Morgan Stanley permitted an employee, one Courtois, to

gain knowledge of and obtain access to confidential and privi-

leged information pertaining to Warner’s planned offer for

Deseret stock ({ 16). Courtois conspired with Antoniu and

Newman to utilize to their personal advantage such privileged

and confidential information and intentionally and knowingly

defrauded plaintiff and class members who sold their Deseret

stock at prices below the tender offer price subsequently an-

nounced ({ 22). Morgan Stanley aided and abetted Courtois,

Antoniu and Newman in this conspiracy; they failed adequate-

ly to supervise Courtois and recklessly and negligently failed

to take steps to safeguard the confidential information and are

liable therefore as a person in control of Courtois and under

common law principles of respondeat superior (4 23). Morgan

Stanley’s actions represent a pattern of [criminal] racketeering

activity within the meaning of the Racketeer Influenced and

Corru,t Organizations Act (4 27).

Plaintiff's brief opposing dismissal of the RICO count notes

that Morgan Stanley has reacted with dismay and outrage to

the charge associating it with criminal racketeering proscribed

by the Racketeering Influenced and Corrupt Organizations

Act.

Unless a plaintiff can point to a factual basis for a charge that

a defendant is a member of a structured criminal organization

with the requisite history of criminal racketeering acts or

meets each of the elements requisite to establishing a RICO

—e ty

< - 2

charge, civil litigation falls to the ground; indeed, such a charge

infects the fundamental fairness of civil litigation.

The Racketeer Influenced and Corrupt Organizations Act,

part of the Organized Crime Control Act of 1970, was designed

in a multifaceted campaign against the pervasive presence of

organized crime infiltrated in American business and trade.

The preamble of the statute states its purpose: “To seek the

eradication of organized crime in the United States. . . .” The

Congress found that there was a drain by organized crime of

billions of dollars from America’s econemy by illegal use of

force, fraud and corruption; by syndicated gambling, loan-

sharking, theft and fencing of property; by importation and

distribution of narcotic and controlled drugs; by infiltration

and corruption of legitimate business and labor unions. Pub. L.

No. 91-452, 84 Stat. 922-23 (1970).

Congress did not define “organized crime.” However, by its

very nature, “organized crime” is not susceptible to a clear,

concise definition. We organized crime brings to mind loan-

sharking, drug dealing, and violent intimidation, it is neither

these activities nor the individual or ethnic identity of the

participants that separates organized crime from unspecified

criminal activity. Entities engaging in organized crime are

characterized by the existence of a well defined hierarchy and

infrastructure. Organized criminal enterprises also employ nu-

merous individuals whose jobs are to ensure that criminal

activity can be carried out without interference from govern-

ment agents or other competitors of the organization. This

preclusion of interference is often accomplished by threat,

bribe, or by actual physical violence. Additionally, organized

criminal enterprises rely on internal, covert and often violent

disciplinary measures for employees who act outside the scope

of their authority.

The courts must facilitate the proper application of statutory

causes of action and must guarantee that they are not abused

and applied to contexts outside those intended by Congress.

This is especially true in the civil context where the additional

dda

check and balancing factor of prosecutorial discretion is ab-

sent.

Courts have recognized that RICO claims could be proved

only if there was a tie to organized crime. These holdings have

been criticized because Congress did not explicitly require that

racketeering activity be tied to organized crime. Indeed, Con-

gress rejected an amendment to RICO designed to explicitly

define organized crime because a “bright line” legislative

definition might unconstitutionally create a status offense and

because it would be easy for organized criminals to alter their

conduct so that they would fall outside of the reach of the

statute.

Legislative failure to establish a “bright line” does not imply

that Congress intended that Courts repudiate their proper

function of legislative interpretation and application. The

Courts are routinely called on to apply general criteria on a

case by case basis. This is especially true where the underlying

subject matter is not well suited to simple definition. Thus, in

obscenity and pornography cases, for example, Courts have

limited the reach of anti-obscenity laws in light of Con-

stitutional interests by employing general criteria on a case by

case basis.' Similar judicial action is appropriate in civil RICO

cases.

The statutory language and recent Supreme Court and

Second Circuit precedent, if carefully applied, can be ex-

traordinarily effective in limiting RICO to its intended scope

and filtering out many RICO claims that are just efforts to

claim treble damages for ordinary violations of criminal or tort

laws. For example, the requirement that the plaintiff show

that the injury for which relief is sought resulted from a viola-

tion of Section 1962, and not simply from a violation of Section

1961, by the commission of the enumerated acts, eliminates

'Cf. Jacobellis v. Ohio, 378 U.S. 184, 197, 84 S.Ct. 1676, 1683, 12

L.Ed.2d 793 (1964) (Stewart, J., concurring) (“I know it when I see

it.”).

55a

from the scope of RICO the cases in which plaintiff seeks to use

RICO to claim damages due to an inability to meet the require-

ments for relief stemming from predicate felonies.

In addition, the requirement of United States v. Turkette,

452 U.S. 576, 583, 101 S.Ct. 2524, 2528, 69 L. Ed.2d 246 (1981),

that the plaintiff must establish that the enterprise is an entity

separate and apart from the pattern of racketeering activity

makes clear that a violation of RICO is not set forth simply by

alleging that the enumerated felonies of Section 1961 have

been committed. If the enterprise that the plaintiff is relying

upon is the criminal partnership of the defendants, the plaintiff

must establish that there is something more to this partnership

than the commission of the underlying felonies. For example, a

developed infrastructure for the criminal partnership, used to

help carry out its goals and enforce its aims, would suffice to

give the group an adequate separate identity to meet the

requirement of Turkette, supra. However, if all that the crimi-

nal partnership consists of is the commission of the requisite

felonies, no violation of Section 1962 can be shown. Proof that

the criminal partnership was an “on-going organization, formal

or informal,” with its associates functioning “as a continuing

unit,” Turkette at 583, 101 S.Ct. at 2528, will suffice to meet the

enterprise requirement.

Criminal prosecution and civil remedies were authorized by

RICO. The civil remedies provided in Section 1964 granted a

private right of action to litigants injured by a violation of

RICO’s criminal provision, Section 1962, in addition to the

injunctive remedies made available to the Attorney General to

stamp out infiltration of legitimate business by divestiture and

otherwise.

Section 1964(c) provides that:

[A]Jny person injured in his business or property by reason

of a violation of Section 1962 of this chapter may sue...

and shall recover threefold the damages he sustains and

the cost of the suit, including a reasonable attorney’s fee.

56a

The proscribed activities under RICO are described in Sec-

tion 1962 and enumerated in Section 1961. These are aimed at

structured criminal organizations who fund, acquire or main-

tain enterprises engaged in or affecting interstate or foreign

commerce with the proceeds of illegal activities by “(a)” invest-

ing income derived from a “pattern of racketeering” in an

enterprise or “(b)” acquiring or maintaining an enterprise

through “a pattern of racketeering,” or “(c)” being employed

by or associated with an “enterprise” to conduct or participate

“in the conduct of such enterprise’s affairs through a pattern of

racketeering,” or “(d)” to conspire to violate any of the forego-

ing. (Section 1962).

The statutory definition of a “pattern” of racketeering activ-

ity [Section 1961(5)] is “at least two acts of racketeering activ-

ity within ten years.” “Racketeering activity” is any act of

felony of the state or federal law listed in Section 1961(1).

The use of the mails or the sale of securities are named as two

of the methods by which the enumerated Section 1961 activi-

ties prohibited in Section 1962 may fall under the ban. The

cardinal question at the threshold is whether there has been a

commission of one of the enumerated prohibited activites—one

of the racketeering crimes in the course of organized crime

defined by the RICO statute—which has caused injury to the

plaintiff.

RICO was thus established as a civil weapon against those

engaged in organized crime who have gained an unfair

competitive or financial advantage through criminal means

associated with racketeering. The statutory offenses created

by RICO were aimed at the evils of criminal racketeering by

organized crime that had spread through the economy. United

States v. Turkette, 452 U.S. 576, 589, 101 S.Ct. 2524, 2531, 69

L.Ed.2d 246 (1981). The sweep of the statute does not embrace

ordinary violators charged in common law fraud actions or

federal securities law violations as the predicate offenses for

RICO relief, albeit the use thereof to accomplish one of the

enumerated felonies in the statute may be an element of and

: ‘a Ps ta Ng > ot ae

ra Tt. oe ae Tn Pre Og. eye

57a

lead to RICO liability if organized criminals engage in the

prohibited activity.

The supporting civil remedies of the statute were designed

against organized criminals and terrorists as an additional

weapon in the crime fighters’ arsenal.

In other words, plaintiffs injury to be cognizable under

RICO must be caused by a RICO violation and not simply by

the commission of a predicate offense, such as mail fraud or

federal securities fraud. RICO’s civil remedy provision per-

mits a recovery to “any person injured in his business or

property by reason of a violation of Section 1962,” 18 U.S.C.

Section 1964(c) (emphasis supplied), that is, where the distinc-

tive RICO violation contributed to plaintiffs injury, i.e.,

where the plaintiff suffered directly a racketeering enterprise

injury at the hands of those sought to be reached by the

Organized Crime Control Act of 1970. See 116 Cong. Rec. 602,

et seq.; 607, et seq.; 819, et seq.; 35201, et seq. (1970). The

purpose was to provide “enhanced sanctions and new remedies

to deal with the unlawful activities of those engaged in orga-

nized crime.” Congressional Statement of Findings and Pur-

poses, Pub.L. No. 91-452, § 1, 84 Stat. 922, 923.

It has appropriately been said:

The civil remedies provisions of RICO were not designed

to convert every fraud or misinterpretation action invoiv-

ing corporations who use the mails or telephones to con-

duct their businesses in interstate commerce into treble

damage RICO actions.

Waterman S.S. Corp. v. Avondale Shipyards, Inc., 527

F.Supp. 256, 260 (E.D.La. 1981). See also, Noonan v.

Granville-Smith, 537 F.Supp. 23 (S.D.N.Y. 1981).

In civil litigation there is every reason why the application of

RICO should be restricted sharply to organized crime and the

enterprises on which its talons have fastened. Thus, courts in

the Southern District and elsewhere have held that RICO

claims for damages could be maintained only if there was a tie

to organized crime. Noonan v. Granville-Smith, 537 F.Supp.

58a

23, 29(S.D.N.Y.1981), and Barrv. WUI/TAS, Inc., 66F.R.D.

109 (S.D.N.Y.1975). See also, Adair v. Hunt International

Resources Corp., 526 F.Supp. 736 (N.D.Il1.1981); Waterman

S.S. Corp. v. Avondale Shipyards, 527 F.Supp. 256

(E.D.La.1981).

Moreover, there is nothing in the legislative history to sug-

gest that Congress intended to create a private right of action

for treble damages for violations of substantive statutes by

ordinary business or parties. For example, it was clearly es-

tablished at the time that RICO was enacted that there was no

private right of action for violations of the mail fraud statute. It

is implausible that Congress could have meant to alter this

accepted rule to the extent of creating a right of action for

treble damages without a single mention of such a revolutiona-

ry consequence anywhere in the legislative history.

Plaintiff, on this motion for summary judgment, fails com-

pletely to satisfy the requirement that there be an underlying

pattern of racketeering activity or even a single act of

racketeering by Morgan Stanley. For these reasons alone, the

RICO claim fails. Morgan Stanley is not principally charged

with any substantive act that could constitute even a single

element of racketeering. In order to connect Morgan Stanley

with a RICO claim, the plaintiff would have to establish facts

which show derivative criminal liability as Section 1961 only

defines acts to be racketeering if they are one of the enumer-

ated felonies punishable under the laws of the United States.

Note that even if the standard of proof is lower in a civil

proceeding under RICO than in a criminal one, this does not

relate to the elements of the crime but only to the burden that.

the plaintiff must bear in showing the elements. Cf. United

States v. Cappetto, 502 F.2d 1351, 1357 (7th Cir. 1974), cert.

denied, 420 U.S. 925, 95 S.Ct. 1121, 43 L.Ed.2d 395 (1975).

There is no claim herein that Morgan Stanley used its em-

ployees or anyone else to violate the Securities Exchange Act.

None of the employees complained of made any investment in *

Morgan Stanely. To the contrary, Morgan Stanley was harmed 3

59a

by Courtois’ and the other defendants’ actions as its reputation

as a safe repository for clients’ secrets was diminished. In

addition, in order to carry out his acts, Courtois had to cireum-

vent Morgan Stanley’s confidentiality controls and had to trade

secretly on an outside account. There is no possible argument

that Morgan Stanley is criminally liable for the acts of anyone

by reason of Section 20(b) of the Seewrities Exchange Act, 15

U.S.C. Section 78t(b). That section has been construed as

requiring a showing that the controlling person [Morgan Stan-

ley] knowingly used the controlled person to commit the illegal

act. Securities Exchange Commission v. Coffey, 493 F.2d

1304, 1318 (6th Cir. 1974), cert. denied, 420 U.S. 908, 95 S.Ct.

826, 42 L.Ed.2d 837 (1975). Nor, what plaintiff apparently

would argue, is Morgan Stanley derivatively criminally liable

under a theory of aiding and abetting. While plaintff alleged in

paragraph 23 of his complaint that Morgan Stanley aided and

abetted Courtois, Antoniu and Newman in their criminal con-

spiracy, he has not alleged or shown any fact that can con-

stitute criminal aiding and abetting. It is well-established that

in order to find a defendant guilty of aiding and abetting, the

defendant must “in some sort associate himself with the ven-

ture .. . participating in it as something he wished to bring

about [and] seeks by his action to make it succeed.” United

States v. Clemente, 640 F.2d 1069, 1079 (2d Cir.) cert. denied,

454 U.S. 820, 102 S.Ct. 102, 70 L.Ed.2d 91 (1981), citing

United States v. Peoni, 100 F.2d 401, 402 (2d Cir.1938). In

addition, an aider and abettor must have some interest in the

criminal venture. Thus, “the mere presence of a defendant

where a crime is being committed, even coupled with knowl-

edge by the defendant that a crime is being committed, or the

mere negative acquiescence by a defendant in the criminal

conduct of others, even with guilty knowledge, is not sufficient

to establish aiding and abetting.” United States v. Stanchich,

550 F.2d 1294, 1300 (2d Cir. 1977).

Clearly, there has been no allegation and no fact asserted to

suggest that Morgan Stanley in any way associated itself with

the activities of the individual defendants. There was no partic-

Ss J

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Tes. ee ie? si . . : ig se)? Petes a eee

60a

ipation by Morgan Stanley. Instead, all of Morgan Stanley’s

acts operated to deter the conspirators and make the accom-

plishment of their goal more difficult. Plaintiff has only alleged

that Morgan Stanley was negligent or reckless in aiding and

abetting. As noted above, no fact has been asserted that can

constitute recklessness as a matter of law. Even if such an

allegation were supported, such a state of mind would be

inadequate along with inaction to constitute criminal aiding

and abetting.

Even if a standard of civil derivative liability were adopted,

which it is not, then Morgan Stanley still could not be

derivatively civilly liable for anyone’s acts in this case for the

reasons stated above with respect to civil derivative liability

for the underlying security counts.

Finally, plaintiff does not satisfy either the requirement that

there can be an underlying pattern of racketeering activity or

that there be an enterprise as required by Section 1962 with an

independent economic existence from the pattern of racketeer-

ing activity.

The provisions of Section 1962(c) require two separate ele-

ments in addition to the elements of causality and an underly-

ing pattern of racketeering activity. There must be an enter-

prise and there must be some nexus between the pattern of

racketeering activity and the enterprise. In United States v.

Turkette, 452 U.S. 576, 583, 101 S.Ct. 2524, 2528, 69 L.Ed.2d

246 (1980), the Supreme Court stated that:

“The enterprise” is not “the pattern of racketeering acti-

vity”; it is an entity separate and apart from the pattern of

activity in which it engages. The existence of an enter-

epedabs ep spppmecemr dt papi cmmamaae a why p

proved by the government.

Thus, the enterprise must have a separate economic ex-

istence from the pattern of racketeering activity. Bennett v.

Berg, 685 F.2d 1053, 1060 (8th Cir.1982). The test for the

essential relationship is defined in United States v. Scotto, 641

6la

F.2d 47, 54 (2d Cir. 1980), cert. denied, 452 U.S. 961, 101 S.Ct.

3109, 69 L.Ed.2d 971 (1981):

One conducts the activities of an enterprise through a

pattern of racketeering activity when (1) one is enabled to

commit the predicate offenses solely by virtue of his posi-

tion in the enterprise or involvement in or control over the

affairs of the enterprise, or (2) the predicate offenses are

rena to the activities of that enterprise. [Emphasis

The plaintiff contended in open court that the enterprise in

the RICO claim against Morgan Stanley is the group of New-

man and his associates. This claim fails to meet the require-

ment of Turkette, supra, that the enterprise have independent

economic significance from the pattern of racketeering activ-

ity. Under this analysis, Morgan Stanley’s pattern of activity

would be identical to the enterprise. As there is no other

organization, or group or individual! that could possibly satisfy

the enterprise requirements, including the Scotto test, the

plaintiff completely fails to make out this element of a RICO

claim.

B.Newman.

Plaintiffs effort to state a claim against Newman is in-

sufficient to warrant relief and withstand his motion to dismiss

pursuant to Rule 12(b)(6). Plaintiff rests his argument that

Newman is liable in treble damages for a violation of RICO on

the mere fact that Newman has been convicted of violating

some of the statutes listed in Section 1961. This assertion

wholly distorts both the language of the statute and con-

gressional intent in its enactment. As previously noted, RICO

does not create a treble damage remedy for violations of the

mail fraud statute. Nor does it create such a remedy whenever

plaintiff alleges a violation of a Securities Act. Otherwise, the

same allegations that the Supreme Court has held do not state

a claim because of a failure to show a breach of duty to disclose,

Chiarella, supra, or deception, Santa Fe Industries v. Green,

430 U.S. 462, 97 S.Ct. 1292, 51 L.Ed.2d 480 (1977), or stand-

62a

ing, Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 95

S.Ct. 1917, 44 L.Ed.2d 539 (1975), or scienter, Ernst & Ernst

v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668

(1976), could give rise to an action for treble damages by the

plaintiffs reference to the RICO statute.

Instead, Section 1964(c) is clear in its requirement that

plaintiff's injury to be cognizable under RICO must flow from

the RICO violation, not simply from the commission of an

enumerated felony. RICO’s civil remedy provision permits a

recovery to any person injured in his business or propert¥ by

reason of a violation of Section 1962, 18 U.S.C. § 1964(c)

(emphasis supplied), that is, where the distinctive RICO

felony caused plaintiffs injury, i.e., where the plaintiff suf-

fered proximately a racketeering enterprise injury at the

hands of the defendant. It is inadequate merely to assert that

damages were caused by commission of the underlying felony

acts. Harper v. New Japan Securities, 545 F.Supp. 1002

(C.D.Cal. 1982). Plaintiffs alleged injury did not result from an

enterprise created or supported by the fruits of a pattern of

racketeering, from an enterprise controlled by racketeers, or

from a pattern of racketeering activity carried on in association

with an enterprise (prerequisites of Section 1962). Nor was the

injury causally connected with a felony enumerated in Section

1961.

Plantiff’s loss of an opportunity for additional profits stem-

med from his decision to sell Deseret stock the day before a

tender offer for this stock was announced by Warner Lambert.

Plantiffs decision to sell was not induced by any act of the

defendants. The subsequent rise in the price of Deseret stock

was the consequence of Warner Lambert’s tender offer, which -

occurred subsequent to the sale. The plantiff's sale was not

timed by any act of the defendants. Even if the on-going

accumulation of funds by Newman, Courtois and Antoniu en-

abled them to purchase Deseret stock, this undisclosed activity

in no way restrained or catalyzed the plaintiff's decision to sell

his stock shortly before the announcement of a price increace.

63a

Thus, as plaintiff has not alleged any injury that flowed from

a violation of Section 1962, as required by the statute, the

motion of defendant Newman to dismiss the RICO count must

be granted.

Summary Judgment is Appropriate here.

Plantiff has correctly argued that the well-pleaded allega-

tions of the complaint must be accepted as true and all reason-

able inferences flowing therefrom must be construed in favor

of the plaintiff on the motion pursuant to Rule 12(b)(6). It isalso

true that the motion for summary judgment may be granted if,

as appears here, the record demonstrates that there are no

genuine issues of material fact to be tried * As a diversionary

statement, plaintiff suggests that it has not yet had an oppor-

tunity to pursue the necessary discovery to develop its claims

against Morgan Stanley. Plaintiff mentions a possible explora-

tion of the reasonableness of Morgan Stanley’s “security pro-

gram and its possible awareness of the long-lived scheme of its

employees.” Finally, plaintiff argues that it is not bound by the

view of government in the criminal case that Morgan Stanley

was a “victim” of the scheme.

Plaintiff may not escape his obligation to go forward with

any actually needed discovery with which to meet a motion for

summary judgment. Plaintiff was duly tendered but waived

such discovery, if indeed there was any useful purpose to be

served by it. No claim to such a need was voiced at the hearing

of the motion.

On September 21,1982, two and one-half months before the

return date of the motions, the parties met with the Court at a

pre-trial conference. It was then agreed that the motion for

summary judgment to bring to a head the question of the

existence of genuine litigable issues would be made and that

\ 2Once the Court decides to accept matters outside the pleading, it

must convert the i.ule 12(b)(6) motion to dismiss into one for sum-

mary judgment. Wright and Miller, Federal Practice and Procedure,

§ 1366, p. 679, n. 66.

64a

before hearing the plaintiff would be afforded whatever dis-

covery plaintiff deemed necessafy to defend the amended com-

plaint. Immediate documentary discovery was provided by

Morgan Stanley and no additional documentation was re-

quested. Plaintiff was asked—repeatedly—and their requests

were confirmed on October 1, 1982, two months ago, to desig-

nate any witness or witnesses connected with Morgan Stanley

for deposition. No request for any deposition of anyone was

made by the plaintiff. Indeed, the plaintiff did not even re-

spond to the defendant’s offers of witnesses. It is a fair in-

ference in the circumstances on the basis of the affidavits

submitted by Morgan Stanley and their challenging effect and

_the background of this case that discovery would demonstrate

cogently the absence rather than the presence of genuine

issues of material fact on either the securities claim or the

RICO claim.

No law can be cited which warrants denial of summary

judgment simply because the plaintiff has deliberately failed to

conduct discovery.

and the “questions” plaintiff's counsel now raises are enough to

preclude summary judgment.

Rule 56(e) of the Federal Rules of Civil Procedure provides

that:

65a

When these sentences were added to Rule 56 in 1963, the

Advisory Committee noted that:

The very mission of the summary judgment procedure is

to pierce the pleadings and to assess the proof in order to

see whether there is a genuine need for trial.

Advisory Committee Note, Proposed Amendments to Rules of

Civil Procedure for the United States District Courts, 31

F.R.D. 648-49 (1962).

As Judge Friendly has stated:

When the movant comes forward with facts showing that

his adversary’s case is baseless, the opponent cannot rest

on the allegations of the complaint but must adduce factual

material which raises a substantial question of the verac-

ity or com

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