Petition for Writ of Certiorari — Robinson Humphrey/American Express, Inc. v. Sanders

Supreme Court brief1988

Ask Donna

What actually matters in this document.

Text

€-8 35

NO. Supreme Court, U.S.

Froe D

IN THE NOV 238 98?

Supreme Court of the United, Staseso se

CLERK

OctToBEerR TERM, 1987

ROBINSON HUMPHREY/AMERICAN EXPRESS, INC.

and SHEARSON/AMERICAN EXPRESS INC.,

Petitioners,

GLENN T. SANDERS and LESLIE D. SANDERS,

on behalf of themselves and all others similarly situated,

. Respondents.

PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE ELEVENTH CIRCUIT

HARVEY D. MYERSON

Counsel of Record

FINLEY, KUMBLE, WAGNER, HEINE,

UNDERBERG, MANLEY, MYERSON & CASEY

425 Park Avenue

New York, New York 10022

(212) 371-5900

LLOYD S. CLAREMAN

FINLEY, KUMBLE, WAGNER, HEINE,

UNDERBERG, MANLEY, MYERSON & CASEY

MALCOLM D. YOUNG, JR.

PETER J. ANDERSON

PETERSON YOUNG SELF & ASSELIN

Attorneys for Petitioners

EDITOR'S NOTE

THE FOLLOWING PAGES WERE POOR HARD COPY

AT THE TIME OF FILMING. IF AND WHEN A

BETTER COPY CAN BE OBTAINED, A NEW FICHE

WILL BR ISSUED,

QUESTIONS PRESENTED

1. Did the Court of Appeals err (a) in applying the fraud-on-

the-market doctrine which eliminates the reliance requirement

of Rule 10b-5, and (b) in extending the doctrine to cases involv-

ing the purchase of original-issue, fixed-price securities that are

not traded on an active and developed market?

2. Did the Court of Appeals err in holding that, for purposes

of deciding a motion for class certification, the District Court

is required to accept as true all the allegations of the complaint,

and may not weigh the record evidence in determining whether

the movants have satisfied their burden of proving compliance

with the requirements of Rule 23, Federal Rule; of Civil

Procedure?

ill

RULE 28.1 LIST*

Non-Wholly-Owned Subsidiaries and

Affiliates of Shearson Lehman Brothers Inc.

Active Subsidiaries

Boston Hambro Corp.

Boulevard Investors Inc.

Boulevard Real Estate Corp.

Burlington Investors Inc.

E.B. Realty

Lombard Realty Corporation

Lowell Investors Inc.

Lowell Real Estate Corp.

Shearson Dat-Cheong Company Limited

Shearson Lehman/Finanz AG

Shearson/KM, Inc.

Inactive Subsidiaries

Genex Insurance Brokerage Ltd.

Mideast-American, Inc.

Affiliates

California S.A.

Shearson Financial Services of Oklahoma, Inc.

Shearson Financial Services of Texas, Inc.

Shearson Lehman Brothers SARL

Intermodal Equipment Associates

KCC Syndicate Managers, Inc.

McLeod Young Weir Limited

New World Corporation

Rex Moor Properties Incorporated

Sovran Energy Corp.

* All parties to the proceeding below are named in the caption. Petitioner Shear-

son Lehman Brothers Inc. was named in the complaint as Shearson/American

Express Inc., and petitioner The Robinson-Humphrey Company, Inc. was named

as Robinson Humphrey/American Express Inc.

Non-Wholly-Owned Subsidiaries and Affiliates

of Shearson Lehman Brothers Holdings Inc., the

Parent Company of Shearson Lehman Brothers Inc.*

American Express Asset Management Limited

American Express Asset Management N.V.

American Express Asset Management S.A.

American Express U.K. Holding Company Inc.

FGIC Corporation

Kuhn Loeb Lehman Brothers International B.V.

Lehman Brothers Internetional UK Ltd.

Lehman International Finance N.V.

Lehman Overseas N.V.

LBKL 82-1 Investors Inc.

Shearson Lehman Broadgate North Inc.

Shearson Lehman Broadgate South Inc.

— ————S

* The parent company of Shearson Lehman Brothers Holding Inc. is the

American Express Company.

TABLE OF CONTENTS

QUESTIONS PRESENTED ...................

NE I hh bio rn as kee endaus sees

py. fF he Piiygy 6 yy) + See re

SIE sooo o rk cc tcadenacvaneesses

po RARE NP Orr re ere PEPE OE eee

STATUTES AND RULES INVOLVED .........

STATEMENT OF THE CASE .................

Si, Ts Pe ek Es io ak ek eae

B. The District Court’s Class Certification

| Saher ee popes Clee i ee

C. The Opinion Of The Eleventh Circuit Court

Tis nye eA, ee

I. APPLICATION OF THE FRAUD-ON-THE-

MARKET THEORY IS AN ISSUE WHICH

THIS COURT ALREADY HAS DEEMED

TO BE OF SUFFICIENT MOMENT TO

WARRANT REVIEW ON CERTIORARI ...

II. INDEPENDENTLY, THE VALIDITY OF

THE ELEVENTH CIRCUIT'S

ABANDONMENT OF THE RULE 10b-5

RELIANCE REQUIREMENT IN THE

CONTEXT OF UNDEVELOPED, NON-

EFFICIENT MARKETS IS AN ISSUE OF

IMPERATIVE NATIONAL IMPORTANCE. .

Page

A. The Fraud-On-The-Undeveloped Market

Theory Lacks Even The Tenuous

Foundations Of Its Developed-Market

| Re Oy eee ll

1. There is no principled basis in law or

economics for the extension of the

fraud-on-the-market theory to

undeveloped, non-efficient markets .... 1]

2. The Eleventh Circuit’s fraud-on-the-

undeveloped-market doctrine effects an

unreasonable abandonment of the Rule

10b-5 reliance requirement ........... 14

B. The Distinction Between So-Called

“Marketable” And “Unmarketable”

Securities, Which Is The Sole Rationale

For The Shores Doctrine, Is Unprincipled

And Contrary To The Fundamental

Structure Of The Federal Securities Laws . 16

1. The notion that securities can be

“unmarketable” is alien to the federal

OE oo hon usb coccce ct ce<ccn 16

2. The “unmarketability” test is an

~. inadequate substitute for the critical

element of reliance................... 17

III. BY RELIEVING CLASS ACTION

PLAINTIFFS OF THEIR RULE 23 BURDEN

OF PROOF AND LIMITING THE

DISTRICT COURT’S INQUIRY TO THE

FACE OF THEIR COMPLAINTS, THE

ELEVENTH CIRCUIT'S OPINION

CONFLICTS WITH PRECEDENT AND

ALSO RAISES AN IMPORTANT

QUESTION CALLING FOR THE

EXERCISE OF THIS COURT’S

SUPERVISORY POWERS ................. 19

IV. THE PANEL OPINION CONFLICTS WITH

THE PRONOUNCEMENTS OF THIS AND

LOWER COURTS FORBIDDING THE

UNREASONABLE EXTENSION OF THE

RULE 10b-5 CAUSE OF ACTION AND

EXPANSION OF PLAINTIFF CLASSES ....

GI 6 Bis Oe a Ce cadeccceutsresccssoes

APPENDICES

Opinion Of The United States Court Of

Appeals For the Eleventh Circuit

. Opinion Of The United States District

Court For The Northern D:strict Of

Georgia On Plaintiffs’ Motion For

Reconsideration Of That Court’s Denial

Of Class Certification

. Opinion Of The United States District

Court For The Northern District Of

Georgia On Plaintiffs’ Motion For Class

Certification

. Opinion Of The United States District

Court For The Northern District Of

Georgia On Defendants’ Motion For

Dismissal

. Order Of The United States Court Of

Appeals For The Eleventh Circuit

Granting Plaintiffs’ Petition For

Interlocutory Review

. Order Of The United States Court Of

Appeals For The Eleventh Circuit Denying

Panel And In Banc Rehearing

Page

Viii

Page

G. Order Of The United States Court Of

Appeals For The Eleventh Circuit Staying

The Issuance Of Its Mandate

H. Statutory And Regulatory Provisions

Involved

TABLE OF AUTHORITIES

CASES

Affiliated Ute Citizens v. United States, 406

ft BSAA ore

Basic Inc. v. Levinson, 107 S. Ct. 1284

(1987), granting cert. to, 786 F.2d 741 (6th

SR Pe ae ee Ps ee

Bishop v. Committee on Professional Ethics

and Conduct of the Iowa State Bar Ass’n,

686 F.2d 1278 (8th Cir. 1982) ............

Blackie v. Barrack, 524 F.2d 891 (9th Cir.

1975), cert. denied, 429 U.S. 816 (1976) ...

Blue Chip Stamps v. Manor Drug Stores, 421

Se Se Rc rerrrewens ka éskssnpscees

Bonner v. City of Prichard, 661 F.2d 1206

(1lth Cir. 1981) (en banc) ...............

Coopers & Lybrand v. Livesay, 437 U.S. 463

— ialegergipe tone ca te sea

RAREST a SST OE Ee

General Telephone Co. v. Falcon, 457 U.S.

EP Or eee ee

In re LTV Securities Litigation, 88 F.R.D.

Se ES PS ca ce sce bbewscecses

In re Petro-Lewis Securities Litigation,

[1984-85 Transfer Binder] Fed. Sec. L. Rep.

(CCH) 4 91,899 (D. Colo. 1984)..........

Kennedy v. Tallant, 710 F.2d 711 (11th Cir.

Si eae felipe Aaa) eee ai

Page(s)

6, 18

passim

Kirkpatrick v. J.C. Bradford & Co., 827 F.2d

Oe COS Ga Sh ik 4 ha eae en

Kline v. Wolf, 702 F.2d 400 (2d Cir. 1983) ..

Levinson v. Basic Inc., 786 F.2d 741 (6th Cir.

1986), cert. granted, 107 S. Ct. 1284 (1987)

List v. Fashion Park, Inc., 340 F.2d 457 (2d

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

Love v. Turlington, 733 F.2d 1562 (11th Cir.

Meer res rey! ee oR ram

McCarthy v. Kleindienst, 741 F.2d 1406

a ee eee ny rere

Mercantile Natl Bank v. Langdeau, 371 U.S.

EEE Wahid a ooen eka ee ceuewen ka

Morrison v. Booth, 730 F.2d 642 (11th Cir.

DD 5 ha 4d Ee Gk Be Ome Pee wo as

Panzirer v. Wolf, 663 F.2d 365 (2d Cir.

1981), cert denied on class action issues, 458

U.S. 1107, cert. granted on other issues,

458 U.S. 1105, vacated as moot, 459 U.S.

SUE SUE 0k 6's pins wpe bau aeevs ce

Peil v. Speiser, 806 F.2d 1154 (3d Cir. 1986) .

Sanders v. Robinson Humphrey/American

Express, Inc., [1985-86 Transfer Binder]

Fed. Sec. L. Rep. (CCH) 4 92,450 (N.D.

GUL I a xo edwin yr denieneene ce Mone bie. «s

Sanders v. Robinson Humphrey/American

Express, Inc., 634 F. Supp. 1048 (N.D. Ga.

1986), rev'd in part, aff'd in part and

remanded sub nom., Kirkpatrick v. J.C.

Bradford & Co., 827 F.2d 718 (11th Cir.

SE eh A aredirg tin ree) oh cee

Page(s)

passim

16, 17

2, 4

Sanders v. Robinson Humphrey/American

Express, Inc., [1986-87 Transfer Binder] Fed.

Sec. L. Rep. (CCH) { 92,880 (N.D. Ga. 1986) .

Santa Fe Industries v. Green, 430 U.S. 462 (1977)

S.E.C. v. Texas Gulf Sulphur Co., 401 F.2d 833

a erwrerer ry er rere

Shores v. Sklar, 647 F.2d 462 (5th Cir. May 1981)

(en banc), cert. denied, 459 U.S. 1102 (1983) ..

Sirota v. Solitron Devices, Inc., 673 F.2d 566 (2d

Cir.), cert. denied, 459 U.S. 838 (1982) .......

Svenningsen v. Piper, Jaffray & Hopwood, Inc.,

[1986-87 Transfer Binder] Fed. Sec. L. Rep.

(CCH) ¢ 92,854 (D. Minn. 1986) ............

Zeidman v. J. Ray McDermott & Co., 651 F.2d

1050 ite Gir, Ge A EGSD) .. eens.

STATUTUES, RULES AND REGULATIONS

Federal Rules of Appellate Procedure

EI ES SCRE OO

Federal Rules of Civil Procedure

ee ee awee reas’

Jurisdictional Statutes

ia esc ec be waw ads cecen ae

Ee ee ee

Rules of the Eleventh Circuit Court of Appeals

ee Sy ee er oe

Securities Act of 1933

eT eg | a

Section 19/3), 15 U.S.C. § T7i(2).............

SS eae Ee | re

oe oe Be rr

Page(s)

passim

xii

Securities and Exchange Commission Regulations

Rule 10b-5, 17 C.F.R. § 240.10b-5...........

Securities Exchange Act of 1934

Section 10(b), 15 U.S.C. § 78j(b).............

pecmon B7, 16 U.S.C. § Teee................

BOOKS, PERIODICALS & TREATISES

Black, Fraud on the Market: A Criticism of

Dispensing with Reliance Requirements in

Certain Open Market Transactions, 62 N.C.L.

Sela ks carn kiti es wands ac.

Note, The Fraud-on-the-Market Theory, 95 Harv.

i SS I I ig bin osc vScesavsasadeas

15 C. Wright, A. Miller, & E. Cooper, Federal

Practice & Procedure § 3911 (1976) ..........

OTHER MATERIALS

Brief Amici Curiae of Arthur Andersen & Co., et

al., in Support of Petitioners, Basic Inc. v.

Levinson, No. 86-279 (U.S.) .................

Brief for the Securities and Exchange Commission

as Amicus Curiae, Basic Inc. v. Levinson, No.

nt SR rrr re rert eee

Brief of American Institute of Certified Public

Accountants as Amicus Curiae in Support of

Petitioners, Basic Inc. v. Levinson, No. 86-279

DME Soo hice b¢s34s0n eekbaees rE...

Page(s)

12, 13

10, 12,

NO.

IN THE

Supreme Court of the United States

OcTosBer TERM, 1987

ROBINSON HUMPHREY/AMERICAN EXPRESS, INC.

and SHEARSON/AMERICAN EXPRESS INC.,

Petitioners,

GLENN T. SANDERS and LESLIE D. SANDERS,

on behalf of themselves and all others similarly situated,

Respondents.

PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE ELEVENTH CIRCUIT

Petitioners, The Robinson-Humphrey Company, Inc.

(“Robinson-Humphrey”), successor to Robinson Humphrey/

American Express, Inc., and Shearson Lehman Brothers Inc.,

successor to Shearson/American Express Inc., respectfully re-

quest that a writ of certiorari issue to review the judgment and

opinion herein of the United States Court of Appeals for the

Eleventh Circuit entered on September 15, 1987. Based on its

holding that the “fraud-on-the-market” theory applies even to

fixed-price, newly issued securities sold on an undeveloped

market, the Eleventh Circuit, inter alia, reversed the district

court’s rejection of the fraud-on-the-market theory in this case

and its related denial of class certification of certain of

respondents’ federal securities claims.

OPINIONS BELOW

The opinion of the Court of Appeals for the Eleventh Circuit,

captioned Kirkpatrick v. J.C. Bradford & Co., is reported at 827

F.2d 718, and is reproduced at Appendix A hereto! The three

opinions of the United States District Court for the Northern

District of Georgia, captioned Sanders v. Robinson-

Humphrey/American Express, Inc., are reported at [1986-87

Transfer Binder] Fed. Sec. L. Rep. (CCH) ¢ 92,880; 634 F. Supp.

1048;? and [1985-86 Transfer Binder] Fed. Sec. L. Rep. (CCH)

{ 92,450. They are reproduced at Appendices B, C and D herein,

respectively.

JURISDICTION

On September 15, 1987, the Eleventh Circuit entered a judg-

ment and an opinion on respondents’ appeal from the district

court’s denial of class certification. (See App. A.) The Appeals

Court had accepted jurisdiction on this matter on August 21, 1986

pursuant to 28 U.S.C. § 1292(b). A copy of the order accepting

jurisdiction is reproduced at Appendix E. Petitioners filed a sug-

gestion for in banc rehearing, which, pursuant to Rule 35-6 of

the Eleventh Circuit, automatically was treated as a petition for

both panel and full-court rehearing. The Court of Appeals denied

panel and in banc rehearing on October 21, 1987. A copy of the

order denying rehearing is reproduced at Appendix F. On

November 17, 1987, the Eleventh Circuit, on petitioners’ motion

pursuant to Fed. R. App. P. 41(b), stayed the issuance of its

' The instant action and two similar Petro-Lewis actions, Kirkpatrick v. J.C.

Bradford ¢ Co. and Parker v. PaineWebber Group, Inc., were considered jointly

by the District Court for purposes of the class action determinations and by

the Eleventh Circuit on plaintiffs’ appeals; each court issued a consolidated opi-

nion for all three cases.

* The opinion and order of the district court denying class certification, originally

entered on March 27, 1986, was modified by order dated June 19, 1986. The

text of the March 27 opinion, as reproduced in both Appendix C hereto and

in the Federal Supplement, incorporates the modifications.

mandate “to and including November 23, 1987.” A copy of the

order staying the issuance of the mandate is reproduced at Ap-

pendix G. The jurisdiction of this Court to review the judgment

of the Eleventh Circuit is invoked under 28 U.S.C. § 1254(1).

STATUTES AND RULES INVOLVED

The statutes and rules involved in the proceeding, which are

set out in full at Appendix H, are Section 10(b) of the Securities

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

Securities and Exchange Commission Rule 10b-5 (“Rule 10b-5”),

17 C.ER. § 240.10b-5; Sections 11, 12(2) and 15 of the Securities

Act of 1933 (the “Securities Act”), 15 U.S.C. §§ 77k, 771(2), 770;

and Rule 23, Federal Rules of Civil Procedure.

STATEMENT OF THE CASE

This action arises from the sale, through petitioner Robinson-

Humphrey to respondents and other putative class members, of

limited partnership interests issued by Petro-Lewis Corporation

(“Petro-Lewis”). Respondents allege that Robinson-Humphrey’s

Petro-Lewis sales during the three-year purported class period

violated various provisions of the federal securities laws, as well

as state and common law. Respondents invoked the district court’s

jurisdiction under Section 27 of the Exchange Act, 15 U.S.C. §

78aa; Section 22 of the Securities Act, 15 U.S.C. § 77v; and under

28 U.S.C. § 1331 (general federal question jurisdiction) as well

as principles of pendent jurisdiction.

A. The Facts

From 1970 to 1983, Petro-Lewis was the nation’s largest seller

of oil and gas income fund limited partnership interests, selling

in excess of $3 billion worth. (App. C-2.) Petro-Lewis acquired

oil and gas properties for public limited partnerships, shared

ownership of those properties, and managed the limited part-

nerships as general partner. (Id.)

Petro-Lewis limited partnership interests were not publicly

traded; there was no active and developed trading market on

which the interests could be purchased or sold. (Id. at 28.) In-

stead, an interested investor could purchase limited partnership

interests from the issuer, Petro-Lewis, through any of numerous

broker-dealers at an inflexible, fixed price which was set by Petro-

Lewis. (Id.) Similarly, limited partners wanting to sell their in-

terests had a limited right to present their interests to Petro-Lewis

for repurchase, again at a price set not by any “market,” but by

Petro-Lewis. (Id.) Petro-Lewis limited partnership interests were

not listed on any national or regional exchange, or any otner

trading medium.

Respondents purchased Petro-Lewis partnership interests

through Robinson-Humphrey, a registered broker-dealer, on three

occasions in 1981 and 1982. (App. D-2.) Respondents did not re-

ly on any of the prospectuses issued in connection with these

limited partnerships in making any of their Petro-Lewis in-

vestments; this is not disputed. In fact, respondents testified at

deposition that they did not even read the prospectuses or any

other written materials prior to making their three investments.

(App. C-25-26 n.12.) Rather, respondents based their Petro-Lewis

investment decisions on the oral recommendations and opinions

of their broker, who had been a friend of Mrs. Sanders’ family

for many years prior to respondents’ first purchase of Petro-Lewis

limited partnership interests. (Id.)

In February 1984, Petro-Lewis announced that financial dif-

ficulties, precipitated by the world-wide decline of oil prices, had

forced it to implement a series of dramatic economy measures.

These measures included reducing partnership distributions by

as much as 50 per cent and selling between one-quarter and one-

third of Petro-Lewis’ oil and gas reserves. (Id. at 2-3.) The misfor-

tunes of Petro-Lewis, well-publicized and widely followed,

prompted the filing of numerous lawsuits.

Eleven consolidated class actions in Colorado filed by investors

against Petro-Lewis and its officers and directors, but in which

brokerage firms like petitioners were not named as defendants,

were settled in late 1984, after stipulated class certification for

settlement purposes. See In re Petro-Lewis Securities Litigation,

Hie Beate + “

[1984-85 Transfer Binder] Fed. Sec. L. Rep. (CCH) { 91,899 (D.

Colo. 1984). The cornerstone of the settlement was the forma-

tion of the American Royalty Trust (the “Trust”). Under the set-

tlement, the Petro-Lewis limited partnership interests and their

related assets were acquired from the settling class members in

return for Trust units. In its opinion approving creation of the

Trust as part of the settlement, the Colorado district court noted

that a key advantage of the Trust structure was that these new

Trust units, unlike the original limited partnership interests, would

be listed on the American Stock Exchange; thus, as of 1985, for

the first time, a true “market” would exist for the Petro-Lewis

partnership-based securities which would “provide new liquidi-

ty” to the settling investors. (Id. at 90,468.) Pursuant to the Col-

orado settlement, respondents herein eventually received Trust

units in exchange for their partnership interests.

Respondent Glenn Sanders commenced the instant action on

January 25, 1985, subsequent to the Colorado settlement. The

complaint was amended on October 17, 1985 to add Mrs. Sanders

as plaintiff.

B. The District Court’s Class

Certification Opins

A class certification motion was filed on April 25, 1985;

respondents sought to represent a class of investors who purchased

the original Petro-Lewis limited partnership interests through

petitioners from January 1, 1981 through February 6, 1984. (App.

C-5.) Under extensive briefing both before and after an eviden-

tiary hearing on Rule 23 issues, the district court denied class

certification. (See App. C.) On respondents’ motion for recon-

sideration, and after still further briefing, the district court reaf-

firmed its order, and certified an interlocutory appeal pursuant

to 28 U.S.C. § 1292(b). (See App. B.)

The district court’s orders denying class certification were based

on a number of independent grounds, only one of which is ger-

mane to this petition — respondents’ failure to meet the Rule

23(b)(3) predominance requirement. The district court held that

because, inter alia, respondents admittedly had relied on the oral

statements of their personal broker rather than on the prospec-

tuses or other written materials relating to the Petro-Lewis limited

partnerships, respondents’ Rule 10b-5 claims raised individualized

questions of reliance that would predominate over common ques-

tions of law and fact. (App. C-29.) The trial court ruled that

respondents were not entitled to a presumption of reliance under

any version of the fraud-on-the-market theory or under the rule

established in Affiliated Ute Citizens v. United States, 406 U.S.

128 (1972). (App. C-29.) Thus, the court held that class treat-

ment of the Rule 10b-5 claims was barred by respondents’ failure

to satisfy their Rule 23(b)(3) burden of proving that common

questions would predominate over individualized questions.

C. The Opinion Of The Eleventh

Circuit Court Of Appeals

The appellate court’s September 15, 1987 opinion affirmed the

denial of class certification of the state and common law claims;

however, the panel reversed the district court’s holding that class

treatment of the federal securities law claims was barred »y Rule

23(b) predominance considerations. (App. A.)

In reversing the lower court, the panel held that the Rule

10b-5(1) and 10b-5(3) claims were certifiable on the sole ground

that those claims, as pleaded, entitled respondents to be excused

from proving reliance affirmatively pursuant to the so-called

fraud-on-the-market exception announced in Shores v. Sklar, 647

F.2d 462 (Sth Cir. May 1981) (en banc), cert. denied, 459 U.S.

1102 (1983). (App. A-6, 7.) In its 12-10 en banc decision, the Shores

court became the first to apply the fraud-on-the-market theory

to a purchase or sale of securities in an undeveloped market.’

* Both the district court and the panel were bound by and constrained from

reexamining Shores. See Bonner v. City of Prichard, 661 F.2d 1206, 1209-10 (lth

Cir. 1981) (en banc). In denying petitioners’ Suggestions For Rehearing In Banc,

the Eleventh Circuit in banc effectively refused to review the ongoing vitality

of Shores.

Stating that the securities laws “cover deliberate, manipulative

schemes to defraud which can annul . . . the market's honest

function,” 647 F.2d at 464 (emphasis added), Shores held that

Rule 10b-5 reliance may be established sufficiently by proof that

the plaintiff “reasonably relied on the [securities’] availability on

the market as an indication of their apparent genuineness,” id.

at 469-70. As applied by the panel herein, this fraud-on-the-

undeveloped-market theory allows a class representative to in-

voke its reliance presumption to establish Rule 23 predominance.

Under Shores, reliance will be deemed established in an

undeveloped-market context only if the securities at issue “were

not entitled to be marketed” at all. Id. at 469; see also App. A-7,

8. Thus, if a plaintiff “proves no more than that the [securities]

would have been offered at a lower price . . . rather than that

they would never have been issued or marketed, he cannot

recover” under the fraud-on-the-undeveloped-market theory.

Shores, 647 F.2d at 470.

The panel in the instant action further stated that under the

Shores doctrine, a plaintiff's reliance on the market need not be

the exclusive or even primary basis for his purchase of securities

in order for him to get the benefit of the presumption. (App. A-8.)

As long as he placed any amount of faith in the mere availabili-

ty of the security to the public, a claimant may proceed on a

fraud-on-the-market theory even if he relied primarily on other

factors in making his investment decisions. (Id.)

Additionally, the panel agreed with the district court that the

Rule 10b-5(2) claims would require individualized proof of

reliance. (Id. at 10-11.) Nevertheless, the panel held that the Rule

23(b)(3) predominance requirement was satisfied by virtue of the

fact that the complaint “alleges ‘a single conspiracy and fraudulent

scheme against a large number of individuals’ and thus is ‘par-

ticularly appropriate for class action. ” (Id. at 10 (quoting Ken-

nedy v. Tallant, 710 F.2d 711, 718 (11th Cir. 1983)).) This was

the sole ground for the reversal of the district court’s determina-

tion that common issues would not predominate with respect to

the 10b-5(2) claims.

REASONS FOR GRANTING THE WRIT

APPLICATION OF THE FRAUD-ONTHE-MARKET

THEORY IS AN ISSUE WHICH THIS COURT

ALREADY HAS DEEMED TO BE OF SUFFICIENT

MOMENT TO WARRANT REVIEW ON

CERTIORARI

This petition seeks review of the so-called “fraud-on-the-

market” doctrine, in particular (i) the doctrine’s effective elimina-

tion of the traditional Rule 10b-5 requirement that plaintiffs plead

and prove reliance on alleged misstatements,‘ and (ii) its

widespread use as a vehicle for circumventing the Rule 23(b)(3)

predominance test. This petition raises issues that are substan-

tially identical to those asserted in the context of developed-market

securities transactions by the petitioners in Basic Inc. v. Levin-

son, 107 S. Ct. 1284 (1987), granting cert. to, 786 F.2d 741 (6th

Cir. 1986), a case now sub judice before the Court.*

This Court granted certiorari in Basic Inc. in order to address,

inter alia, the legitimacy of the fraud-on-the-market theory in

an open-market context. Basic Inc. involved claims by a putative

class of sellers of the common stock of Basic Incorporated (“Basic”)

that the price at which Basic shares were traded on the New York

Stock Exchange was artificially depressed due to certain allegedly

misleading public statements issued by Basic. On the basis of these

* In order to avoid repetition, petitioners use the term “misstatements” to refer

to misrepresentations, omissions, and any device, scheme or other means by

which a defendant is alleged to make fraudulent disclosures or nondisclosures

of material information.

* Because So many class actions are settled before final judgment, the fraud-on-

the-market theory has eluded this Court's review despite its vital importance.

This Court granted certiorari in order to review the doctrine as early as 1982;

however, that case was vacated as moot when the plaintiff-respondent withdrew

the lawsuit prior to argument. Panzirer v. Wolf, 663 F.2d 365 (2d Cir. 1981),

cert. denied on class action issues, 458 U.S. 1107, cert. granted on other issues,

458 U.S. 1105, vacated as moot, 459 U.S. 1027 (1982).

fraud-on-the-market allegations, the district court certified a class

of sellers of Basic shares, but explicitly noted that, absent a

presumption of reliance, denial of class certification would have

been required under Fed. R. Civ. P. 23(b)(3). After discovery, the

district court granted summary judgment for defendants. Plain-

tiffs appealed, and defendants cross-appealed the order granting

class certification. The Sixth Circuit Court of Appeals reversed

the order granting summary judgment but affirmed class cer-

tification, noting with approval the district court’s application

of a fraud-on-the-market presumption of reliance “[t]o circum-

vent what the district court perceived to be a barrier to class ac-

tions in 10b-5 cases . . . .” Levinson v. Basic Inc., 786 F.2d 741,

749-50 (6th Cir. 1986), cert. granted, 107 S. Ct. 1284 (1987).

The instant petition, like that in Basic Inc., asks the Court to

resolve the important question of whether the fraud-on-the-

market theory properly may be invoked to subvert the long-

standing Rule 10b-5 reliance requirement, and thereby provide

a shortcut to class certification. If this Court rejects the theory

in the traditional, developed-market context presented in Basic

Inc., the instant case will require, at a minimum, remand to the

Court of Appeals for reconsideration in light of that opinion.

Clearly, the more extreme version of the fraud-on-the-market

theory created by Shores and applied in this case could not sur-

vive a holding in Basic Inc. that rejected fraud-on-the-market

in the developed-market context. Thus, this Court should grant

the instant petition on grounds that it presents a case which is

closely related to, and potentially controlled by, Basic Inc.

Il.

INDEPENDENTLY, THE YALIDITY OF THE

ELEVENTH CIRCUITS ABANDONMENT OF THE

RULE 10b-5 RELIANCE REQUIREMENT

IN THE CONTEXT OF UNDEVELOPED,

NON-EFFICIENT MARKETS IS AN ISSUE OF

IMPERATIVE N4TIONAL IMPORTANCE

Even assuming the validity of the fraud-on-the-market doc-

trine as applied to open-market transactions, the instant peti-

tion should be granted so that this Court may consider the validity

of that theory in its most extreme form — the Shores applica-

tion of the doctrine to undeveloped markets.

The Eleventh Circuit's extension of the fraud-on-the-market

doctrine to undeveloped markets takes the instant case beyond

even the questionable theoretical underpinnings of fraud-on-the-

market as applied in Basic Inc. Unlike Basic securities which were

traded on the New York Stock Exchange, Petro-Lewis limited

partnership interests were not listed on the New York, American,

or any of the regional stock exchanges, nor were they traded on

any market on which prices arguably fluctuate in supposed

response to available information. Rather, Petro-Lewis interests

were purchased from, and on occasion were resold (by redemp-

tion) to, Petro-Lewis. These securities never were “traded” at all,

certainly not in the sense of trading on an active, price-sensitive

market.

This distinction makes the instant case an even more compelling

candidate than Basic Inc. for this Court's review.* At a minimum,

the developed-market/undeveloped-market distinction makes this

case aX.important complement to Basic Inc. While rejection of

the fraud-on-the-market doctrine in Basic Inc. necessarily would

* The amicus brief of the Securities and Exchange Commission (“SEC”) in the

Basic Inc. proceeding similarly draws a distinction between the two versions

of the fraud-on-the-market theory, and expressly declines to address the merits

of the theory in the undeveloped-market context. See Brief for the Securities

and Exchange Commission as Amicus Curiae, Basic Inc. v. Levinson, No. 86-279

(U.S.) (SEC Br”) at 22 n.26.

compel rejection of the doctrine in the context of the undeveloped

markets for unlisted, untraded securities such as Petro-Lewis in-

terests, a contrary finding in Basic Inc. would leave unaddress-

ed the much more controversial question of the doctrine’s validity

in this closely related, companion area. Thus, granting the re-

quested writ will permit the Court to deal with the full scope

of the fraud-on-the-market theory as it is being applied by the

lower courts.

A. The Fraud-On-The-Undeveloped-Market

Theory Lacks Even The Tenuous Foundations

Of Its Developed-Market Counterpart

Proponents of the traditional, developed-market fraud-on-the-

market theory justify the doctrine in two ways. First, they claim

theoretical economic support for the doctrine in the “efficient

market hypothesis.” Second, they disclaim subversion of the

reliance requirement, arguing that the rebuttable presumption

created by the doctrine “merely” effects a reallocation of the

burden of proof, not an elimination of the reliance element of

the cause of action. The fraud-on-the-undeveloped-market theory,

however, cannot be buttressed by either of those two arguments.

l. There is no principled basis in law

or economics for the extension of

the fraud-on-the-market theory to

undeveloped, non-efficient markets

The fraud-on-the-undeveloped-market theory, while sweep-

ing in scope, is wholly devoid of any sound rationale. The

theoretical foundation for the traditional fraud-on-the-market

theory (of the Basic Inc. variety) is the “efficient market

hypothesis,” an economic theory of market behavior which, by

definition, is inapplicable to undeveloped markets.’ As the SEC

explained in its friend-of-the-court brief in Basic Inc.,

’ The efficient market hypothesis focuses on the supposed valuation functions

of a developed market, such as the national exchanges, and holds that the price

(footnote continued on next page)

[t]he fraud on the market theory rests on two pro-

positions: that in an active secondary market the price

of a company’s stock is determined by all material in-

formation available regarding the company and its

business; and that investors rely on the integrity of —

market prices when making investment decisions.

These propositions together establish that such investors

rely, albeit indirectly, on material misrepresentations

concerning actively traded securities.

SEC Br. at 22 (emphasis added) (citations omitted). The SEC’s

synopsis properly identifies the critical element upon which the

entire doctrine turns: the existence of active, price-sensitive secon-

dary markets on which the securities are traded. In the absence

of such a market, the fundamental underpinning of the fraud-

on-the-market theory is missing, and the theory must fail.

Manifestly, even the “traditional” fraud-on-the-market theory

is sufficiently controversial to have warranted certiorari in Basic

Inc. The Eleventh Circuit, however, has extended the doctrine’s

already attenuated justifications beyond all economic or legal

realities by applying the doctrine to non-efficient, undeveloped

markets. The efficient market hypothesis, the very heart of the

fraud-on-the-market theory, does not operate where the market

is undeveloped. E.g., Note, The Fraud-on-the-Market Theory,

95 Harv. L. Rev. 1143, 1161 (1982) (“[B]ecause it is at best uncer-

tain whether undeveloped markets are efficient, the fraud-on-

the-market theory should not be applied to them in any form.”).

(footnote continued from previous page)

at which a security is traded on such a r: arket reflects all available material

information bearing on that security. Market participants assemble and analyze

the public information and, by trading in reliance on that information, place

upward or downward pressure on a security's price. Theoretically, then, the

resultant price represents the fair and true value of the security as long as the

information in the market is complete and correct. See generally Peil v. Speiser,

806 F.2d 1154, 1160-61 (3d Cir. 1986); In re LTV Securities Litigation, 88 F.R.D.

134, 142-45 (N.D. Tex. 1980); Note, The Fraud-on-the-Market Theory, 95 Harv.

L. Rev. 1143, 1153-56 (1982).

By definition, in the undeveloped-market setting there is no

market on which an investor relies to assimilate and transmit

alleged misstatements by means of a distorted market price. There

can be no distortion of the pricing function where price is set

not by an impersonal market, but by the issuer itself. Without

a price-elastic market acting as an investor’s “agent” for valua-

tion purposes, the investor himself cannot logically escape the

necessity of proving his actual reliance on alleged misstatements

as a prerequisite to a Rule 10b-5 recovery. Commentators,

recognizing this, thus have criticized as unprincipled both the

fraud-on-the-undeveloped-market doctrine generally and the

Shores opinion specifically. See, e.g., Black, Fraud on the Market:

A Criticism of Dispensing with Reliance Requirements in Cer-

tain Open Market Transactions, 62 N.C.L. Rev. 435, 453 (1984);

Note, The Fraud-on-the-Market Theory, 95 Harv. L. Rev. at

1156-58.

The fraud-on-the-undeveloped-market theory not only lacks

the supporting rationale which underlies its open-market counter-

part; it conflicts with it. Indeed, most Courts of Appeals expressly

hold that the fraud-on-the-market theory has no application

where markets are non-efficient: proof that the efficient market

hypothesis is inoperative with respect to a particular security is

held to remove a given case from the ambit of the traditional

fraud-on-the-market theory.’ And a number of courts, some ex-

plicitly referring to Shores, have observed that the traditional

theory’s rationale does not necessarily provide any support for

the undeveloped-market variant. See, e.g., Peil v. Speiser, 806

F.2d 1154, 1161 n.10 (3d Cir. 1986); Basic Inc., 786 F.2d at 751

(distinguishing situations not involving “an impersonal exchange

in the open market”); see also In re LTV Securities Litigation,

* Thus, the courts uniformly allow defendants to rebut the reliance presump-

tion by showing, inter alia, “that the market price did not reflect the corporate

statements” alleged to be actionable. SEC Br. at 22 n.26; see, e.g., Peil v. Speiser,

806 F.2d 1154, 1161 (3d Cir. 1986); Basic Inc., 786 F.2d at 750 n.6; Blackie v.

Barrack, 524 F.2d 891, 906 (9th Cir. 1975), cert denied, 429 U.S. 816 (1976).

In other words, an open-market defendant is allowed to defeat the presump-

tion by proving that which is always true in fraud-on-the-undeveloped market

Cases.

88 F.R.D. 134, 146 (N.D. Tex. 1980); Svenningsen v. Piper,

Jaffray & Hopwood, Inc., [1986-87 Transfer Binder] Fed. Sec.

L. Rep. (CCH) 4 92,854 at 94,149 (D. Minn. 1986).

The instant case is a textbook example of why the fraud-on-

the-market theory lacks any theoretical or logical basis in the con-

text of an undeveloped market. Here, it is undisputed (and dis-

closed in the prospectuses) that the price of Petro-Lewis part-

nership interests was established exclusively by the issuer and did

not fluctuate at all in the manner of actively traded securities.

The fraud-on-the-market theory espoused by Shores and applied

herein thus does not supply even the strained justification that

arguably is present in the open-market context for circumven-

ting the reliance requirement in Rule 10b-5 cases.

Therefore, even if the fraud-on-the-market theory is held by

this Court to play a legitimate role in the open-market context

— petitioners, like Basic, believe it does not — the Eleventh Cir-

cuit’s extension of that theory beyond the boundaries of any col-

orable theoretical foundation nevertheless would warrant separate

consideration by this Court. The question of the validity of the

fraud-on-the-market theory — of imperative national significance

even in the traditional context of developed markets — takes on

even more sweeping but less justifiable dimensions when the

theory is transplanted into undeveloped markets.

2. The Eleventh Circuit’s fraud-on-

the-undeveloped-market doctrine

effects an unreasonable abandonment

of the Rule 10b-5 reliance requirement

As traditionally applied, the fraud-on-the-market theory pur-

ports to be nothing more than an evidentiary rule allocating the

burden of proving reliance. The Basic Inc. petitioners argue, with

merit, that despite the case taw holding the traditional fraud-

on-the-market reliance presumption to be rebuttable, any

theoretical right to offer a rebuttal is illusory in most cases,

especially in large class actions.

Defendants confronted with the undeveloped-market version

of the theory fare even worse. Despite the absence of a logical

foundation, the fraud-on-the-undeveloped-market theory effec-

tively eliminates reliance as a substantive element of the Rule

10b-5 cause of action. Upon a showing that the securities at issue

were not “entitled to be marketed,” not only are plaintiffs excused

from proving affirmative reliance, but defendants cannot even

overcome the “presumption” with direct evidence of non-reliance.

For all practical purposes, the Eleventh Circuit has created by

judicial fiat a substantive rule of law sanctioned neither = this

Court nor by Congress.

The original, developed-market version of fraud-on-the-market

allows defendants to defeat the presumption of reliance in one

of at least two ways: by showing (i) that the price of the securities

at issue was not affected by the alleged misstatements, i.e., the

market was not efficient, or (ii) that the plaintiffs relied on fac-

tors other than the integrity of the market when making their

investments. See, e.g., Peil, 806 F.2d at 1161; Kline v. Wolf, 702

F.2d 400, 403 (2d Cir. 1983); Blackie v. Barrack, 524 F.2d 891,

906 (9th Cir. 1975), cert. denied, 429 U.S. 816 (1976). Neither

form of rebuttal is afforded by the Eleventh Circuit’s extension

of fraud-on-the-market into undeveloped markets.

In the context of an undeveloped market, which by definition

is inefficient, the first rebuttal option — showing the inefficien-

cy of the market — is simply not permitted. If it were other-

wise, the “presumption” automatically would be rebutted. In this

respect, the two versions of the fraud-on-the-market theory ac-

tually conflict.

Second, the panel here also rejected expressly, albeit on unar-

ticulated grounds, the second rebuttal avenue — proving that

a plaintiff actually relied on other, non-market” factors. (See A-9.)

The panel opinion thereby stands in conflict with the extensive

line of cases holding that the fraud-on-the-market reliance

presumption may be rebutted by proof that the plaintiff relied

on factors other than the market’s integrity. Thus, as predicted

by the ten Shores dissenters, the fraud-on-the-undeveloped-market

rule has done far more than merely shift the burden of proving

reliance: it has made the “presumption” irrebuttable and

eliminated as a matter of substantive law the long-standing

reliance element of Rule 10b-5(1) and (3) causes of action. See,

e.g., Shores, 647 F.2d at 476-77, 479 (Randall, J., dissenting).

As the papers filed with this Court in Basic Inc. demonstrate,

the language and structure of the securities statutes do not allow

for such extreme and unprincipled excisions of basic ele:aents of

a claim for relief based on those laws.® Reliance and the related

element of causation are all that distinguish Rule 10b-5 from an

insurance plan for disappointed investors, something Congress

never intended to adopt. See, e.g., List v. Fashion Park, Inc.,

340 F.2d 457, 462-63 (2d Cir.), cert. denied, 382 U.S. 811 (1965).

B. The Distinction Between So-Called

“Marketable” And “Unmarketable”

Securities, Which Is The Sole Rationale

For The Shores Doctrine, Is Unprincipled

And Contrary To The Fundamental Structure

Of The Federal Securities Laws

The fraud-on-the-undeveloped-market theory’s lack of legal

or theoretical merit is epitomized by the distinction it draws be-

tween so-called marketable and unmarketable securities. See p.

7 supra. That distinction, on which the entire doctrine purports

to turn, is illusory.

1. The notion that securities

can be “unmarketable” is alien

to the federal securities laws

As the Shores dissenters note, the purpose of the federal

securities laws is to require full and truthful disclosure, not to

*See Brief Amici Curiae of Arthur Andersen & Co., et al., in Support of Peti-

tioners, Basic Inc. v. Levinson, No. 86-279 (U.S.) at 4-9; Brief of American In-

stitute of Certified Public Accountants as Amicus Curiae in Support of Peti-

tioners, Basic Inc. v. Levinson, No. 86-279 (U.S.) at 6-15. In light of the exten-

sive discussion of the statutory scheme and legislative history of the securities

acts presented in Basic Inc., and argued only days ago on November 2, 1987,

petitioners will not burden the Court with a reiteration of those points.

pass on the merit or prospects of particular securities. 647 F.2d

at 482; see also Santa Fe Industries v. Green, 430 U.S. 462, 477-78

(1977). Indeed, the principles underlying the federal securities

laws hold that any security is “entitled to be marketed” as long

as all material information relating to it is fully disclosed; even

a security which is so lacking in prospects as to appear valueless

to the reasonable investor may be “marketed” as long as poten-

tial investors are told the truth about it. Members of the public

then are free to make their own informed decisions regarding

whether they wish to buy what is offered. Liability under Rule

10b-5 is based only on intentionally false disclosures upon which

investors rely to their detriment. Thus, the central premise set

up by Shores, that there is some category of securities which are

“not entitled to be marketed,” is contrary to the central premise

of the federal securities statutes. Yet Shores itself acknowledges

that without drawing this dichotomy the fraud-on-the-

undeveloped-market doctrine could not exist. Shores, 647 F.2d

at 470."

2. The “unmarketability” test is an

inadequate substitute for the

critical element of reliance

The reliance requirement swept away by Shores and the panel

opinion herein supplies an essential limitation on the scope of

Rule 10b-5 causes of action. Specifically, reliance is the link in

the logical chain necessary (a) to establish that a particular defen-

dant’s alleged misstatements in fact caused a claimant’s injury,

and, concomitantly, (b) to ensure that Rule 10b-5 is not trans-

formed into an “insurance plan” for disappointed investors. See,

e.g., List, 340 F.2d at 462-63. The fraud-on-the-un-developed-

” In effect, the Eleventh Circuit, in adopting Shores, has elevated a difference

in degree of injury to a difference in kind that defines the substantive elements

of the cause of action. This leads to anomolous results. For example, the Shores

doctrine holds that a person who pays 10 dollars for a share of stock which

would be worth nothing if the alleged fraud had not occurred would be excused

from proving reliance, while another person who paid 20 dollars for a different

stock actually worth one dollar would be required to prove affirmatively his

direct reliance on specific misstatements. There is no principled basis for such

a distinction.

market theory, by removing the causal link of reliance, disposes

of a key limitation on otherwise bovndless potential liability under

Rule 10b-5.

The Shores doctrine supplies no effective replacement for ac-

tual reliance. The “but-for” causation sanctioned by Shores and

applied by the panel here (but for the fraud, the securities could

not have been marketed) fails to establish causation in fact" Proof

that a security would have been unavailable “but for” a defen-

dant’s alleged misstatements is not the functional equivalent of

reliance on those misstatements. At most, such proof would

establish only that an individual investor would not have had

the opportunity to rely on those misstatements if the securities

had not been marketed.

Rule 10b-5, however, requires more — specifically, a showing

that the misstatements in fact were relied upon and therefore

caused the injury. As this Court has recognized, an investor seek-

ing to recover under Rule 10b-5 must establish “causation in fact.”

Affiliated Ute Citizens v. United States, 406 U.S. 128, 154 (1972)

(emphasis added). The panel’s elimination of this requirement

by relieving Rule 10b-5 plaintiffs in the Eleventh Circuit of any

obligation to prove reliance plainly contravenes this mandate and

warrants the Court’s review.

" The panel's decision specifically recognizes that the Shores doctrine at best

establishes mere “but-for” causation, without recognizing that “but-for” causation

is no adequate substitute for causation in fact, which can be established only

by reliance:

A Shores fraud-on-the-market claim thus is especially suited for

class action treatment, as it makes virtually irrelevant the possibility

that the various purchasers may have relied on different represen-

tations regarding the desirability of the particular security in ques-

tion: all have relied on the integrity of the market in the but-for

sense required by Shores.

(App. A-9 (emphasis added).)

Ill.

BY RELIEVING CLASS ACTION PLAINTIFFS OF

THEIR RULE 23 BURDEN OF PROOF AND

LIMITING THE DISTRICT COURT'S INQUIRY TO

THE FACE OF THEIR COMPLAINTS, THE

ELEVENTH CIRCUIT'S OPINION CONFLICTS

WITH PRECEDENT AND ALSO RAISES AN IMPOR-

TANT QUESTION CALLING FOR THE EXERCISE

OF THIS COURT'S SUPERVISORY POWERS

In the very first paragraph of their Argument to the Eleventh

Circuit, respondents urged reversal on the grounds that the district

court was required to limit its class certification inquiry to the

allegations of their complaint, and that the lower court therefore

erred by considering facts relating to the class certification issue.

See Brief of Glenn T. Sanders and Leslie D. Sanders, Appellants

at 20-21. Despite the body of controlling law to the contrary,

respondents’ position prevailed before the Eleventh Circuit.

It is well settled that a moving plaintiff must carry the burden

of establishing each of the Rule 23 class action requirements. See,

e.g., General Telephone Co. v. Falcon, 457 U.S. 147, 156 (1982);

Love v. Turlington, 733 F.2d 1562, 1564 (llth Cir. 1984); Bishop

v. Committee on Professional Ethics and Conduct of the Iowa

State Bar Ass’n, 686 F.2d 1278, 1288 (8th Cir. 1982); Zeidman

v. J. Ray McDermott & Co., 651 F.2d 1030, 1038 (Sth Cir. Unit

A 1981). Similarly, it is this Court’s long-standing rule that a trial

court may, and often must, turn to the factual record to deter-

mine whether the movant has carried his burden of proof.

As we noted in Coopers & Lybrand v Livesay, 437 US

463, 57 L Ed 2d 351, 98 S Ct 2454, ‘the class deter-

mination generally involves considerations that are

“enmeshed in the factual and legal issues comprising

the plaintiff's cause of action.” ’ Id., at 469, 57 L Ed

2d 351, 98 S Ct 2454 (quoting Mercantile Nat. Bank

v Langdeau, 371 US 555, 558, 9 L Ed 2d 523, 83 S

Ct 520). Sometimes the issues are plain enough from

the pleadings to determine whether the interests of the

absent parties are fairly encompassed within the named

plaintiffs claim, and sometimes it may be necessary

for the court to probe behind the pleadings before com-

ing to rest on the certification question.

Falcon, 457 U.S. at 160 (emphasis added); see also McCarthy

v. Kleindienst, 741 F.2d 1406, 1414 n.8 (D.C. Cir. 1984); Mor-

rison v. Booth, 730 F.2d 642, 643 (L1th Cir. 1984); Sirota v. Solitron

Devices, Inc., 673 F.2d 566, 571 (2d Cir.), cert. denied, 459 US.

838 (1982).

Thus, the district court acted well within the bounds of Rule

23 precedent when, while addressing respondents’ effort to meet

the Rule 23(b)(3) predominance requirement, it openly considered

matters of record beyond the face of the pleadings. Finding on

the basis of facts adduced during discovery and at an eviden-

tiary hearing that respondents had failed to make any showing

that Petro-Lewis interests were “not entitled to be marketed,” the

trial court held that respondents could not resort to the Shores

fraud-on-the-undeveloped-market reliance presumption in ord

to satisfy their Rule 23 burden of proving predominance. Likewise,

the district court determined on the basis of record evidence that

because the alleged misrepresentations were primarily oral, each

putative class member would be required to prove individual

reliance. Hence, individual issues would predominate.

The panel reversed the district court on both of these issues,

but not on any finding that the district court’s factual determina-

tions were clearly erroneous. Rather, error was found in the fact

that the district court endeavored to make such a determination

at all rather than simply accept the unsupported allegations of

the complaint. Addressing respondents’ Rule 10b-5(1) and (3)

claims, the panel stated:

” Indeed, these principles, discussed by the Court in Falcon in the context of

Rule 23(a)(4) inquiries, are of even greater relevance here because, as this Court

observed in Coopers & Lybrand v. Livesay, the “ ‘more complex determina-

tions required in Rule 23(b)(3) class actions entail even greater entanglement

with the merits . . . ’ ” 437 US. at 469 n. 12 (quoting 15 C. Wright, A. Miller,

& E. Cooper, Federal Practice ¢ Procedure § 3911, p. 485 n.45 (1976)).

ce ee Cae eet en aati

eee Ty a Pee eT

sionally

Here, consistent with Shores, plaintiffs alleged that the

Petro-Lewis shares, which were not traded on the open

market, could not have been marketed but for the

defendants’ fraud.

In rejecting this claim as improper for class treat-

ment, the court relied solely on its conclusion that the

plaintiffs’ allegations lacked evidentiary support.

Despite the court's assertions to the contrary, this deter-

mination was an inappropriate inquiry into the merits

\ of the plaintiffs’ claims.

(App. A-7 (emphasis added).) Similarly, with respect to respon-

dents’ Rule 10b-5(2) claims, the panel concluded that the allega-

tion of a “common course of [fraudulent] conduct” was sufficient,

— regardless of considerations of proof, to warrant class certifica-

tion. (Id.) Thus, according to the panel, the mere allegations,

however unsupported, that Petro-Lewis interests were inherent-

ly unmarketable and that petitioners engaged in a course of

fraudulent conduct “common” to each member of the purported

class, were sufficient to require class certification.

In so holding, the panel below has eliminated the district courts’

traditional discretion to determine, as a matter of fact, whether

class action plaintiffs have met the requirements of Rule 23, and

has shackled the district courts to the mere allegations of the com-

plaints. Moreover, the panel thereby has relieved the moving par-

ties of their burden of proving (as opposed to merely alleging)

Rule 23 compliance, while at the same time disabling the op-

posing parties from disproving Rule 23 compliance with facts.

There is no sound basis, statutory or otherwise, for affording

a plaintiff all the power and leverage of the class action device

— to say nothing of requiring that a district court do so — unless

and until he meets the Rule 23 test not by mere allegation, but

by a prima facie factual showing. Indeed, the propriety of a

court’s review of the full state of the record is not only confirmed

by the prior holdings of this Court, it is also implicit in Rule

23(c)(1), which empowers the district courts to modify their class

determinations pursuant to the evolving state of the record

throughout the course of the litigation. The holding below plainly

expresses the Eleventh Circuit's support for class actions on

“policy” grounds, but it runs afoul of this Court’s holdings which

require a plaintiff to prove his entitlement to class certification,

as well as the decisions noted below which cast serious doubt

on the social desirability of such a “policy.” This unprincipled

and far-reaching departure from settled Rule 23 law by a federal

Court of Appeals requires review by this Court, lest it be applied

in the countless class actions\which, as is common, will be set-

tled for inflated sums and never reach this Court for review.

IV.

THE PANEL OPINION CONFLICTS WITH THE

PRONOUNCEMENTS OF THIS AND LOWER

COURTS FORBIDDING THE UNREASONABLE EX-

TENSION OF THE RULE 10b-5 CAUSE OF ACTION

AND EXPANSION OF PLAINTIFF CLASSES

Only rarely will fraud-on-the-undeveloped-market cases reach

trial. Faced with the abandonment of the reliance requirement

and a class so broad that defendants are exposed to potential

judgments exceeding many times over any appropriate liability,

many class action defendants will deem the risks and expense

of class litigation too high, and will settle regardless of the merits

of the claims. The Eleventh Circuit’s rule thus creates a hospitable

environment for strike suits.

As discussed above, elimination of the requirement to show

actual reliance severs the only direct causal tie between a defen-

dant’s alleged misstatements and the plaintiff-investor’s invest-

ment decision. Comparable efforts to expand the ambit of Rule

10b-5 liability have been rejected by this Court in the past. See,

e.g., Ernst ¢ Ernst v. Hochfelder, 425 U.S. 185 (1976) (reaffirm-

ing the restrictive scienter requirement); Blue Chip Stamps v.

Manor Drug Stores, 421 U.S. 723 (1975) (holding that the “in con-

nection with” requirement limits standing to sue). This Court

has explained its unwillingness to open the floodgates to Rule

10b-5 actions that are unconstrained by the traditional elements

of that cause of action by stating that:

to the extent [an expanded view of Rule 10b-5 stan-

ding] permits a plaintiff with a largely groundless claim

to simply take up the time of a number of other peo-

ple, with the right to do so representing an in terrorem

increment of the settlement value . . . it is a social cost

rather than a benefit. Yet to broadly expand the class

of plaintiffs who may sue under Rule 10b-5 would ap-

pear to encourage the least appealing aspect of the use

of the discovery rules.

Blue Chip Stamps, 421 U.S. at 741”

In a similar vein, this Court has identified the precise danger

inherent in tipping the scales in favor of rubber stamp certifica-

tion of Rule 23 classes:

Certification of a large class may so increase the defen-

dant’s potential damages liability and litigation costs

that he may find it economically prudent to settle and

to abandon a meritorious defense.

Coopers & Lybrand v. Livesay, 437 U.S. 463, 476 (1978).

Despite these precedents, the Eleventh Circuit’s ruling has

broadened immeasurably both the Rule 10b-5 cause of action

and the class of investors which may pursue such a claim. The

risks faced by defendants in contemplation of trial, and the

pressures to settle the action, are multiplied correspondingly. The

odds having been stacked against them, many defendants will

settle even those fraud-on-the-undeveloped-market suits which

are wholly lacking in merit. Since the pressures to do so derive

from the Eleventh Circuit’s unprincipled dilution of the proof

® This Court also referred in Blue Chip Stamps to the possibility that unduly

extensive imposition of civil liability under Rule 10b-5 “ ‘will lead to large

judgments, payable in the the last analysis by innocent investors, for the benefit

of speculators and their lawyers;'” the Court futher noted the “widespread

recognition that litigation under Rule 10b-5 presents a danger of vexatiousness

different in degree and in kind from that which accompanies litigation in

general.” 42] U.S. at 739 (1975) (quoting S.E.C. o. Texas Gulf Sulphur Co., 401

F.2d 833, 867 (2d Cir. 1968) (Friendly, J., concurring)).

required in Rule 10b-5 cases, coupled with its impermissible skew-

ing of established Rule 23 procedures in favor of class plaintiffs,

this Court's review is imperative.

Time and again, the fraud-on-the-market doctrine is invoked

by plaintiffs who never read, let alone relied upon, the alleged

misstatements of which they complain. Under the prevailing

fraud-on-the-market doctrine, this approach enables plaintiffs

not merely to avoid dismissal of their own defective claims, but

indeed to support their use of Rule 23 to expand such claims in-

to the blunt instrument of a class action. The perversity of such

a practice, its pervasive use in nearly every major securities litiga-

tion, and the ability of the fraud-on-the-market doctrine to elude

this Court’s review since certiorari was first granted to review

it five years ago, strongly supports the granting of this petition.

CONCLUSION

For all of the foregoing reasons, petitioners respectfully urge

the Court to grant this petition and issue a writ of certiorari to

the United States Court of Appeals for the Eleventh Circuit in

order to address these issues of national importance.

Dated: New York, New York

November 23, 1987

Harvey D. Myerson

Counsel of Record for Petitioners

FINLEY, KuMBLE, WAGNER, HEINE,

UNDERBERG, MANLEY, MYERSON & CASEY

425 Park Avenue

New York, New York 10022

(212) 371-5900

Lioyp S. CLAREMAN

FinLey, KuMBLE, WAGNER, HEINE,

UNDERBERG, MANLEY, MYERSON & CASEY

Ma.coim D. Youn, Jr.

Perer J. ANDERSON

PETERSON YOUNG SELF & ASSELIN

Attorneys for Petitioners

APPENDIX

Suzanne KIRKPATRICK; Dorothy D. Casler and Charles H.

Lindsey, on behalf of themselves and all others similarly situated,

Plaintiffs-Appellants,

J.C. BRADFORD & CO.,

Defendant-Appellee.

Glenn T. SANDERS on behalf of himself and all others similarly

situated, and Leslie D. Sanders,

Plaintiffs-Appellants,

Vv.

ROBINSON HUMPHREY/ AMERICAN EXPRESS, INC., and

Shearson/ American Express, Inc.,

Defendants-Appellees.

Tommy E. PARKER, as custodian for Kimberly M. PARKER

and James L. Smith, on behalf of themselves and all others

similarly situated,

Plaintiffs-Appellants,

PAINE WEBBER GROUP, INC.,

Defendant-Appellee.

Nos. 86-8624 to 86-8626.

United States Court of Appeals,

Eleventh Circuit.

Sept. 15, 1987.

A-2~ a

Appeals from the United States District Court for the

Northern District of Georgia.

Before VANCE and KRAVITCH, Circuit Judges, and

BROWN’, Senior Circuit Judge.

KRAVITCH, Circuit Judge:

Plaintiffs in these companion cases filed certified interlocutory

appeals pursuant to 28 U.S.C. § 1292(b) challenging the district

court’s denial of class certification under Rule 23 of the Federal

Rules of Civil Procedure. The district court denied class certifica-

tion in each case on the alternative grounds that the named

plaintiffs were not adequate class representatives as required by

Fed.R.Civ.P. 23(a)(4) and that individual questions of fact

predominated over common questions of law and fact in con-

travention of Fed.R.Civ.P. 23(b)(3). Concluding that the district

court applied erroneous legal standards, we reverse and remand

for further consideration.

I. BACKGROUND

These are a few of the many cases arising out of the virtual

collapse in 1984 of the Petro-Lewis oil and natural gas invest-

ment funds. From 1970 to 1984, about 180,000 people purchased

more than $3 billion worth of Petro-Lewis securities and limited

partnerships. When the price of oil and gas declined in 1981

and 1982, Petro-Lewis began borrowing funds to pay partner-

ship distributions, to service its debt, and to promote the sale

of additional programs. In February 1984, revealing for the first

time that it was in dire financial straits, Petro-Lewis announced

that it would implement a series of drastic economy measures,

including cutting partnership distributions by as much as 50 per

cent and selling between one quarter and one third of its reserves. ;

Numerous lawsuits followed.

In In re Petro-Lewis Securities Litigation, [1984-85 Transfer :

Binder], Fed.Sec.L.Rep. { 91,899 (D.Colo.1984), the U.S. District .

Court for the district of Colorado approved a settlement of eleven

* Honorable John R. Brown, Senior U.S. Circuit Judge for the Fifth Circuit,

sitting by designation.

a i

A-3

consolidated class suits brought under various provisions of the

federal securities laws against the directors and certain corporate

entities of the Petro-Lewis organization. Under the terms of the

settlement, the participating class members agreed to release

the defendants and all Petro-Lewis subsidiaries in return for the

formation of a royalty trust and a settlement fund valued at $23.5

million. The settlement agreement expressly provided that the

plaintiff class members retained the right to file suit against any

nondefendants, including broker-dealers of Petro-Lewis securi-

ties and limited partnerships.

In these cases, plaintiffs allege that the actions of the de-

fendant brokerage firms and individuals in selling and promoting

interests in Petro-Lewis violated sections 11 and 12(2) of the

Securities Act of 1933, 15 U.S.C. §§ 77k, 771(2), section 10 of

the Securities Exchange Act of 1934, 15 U.S.C. § 78j, Rule 10b-5

promulgated thereunder, 17 C.F.R. § 240.10b-5, and various

common law and statutory obligations under state law: Claiming

to represent classes of plaintiffs who, between January 1, 1981

to February 6, 1984, purchased, reinvested in, or otherwise ac-

quired Petro-Lewis limited partnership interests from the de-

fendant firms, the plaintiffs alleged that the defendants know-

ingly or recklessly participated with Petro-Lewis in disseminating

materially misleading information regarding Petro-Lewis’ fi-

nancial condition and failed to provide other information that

would have made the statements not misleading.

After discovery and hearings, the district court issued an order

and an amended order denying certification of the classes under

Rule 23 of the Federal Rules of Civil Procedure. Although the

court determined that each suit satisfied the class action prereq-

uisites of Fed.R. 23(a)(1), (2), and (3), the court denied certifica-

tion on the ground that the named plaintiffs were not adequate

class representatives as required by Rule 23(a)(4). The basis for

this determination was that the named plaintiffs did not

' Additional claims were asserted in some of the complaints. The district

court’s ruling on these other claims were not challenged on appeal. Accordingly,

the district court’s denial of class certification as to those claims will not be

disturbed.

A-4

demonstrate that they would pursue the litigation with suffi-

cient vigor to protect the interests of the class. As an alternative

ground of decision, the court held that individual questions of

law and fact outweighed common questions and thus that the

actions did not satisfy the standards of Rule 23(b)(3). Concluding

that its ruling was based upon determinations of law as to which

there may be substantial ground for difference of opinion and

that an immediate appeal from the denial of class certification

would materially advance the ultimate determination of the ac-

tions, the court certified its order for an interlocutory appeal

pursuant to 28 U.S.C. § 1292(b). We accepted jurisdiction. See id.

II. RULE 23(b)(3): PREDOMINANCE OF COMMON

OR INDIVIDUAL QUESTIONS

The district court’s conclusion that individual questions

predominate over common questions is based directly on the

court’s interpretation of the substance of the plaintiffs’ claims.

Consequently, we will consider first that aspect of the court’s

denial of class certification.

In holding that certification was improper under Rule

23(b)(3),? the court concluded that common questions of law

and fact in the 10(b) and 10b-5 claims were dominated by in-

dividual questions of reliance on the part of the particular

2 A suit may be maintained as a class action only if the four prerequisites

of Rule 23(a) are satisfied and, in addition, the case satisfies one of the

requirements of Rule 23(b). See Fed.R.Civ.P. 23(b). In this case, there is no

dispute that subsections (1) and (2) of Rule 23(b) do not apply. Rule 23(b)(3)

permits class action treatment if:

(3) the court finds that the questions of law or fact common

to the members of the class predominate over any questions af-

fecting only individual members, and that a class action is superior

to other available methods for the fair and efficient adjudication

of the controversy. The matters pertinent to the findings include:

(A) the interest of members of the class in individually control-

ling the prosecution or defense of separate actions; (B) the extent

and nature of any litigation concerning the controversy already

commenced by or against members of the class; (C) the desirability

or undesirability of concentrating the litigation of the claims in

the particular forum; (D) the difficulties likely to be encountered

in the management of a class action.

A-5

purchasers, statutes of limitations in each state in which there

may be class members, and arbitration agreements in many of

the purchase contracts. The court viewed the state law claims

to be inappropriate for class action treatment because liability

would depend upon the substantive law of the different states.

Finally, the court refused to consider certifying classes limited

to the section 11 and 12(2) claims after concluding that the 10(b)

and state law claims were the dominant claims asserted in the

complaints.

A. Section 10(b) and Rule 10b-5

The complaints allege that the defendants violated section

10(b) and Rule 10b-5 by engaging in two related but different

courses of conduct. First, the complaints contend that the defen-

dants participated with Petro-Lewis in disseminating misleading

prospectuses and in engaging in a standardized promotion by the

individual brokers. Second, the plaintiffs claim that the firms

continued to sell and promote Petro-Lewis shares despite the firms’

awareness or reckless disregard of Petro-Lewis’ severe financial

difficulties. Based on these allegations, the plaintiffs assert three

theories of liability under which common issues of law and fact

. necessarily would outweigh individual issues. They first contend

that their claims concern primarily acts of omission and thus that

reliance on the part of individual purchasers should be presum-

ed under the rule of Affiliated Ute Citizens v. United States, 406

US. 128, 92 S.Ct. 1456, 31 L.Ed.2d 741 (1975). Second, they argue

that the claims fall under the fraud-on-the-market theory adopted

by our predesessor court in Shores v. Sklar, 647 F.2d 462 (5th

Cir. May 1981) (en banc), cert. denied, 459 U.S. 1102, 103 S.Ct.

722, 74 L.Ed.2d 949 (1983).’ Finally, they argue that the allega-

tions involve a common course of conduct toward all defendants,

and thus that any issues of individual reliance could not

predominate over common questions of facts. See e.g., Kennedy

v. Tallant, 710 F.2d 711 (lth Cir. 1983).

> The Eleventh Circuit, in the en banc decision Bonner v. City of Prichard,

661 F.2d 1206, 1209 (llth Cir.1981), adopted as precedent decisions of the

former Fifth Circuit rendered prior to October 1, 1981.

A-6

The district court rejected each of these theories. The court

found the characterization of the claims as involving primarily

omissions to be precluded by the interpretation in Huddleston

v. Herman ¢ McLean, 640 F.2d 534 (5th Cir. Unit A March 1981),

affd in part and rev‘d in part on other grounds, 459 U.S. 375,

103 S.Ct. 683, 74 L.Ed.2d 548 (1983), and Cavalier Carpets v.

Caylor, 746 F.2d 749 (llth Cir.1984), of the requirements for an

omissions case under Affiliated Ute. The court rejected the fraud-

on-the-market theory as insufficiently supported by the pleadings

or the evidence proffered by the plaintiffs. Finally, the court re-

fused class action treatment under the course of conduct theory

based on the court’s determination that the plaintiffs’ allegations

involve primarily individualized oral representations rather than

a common scheme by the defendants toward the plaintiff

purchasers.

We agree with the district court that under the precedent of

this circuit the plaintiffs’ complaints cannot be properly

characterized as omissions cases under the standards of Affiliated

Ute. Here, as in Cavalier Carpets, supra, and Huddleston, supra,

the complaints indicate that “[t]he defendants did not stand mute

in the face of a duty to disclose as did the defendants in Affiliated

Ute.” Cavalier Carpet, 746 F.2d at 749 n. 22 (quoting Huddleston,

640 F.2d at 548). Rather, as in those cases, the allegations con-

tend that the defendants “undertook . . . to disclose relevant in-

formation . . . now alleged to contain certain misstatements of

fact and to fail to contain other facts necessary to make the

statements made, in light of the circumstances, not misleading.”

Id. Consequently, the district court properly concluded that the

complaints at most allege mixed claims of misrepresentations and

omissions and thus that Affiliated Ute’s presumption of reliance

does not apply.

We cannot agree, however, with the court’s rejection of the

fraud-on-the-market theory as a basis for class action treatment.

In Shores v. Sklar, supra, the former Fifth Circuit sitting en banc

held that, in fraud claims asserted under Rules 10b-5(1) and (3),

the reliance element of Rule 10b-5 may be satisfied by proof that

the plaintiff relied on the integrity of the market rather than on

specific misrepresentations by the defendants. Under Shores,

A-7

reliance may be established by proof that securities not traded

on the open market could not have been issued but for a

fraudulent scheme by the defendants. 647 F.2d at 469; cf. Lip-

ton v. Documation, Inc., 734 F.2d 740, 747 (11th Cir.1984), cert.

denied, 469 U.S. 1132, 105 S.Ct. 814, 83 L.Ed.2d 807 (1985)

(adopting fraud-on-the-market theory in context of securities

traded in open market). Here, consistent with Shores, plaintiffs

alleged that the Petro-Lewis shares, which were not traded on

the open market, could not have been marketed but for the

defendants’ fraud.

In rejecting this claim as improper for class treatment, the

court relied solely on its conclusion that the plaintiffs’ allega-

tions lacked evidentiary support. Despite the court’s assertions

to the contrary, this determination was an inappropriate inquiry

into the merits of the plaintiffs’ claims. Certainly, as the court

noted in its order, a court may look beyond the allegations of

the complaint in determining whether a motion for class cer-

tification should be granted. General Telephone Co. of

Southwest v. Falcon, 457 U.S. 147, 160, 102 S.Ct. 2364, 2372,

72 L.Ed.2d 740 (1982); Love v. Turlington, 733 F.2d 1562, 1564

(1lth Cir.1984). Indeed, it is often necessary for a district court

to consider, for example, a deposition of a named plaintiff to

determine whether Rule 23(a)’s commonality and typicality re-

quirements are met. See, e.g., Falcon, supra; Nelson v. U.S. Steel

Corp., 709 F.2d 675, 679-80 (11th Cir.1983). Here, however, the

court’s rejection of the fraud-on-the-market theory was based

upon nothing other than the court’s assessment of the plaintiffs’

likelihood of success on the claims. This is an improper basis

for deciding the propriety of a class action. E.g., Eisen v. Carlisle

& Jacquelin, 417 U.S. 156, 177-78, 94 S.Ct. 2140, 2152-53, 40

L.Ed.2d 732 (1974); Nelson, 709 F.2d at 679.

Nor can the court’s rejection of the fraud-on-the-market

theory be upheld under the rationale that fraud-on-the-market

claims are improper for class treatment where, as here, the

evidence indicates that the named plaintiffs relied on the ad-

vice of their brokers rather than solely on the integrity of the

market. As the defendants note, several district courts have

denied class certification for fraud-on-the-market claims where

A-8

evidence indicates that the named plaintiffs may in fact have

relied on factors other than the market’s integrity. These cases,

however, generally have concerned fraud-on-the-market claims

involving securities traded in an open market. See Masri v.

Wakefield, 106 F.R.D. 322, 325 (D.Colo.1984); Seiler v. E.F. Hut-

ton ¢> Co., 102 F.R.D. 880, 890 (D.N.J.1984); McNichols v. Loeb

Rhoades, 97 F.R.D. 331, 334 (N.D.11L.1982). But see Shores v. Sklar,

[current] Fed.Sec.L.Rep. (CCH) { 92,874 (N.D.Ala. July 30, 1986)

(on remand, denying class certification of fraud-on-the-market

claim involving security not openly traded). That version of the

fraud-on-the-market theory focuses on the plaintiffs’ reliance on

the integrity of an open and developed market to set a price ac-

curately reflecting the security's value. See Lipton v. Documa-

tion, 734 F.2d at 743. The issue of reliance on an open market

thus turns on a matter of degree--the price of the security--and

not, as in Shores, the absolute question of whether the security

was worthy of being issued.

Because the Petro-Lewis shares were not traded on the open

market, we need not now consider the appropriateness of class

certification of traditional fraud-on-the-market claims involving

securities that are openly traded. We conclude, however, that

where as here, a complaint alleges that a security not traded on

the open market could not have been issued but for the fraud

of the defendants, class action treatment is not precluded by the

possibility that some purchasers, including the named plaintiffs,

might have relied on factors other than the integrity of the market.

Shores did not hold, as the defendants contend, that recovery

is possible under a fraud-on-the-market claim only when a

claimant proves reliance on the integrity of the market to the

exclusion of all other factors. Rather, Shores was based on the

premise that “(t]he securities laws allow an investor to rely on

the integrity of the market to the extent that the securities it of-

fers to him for purchase are entitled to be in the marketplace.”

647 F.2d at 471. Consequently, where a security could not have

been issued but for a fraudulent scheme, the fact that the in-

vestor may have relied on other factors in deciding to purchase

that security at a particular price does not minimize the essen-

tial fact that the purchaser relied on the market's integrity to

a et a ae

A-9

ensure that the security was worthy of being issued. Indeed, as

the court noted in Shores, under a theory that the defendants’

fraud caused securities to be issued, “it would have availed [the

plaintiff] nothing to have read the [allegedly misleading] Offer-

ing Circular.” Id. at 470-71. A Shores fraud-on-the-market claim

thus is especially suited for class action treatment, as it makes

virtually irrelevant the possibility that the various purchasers may

have relied on different representations regarding the desirabili-

ty of the particular security in question: all have relied on the

integrity of the market in the but-for sense required by Shores.*

* In remanding to the district court, Shores instructed the court to “recon-

sider the maintainability of this action as a class action as to members of a

properly defined class of Bond purchasers who did not . . . rely [on the alleged-

ly misrepresentative offering circular].” 647 F.2d at 472. This instruction should

not be misconstrued as an indication that the fraud-on-the-market claim would

be available only to those individuals who did not rely on the circular. The

district court previously had determined that a Rule 10b-5(2) misrepresenta-

tion claim could be brought as a class action on behalf of a class of purchasers

who had relied on the offering circular. The court of appeals recognized that

any member of a class so defined necessarily would satisfy one of the elements

of a 10b-5(2) claim and thus could recover if it were proven on a class-wide

basis that the defendants knowingly made materially misleading statements

in the offering circular and that the purchasers suffered losses as a result. See

647 F.2d at 468 (listing elements of 10b-5(2) misrepresentation claim). The

court realized that, under the facts alleged in that case, these class-wide

10b-5(2) issues would be contained in the proof necessary for recovery under

the 10b-5(1) and (3) fraud-on-the-market theory. See 647 F.2d at 468 (“{T]he

Offering Circular was assertedly only one step in the course of an elaborate

scheme.”). Those purchasers who did not rely could recover, however, only

by meeting the additional burden of proving, under the fraud-on-the-market

theory, that the securities could not have been issued but for the fraud of the

defendants. Thus, the instruction that the district court determine the main-

tainability of a separate class for purchasers who did not rely was based simply

upon the recognition that, as a practical matter, those purchasers would have

a greater factual burden to establish liability than would taose who relied

on the offering circular. The instruction did not imply, however, that those

who had relied on the offering circular could not also recover under the fraud-

on-the-market theory. To the extent that the district court on remand reached

a different conclusion, see Shores v. Sklar, [current] Fed.Sec.L.Rep. (CCH)

{ 92,074 (N.D.Ala. July 30, 1986), we reject that court's interpretation of the

en banc decision.

A-10

We conclude for similar reasons that the district court also

improperly found that the plaintiffs’ 10b-5(2) misrepresentation

claims were not suited for class treatment. The basis for the

court’s denial of class certification of the misrepresentation

claims was the court’s conclusion that the claims involved

primarily oral representations and thus would present individual

issues of reliance. To arrive at this conclusion, the court focused

on deposition evidence indicating that the named plaintiffs relied

not so much on prospectuses and other written materials as on

the recommendations of their individual brokers. The court fur-

ther found that the plaintiffs had uncovered no evidence to show

that their particular brokers had attended the Petro-Lewis sales

sessions or explicitly followed the standardized sales pitch.

Contrary to the court’s construction of the claims, however,

the complaints alleged that the defendant brokerage firms and

individual officers engaged in a common course of conduct to

misrepresent, by affirmative acts and by omission, the finan-

cial condition of Petro-Lewis. See, e.g., Kennedy v. Tallant, 710

F.2d at 711. Neither the complaints nor the deposition testimony

relied upon by the district court indicate that any oral repre-

sentations to the named plaintiffs varied materially from the

misleading information alleged to have been disseminated

generally as a result of the defendants’ common schemes. See

id.; cf. Simon v. Merrill Lynch, Pierce, Fennner and Smith, Inc.,

482 F.2d 880, 883 (5th Cir.1973) (“If there is any material varia-

tion in the representations made or in the degrees of reliance

thereupon, a fraud case may be unsuited for treatment as a class

action.”). Consequently, the possibility that the named plain-

tiffs or other potential class members may have obtained the

allegedly misleading information via their individual brokers

rather than through widely distributed written information can-

not transform the allegations of the complaints into claims con-

cerning primarily questions of individual reliance. The claims

essentially involve allegations that the defendants “committed

the same unlawful acts in the same method against the entire

class.” Kennedy v. Tallant, 710 F.2d at 717.

As in any 10b-5(2) misrepresentation claim, each potential

class member must prove reliance on some form of the allegedly

A-11

misleading information in order to recover. See, e.g., Shores v.

Sklar, 647 F.2d at 468. In view of the overwhelming number

of common factual and legal issues presented by plaintiffs’

misrepresentation claims, however, the mere presence of the fac-

tual issue of individual reliance could not render the claims un-

suitable for class treatment. Here, as in Kennedy v. Tallant, each

of the complaints alleges “a single conspiracy and fraudulent

scheme against a large number of individuals” and thus is “par-

ticularly appropriate for class action.” 710 F.2d at 718. Moreover,

given the numerous and substantial common issues presented

by both the fraud-on-the-market and the misrepresentation

claims, the common questions in these cases cannot legitimate-

ly be considered subordinate to the individual questions

presented by the different state statutes of limitations that may

be applicable or by the arbitration agreements contained in some

of the purchasers’ contracts.* “Rule 23 does not require that all

the questions of law and fact raised by the dispute be common.”

Cox v. American Cast Iron Pipe Co., 784 F.2d 1546, 1557 (lth

Cir.), cert. denied, _U.S._, 107 S.Ct. 274, 93 L.Ed.2d 250

(1986).

In sum, we conclude that as a result of the district court's

erroneous analysis of the fraud-on-the-market claims and its

mischaracterization of the misrepresentations claims, the court

incorrectly determined that individual issues predominated over

common issues. Contrary to the court’s conclusions, these claims

involve common issues that clearly overwhelm the individual

issues that may be present. Consequently, “[s]eparate actions

by each of the class members would be repetitive, wasteful, and

an extraordinary burden on the courts.” Kennedy v. Tallant, 710

* The presence of arbitration agreements is relevant for another factor in

determining the suitability of class treatment on the 10b-5 claims. After the

district court’s order was issued, the Supreme Court in Shearson /American

Express v. McMahon, __U.S._, 107 S.Ct. 2332, 96 L.Ed.2d 185 (1987), upheld

the enforceability of agreements requiring the arbitration of 10b-5 claims.

Those purchasers whose 10b-5 claims are subject to arbitration thus could not

be considered members of the class. In ruling on the motion for class certifica-

tion, the district court did not determine whether the potential class members

not subject to arbitration would be sufficient to satisfy the numerosity require-

ment of Rule 23(a)(2). The court should make this determination on remand.

A-12

F.2d at 718. The district court thus abused its discretion in rul-

ing that the requirements of Rule 23(b)(3) were not satisfied in

this case. See, e.g., Cox v. American Cast Iron Pipe Co., 784

F.2d at 1557-58.

B. State Law Claims

In concluding that the state law claims failed to satisfy the

requirements of Rule 23(b)(3), the district court reasoned that

the differing standards of liability required by the laws of the

various states would render class action treatment un-

manageable. We agree with the district court that the state law

claims would require application of the standards of liability

of the state in which each purchase was transacted.* The district

court thus did not abuse its discretion in denying class certifica-

tion on these claims. See, e.g., Simon v. Merrill Lynch, Pierce,

Fenner and Smith, Inc., 482 F.2d at 883.

C. Section 1] and 12(2) Claims

In explaining its denial of class certification of the section 11

and 12(2) claims, the district court stated that it “did not

* Under the Georgia law applicable to these diversity claims, see Klaxon Co.

v. Stentor Electric Mfg. Co., 313 U.S. 487, 61 S.Ct. 1020, 85 L.Ed. 1477 (1941),

the standard of liability would be determined, as an initial matter, by the

law of the state in which the purchaser acquired the security, not of the state

from which the shares were sold. See Risdon Enterprises, Inc. v. Coleman

Enterprises, Inc., 172 Ga. App. 902, 324 S.E.2d 738, 740 (1984) (explaining

Georgia's lex loci delecti choice of law rule in tort cases); see also Zandman

v. Joseph, 102 F.R.D. 924, 930 (N.D.Ind.1984) (Indiana's lex loci delecti rule

“would require use of the law of the state where each class member suffered

his or her pecuniary loss”). If a particular state does not have a controlling

statute, however, the Georgia choice of law rule requires application of the

common law as construed by the courts of Georgia. See Frank Briscoe, Inc.

v. Georgia Sprinkler Co., Inc., 713 F.2d 1500, 1503 (llth Cir.1983); Risdon

Enterprises, 324 S.E.2d at 741 (1984). Thus, although the law of Georgia might

eventually be applied on some claims involving purchases made in other states,

that could be determined only after the district court had fully surveyed the

law of the states of purchase. Moreover, even if Georgia law would require

application of its own common law rules to some claims involving purchases

in other states, the law of Georgia could be applied consistent with due pro-

cess only if the particular transaction had some significant relation to Georgia.

Phillips Petroleum Co. v. Shutts, 472 U.S. 797, 105 S.Ct. 2965, 2980, 86 L.Ed.2d

628 (1985).

A-13

address” these claims individually because to separate these

ciaims from the Rule 10b-5 and state law claims would be “un-

duly burdensome” on the court. The court consequently denied

class certification of the Rule 11 and 12(2) claims based upon

its conclusion that the 10b-5 and the state law claims did not

meet the requirements of Rule 23(b)(3). In view of our deter-

mination that the court erroneously ruled that 10b-5 claims did

not meet the requirements of Rule 23(b)(3), the court must of

course reconsider its decision regarding the Section 11 and 12(2)

claims.

Independent of our decision on the 10b-5 claims, however,

we conclude that the court erred in failing to consider separately

the appropriateness of the class action treatment of the section

11 and 12(2) claims. Although there is some overlap between

section 10(b) and sections 11 and 12(2), the provisions “involve

distinct causes of action and were intended to address different

types of wrongdoing.” Herman ¢ McLean v. Huddleston, 459

U.S. 375, 103 S.Ct. 683, 687, 688, 74 L.Ed.2d 548 (1983). The

failure of the district court to give separate consideration to class

action certification of these distinct claims thus could serve

neither the securities laws’ purpose of protecting investors, see,

e.g., id., 103 S.Ct. at 687, nor Rule 23’s purpose of protecting

the courts from needlessly repetitious litigation, see, e.g., Ken-

nedy v. Tallant, 710 F.2d at 718. By failing to consider these

claims separately, the court abused its discretion.

III. ADEQUATE CLASS REPRESENTATION

Having concluded that the district court’s ruling on the re-

quirements of Rule 23(b)(3) constituted an abuse of the court’s

discretion, we must address the court’s alternative holding that

the named plaintiffs in each of these cases did not satisfy the

adequate representation requirement of Rule 23(a)(4) because

they failed to demonstrate sufficient “vigor” to prosecute a class

suit.

Among the prerequisites to the maintenance of a class action

is the requirement of Rule 23(a)(4) that the class representatives

A-14

“will fairly and adequately protect the interests of the class.”

The purpose of this requirement, as of many other of Rule 23’s

procedural mandates, is to protect the legal rights of absent class

members. Because all members of the class are bound by the

res judicata effect of the judgment, a principal factor in deter-

mining the appropriateness of class certification is “the forth-

rightness and vigor with which the representative party can be

expected to assert and defend the interests of the members of

the class.” Mersay v. First Republic Corp., 43 F.R.D. 465, 470

(S.D.N.Y.1968); see also Shatzman v. Talley. 91 F.R.D. 270, 273

(N.D.Ga.1981) (insufficiency of funds to prosecute suit indicates

the “vigor with which the case will be pursued”); Dolgow v.

Anderson, 43 F.R.D. 472, 494 (E.D.N.Y.1968) (court “must be

assured that ‘the representatives [will] put up a real fight’ ”

(quoting J. Chafee, Some Problems in Equity 231 (1950)), revd

on other grounds, 438 F.2d 825 (2d Cir.1971); cf. Falcon, 457

U.S. at 161, 102 S.Ct. at 2372.

The inquiry into whether named plaintiffs will represent the

potential class with sufficient vigor to satisfy the adequacy re-

quirement of Rule 23(a)(4) most often has been described to “in-

volve[ ] questions of whether plaintiffs’ counsel are qualified,

experienced, and generally able to conduct the proposed litiga-

tion and of whether plaintiffs have interests antagonistic to those

of the rest of the class.” Griffin v. Carlin, 755 F.2d 1516, 1532

(11th Cir.1985). Even where these two requirements are satisfied,

however, named plaintiffs might not qualify as adequate class

representatives because they do not possess the personal

characteristics and integrity necessary to fulfill the fiduciary role

of class representative. See, e.g., Kline v. Wolf, 702 F.2d 400,

402-03 (2d Cir.1983); Armour v. City of Anniston, 89 F.R.D.

331, 332 (D.C.Ala.1980), affd, 654 F.2d 382 (5th Cir. Unit B

Aug. 1981); 7A C. Wright, A. Miller and M. Kane, Federal Prac-

tice and Procedure, Civil 2d § 1766 at pp. 308-10.

For similar reasons, some courts have found, as did the district

court here, that Rule 23(a)(4) was not satisfied where the nam-

ed plaintiffs demonstrated insufficient participation in and

awareness of the litigation. See, e.g., Darvin v. International

Harvester Co., 610 F. Supp. 255, 257 (S.D.N.Y.1985);

A-15

Massengill v. Board of Educ., 88 F.R.D. 181 (N.D.II1.1980). In

following the lead of these cases, however, the district court ap-

pears to have applied a standard that does not vindicate the

policies and purposes of Rule 23. Contrary to the district court’s

approach to the issue, adequate class representation generally

does not require that the named plaintiffs demonstrate to any

particular degree that individually they will pursue with vigor

the legal claims of the class. Although the interests of the plaintiff

class certainly would be better served if the named plaintiffs

fully participate in the litigation, see, e.g., In re Goldchip Fun-

ding Co., 61 F.R.D. 592, 594-95 (M.D.Pa.1974), the economics

of the class action suit often are such that counsel have a greater

financial incentive for obtaining a successful resolution of a class

suit than do the individual class members. See Deposit Guaranty

Nat. Bank v. Roper, 445 U.S. 326, 338-39, 100 S.Ct. 1166, 1174,

63 L.Ed.2d 427 (1980) (plurality opinion). It is not surprising,

then, that the subjective desire to vigorously prosecute a class

action, which the district court here found missing in the nam-

ed plaintiffs, quite often is supplied more by counsel than by

the class members themselves. Obviously this creates a poten-

tial for abuse. See id. at 339, 100 S.Ct. at 1174. Yet the financial

incentives offered by the class suit serve both the public interests

in the private enforcement of various regulatory schemes, par-

ticularly those governing the securities markets, and the private

interests of the class members in obtaining redress of legal

grievances that might not feasibly be remedied “within the

framework of a multiplicity of small individual suits for

damages.” Id.

As the district court aptly noted, a potential class is entitled

to “more than blind reliance upon even competent counsel by

uninterested and inexperienced representatives.” In re Goldchip

Funding Co., 61 F.R.D. at 594. For where the named plaintiffs

“have abdicated their role in the case beyond that of furnishing

their names as plaintiffs,” the attorneys, in essence, are the class

representative. Helfand v. Cenco, 80 F.R.D. 1, 7-8 (N.D.III.1977).

Several district courts thus have properly denied class certifica-

tion where the class representatives had so little knowledge of

and involvement in the class action that they would be unable

A-16

or unwilling to protect the interests of the class against the

possibly competing interests of the attorneys. See, e.g. Efros v.

Nationwide Corp., 98 F.R.D. 703, 707 (S.D.Ohio 1983); Hel-

fand v. Cenco, supra; see also 7A Wright, Miller & Kane at §

1766 pp. 310-11 (the “inquiry into the knowledge of the represen-

tative is to ensure that the party is not simply lending his name

to a suit controlled entirely by the class attorney.”)

In concluding that the named plaintiffs in these cases do not

satisfy the adequate representation requirement of Rule 23(a)(4),

the district court noted that neither this court nor the Supreme

Court has set forth standards for determining the adequacy of

class representatives.’ Because the issue of adequate class

representation arises in a wide variety of contexts, it would be

inappropriate for us to establish a standard for general applica-

tion. We conclude, however, that in securities cases such as these,

where the class is represented by competent and zealous counsel,

class certification should not be denied simply because of a

perceived lack of subjective interest on the part of the named

plaintiffs unless their participation is so minimal that they vir-

tually have abdicated to their attorneys the conduct of the case.

To require less would permit attorneys essentially to serve as class

7 In support of its conclusion that the named plaintiffs in these cases are in-

adequate class representatives, the court cited Rothenberg v. Security Manage-

ment Co., Inc., 667 F.2d 958 (llth Cir. 1982). Rothenberg upheld the dismissal

of a Rule 23.1 derivative shareholders’ action where the named plaintiff had

been found not to be an adequate representative of the other shareholders.

In making this determination, the district court and the panel on appeal relied

on factors similar to those relied upon by the district court here. Rothenberg,

however, is not entirely apposite to the determination of adequacy of a class

representative under Rule 23(a)(4). A derivative suit poses inherent conflicts

between those minority shareholders who are bringing the suit and the ma-

jority shareholders whose administration is being challenged either directly

or indirectly. See 7C C. Wright, A. Miller & M. Kane, Federal Practice and

Procedure § 1833 at pp. 137-39. In contrast, a class suit by definition serves

to benefit the members of the class. Consequently, a different degree of par-

ticipation might well be required of a named plaintiff in a Rule 23.1 derivative

than of a named plaintiff in a Rule 23 class action. The case before us does

not involve a Rule 23.1 certification, and we express no opinion as to what

the standard for such cases should be.

A-17

representatives; to require more could well prevent the vindica-

tion of the legal rights of the absent class members under the

guise of protecting those rights.

Although we conclude that the district court applied an er-

roneous standard in determining that the named plaintiffs would

not be adequate class representatives, it would be inappropriate

for us to make an independent application of the correct stan-

dard in this case. In contrast to the more strictly legal questions

presented by the district court’s characterization of the plain-

tiffs’ claims in its rulings on the Rule 23(b)(3), the adequacy

of class representation is primarily a factual issue that is best

left for determination by the district court. Consequently, we

remand the Rule 23(a)(4) issue for the district court to apply

the standard we have set forth above.

IV. CONCLUSION

For the foregoing reasons, the order of the district court is

REVERSED IN PART, AFFIRMED IN PART, and REMAND-

ED with instructions.

B-1

IN THE UNITED STATES DISTRICT COURT

FOR THE NORTHERN DISTRICT OF GEORGIA

ATLANTA DIVISION

GLENN T. SANDERS, on behalf of himself and

all others similarly situated,

Plaintiffs,

vs.

ROBINSON HUMPHREY/AMERICAN EXPRESS, INC.,

et al.,

Defendants.

CIVIL ACTION No. C 85-172 A

TOMMY E. PARKER, as custodian for KIMBERLY M.

PARKER, and JAMES L. SMITH, on behalf of themselves

and others similarly situated,

Plaintiffs,

vs.

PAINE WEBBER GROUP, INC.,

Defendant.

CIVIL ACTION No. C 85-1586 A

SUZANNE KIRKPATRICK, DOROTHY D. CASLER,

and CHARLES H. LINDSEY,

Plaintiffs,

vs.

J.C. BRADFORD & CO.,

Defendants.

CIVIL ACTION No. C 85-1891 A

July 8, 1986

B-2

OPINION OF VINING, DISTRICT JUDGE

ORDER

In these federal securities actions, three motions are now before

the court. The facts of these cases are set forth in this court's re-

cent order, filed on March 28, 1986 (“the previous order”). The

first motion is the plaintiffs’ motion to reconsider the previous

order, which denied their motion for class certification under Rule

23, Federal Rules of Civil Procedure. Second, the plaintiffs have

asked this court to amend the previous order to certify it for in-

terlocutory appeal, pursuant to Rule 5 of the Federal Rules of

Appellate Procedure and 28-U:S.C. § 1292(b). Last, the plain-

tiffs have moved for an ora.t staying the previous order until the

date when the Eleventh Circuit Court of Appeals rules on the

plaintiffs’ interlocutory appeal. The court addresses each of these

motions in turn.

I. MOTION FOR RECONSIDERATION

The court’s denial of class certification in each of these cases

was based upon an extensive review of the record presented to

the court through pleadings, discovery, and oral hearings. Five

areas of concern required that the court deny class certification

to the named plaintiffs. These areas of concern and the reason-

ing behind the court’s treatment of each area are set out in com-

plete detail in the previous order. The first of these is that the

plaintiff cannot adequately represent the class as a whole as re-

quired by Rule 23(a)(4), Federal Rules of Civil Procedure. The

remaining four bases for denial of class cei dfication address the

requirements of Rule 23(b)(3), that common questions of law and

fact do not predominate over individual issues. These individual

issues involve the requirement of proof of reliance as an element

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

1934, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated under that

Act; the fact that arbitration agreements signed by potential class

members provide for a better, more efficient method of ad-

judicating the claims by many of the potential class participants;

and the fact that many potential class members are from various

states throughout the country, thus requiring application of their

individual state statutes of limitations as well as the need to apply

the law of each state in which potential class members reside.

B-3

The plaintiffs disagree with the court’s finding in each of these

areas and have requested the court to reconsider the class cer-

tification based upon these findings as well as the court’s failure

to address Counts I and II, brought pursuant to sections 11 and

12(2) of the Securities Act of 1933, 15 U.S.C. §§ 77k, 771(2). Each

of these areas addressed by the plaintiffs will be discussed seriatim

below. However, the court at this juncture believes it necessary

to inform the plaintiffs of its method of handling the class cer-

tification issue.

First, the plaintiffs request that the court consider each in-

dividual issue, count, or other separate determination as a single

issue not tied to any other issue for purposes of class certifica-

tion. Although some courts have opted to bifurcate class actions,

this court finds that to do so in this case wou'vi be unduly burden-

some and would not be the best method of handling the cases.

Therefore, the court has looked at each requirement of Rule 23,

then combined its findings on each element of Rule 23 to deter-

mine whether class certification is appropriate for each case as

a whole. For this reason, the court did not address the counts

brought under sections 11 and 12(2) of the Securities Act of 1933.

After reviewing the requirements for class certification under sec-

tion 10(b) and Rule 10b-5 and the state law claims, the court

determined that the plaintiffs had not met their burden of prov-

ing the elements necessary to meet the class certification re-

quirements for these claims and did not, nor does it now, believe

the section 11 and section 12(2) claims needed to be addressed

in determining whether the plaintiffs’ actions as a whole war-

rant class certification.

As to the remainder of the issues addressed by the plaintiffs

in their motions to reconsider, the court believes that some

clarification is necessary. After carefully considering each of the

plaintiffs’ contentions, the court finds them all without merit.

A. Rule 23(a)(4): Adequacy of Representation

In the previous order, the court held that the plaintiffs failed

to satisfy the second requirement of Rule 23(a)(4) because they

failed to convince the court that they would vigorously prosecute

these class actions. Order at p. 22. First, the plaintiffs did not

B-4

attend the hearing. In the motion for reconsideration the plain-

tiffs contend that they did not appear at the hearing because the

court quashed subpoenas seeking to compel their attendance.

While the plaintiffs are correct that they were not required to

attend the hearing, the court views their unwillingness to do so

as one indication of a lack of interest in these lawsuits. Contrary

to the plaintiffs’ contentions, their failure to appear at the hear-

ing was not determinative. As the court stated in its previous

order, the “totality of the circumstances” surrounding this litiga-

tion led the court to its decision. Id.; see id. at 23-26 (setting out

the other reasons that the plaintiffs are inadequate

representatives).

The plaintiffs also contend that the court placed undue em-

phasis on their lack of familiarity with the complaint and the

case as a whole. This court has stated that “the knowledge and

involvement of plaintiff with the suit . . . [are] some of the fac-

tors relevant to a determination of a plaintiff's adequacy as a

class representative.” Schatzman v. Talley, 91 F.R.D. 270, 273

(N.D. Ga. 1981). Again, under the totality of the circumstances,

the plaintiffs’ lack of familiarity with these cases is another in-

dication of their uncertain commitment to these lawsuits. The

plaintiffs cite Surowitz v. Hilton Hotels Corp., 383 U.S. 363, 86

S. Ct. 845 (1966), for the proposition that their lack of familiarity

is not a critical issue. Surowitz is inapposite because it does not

address the degree of interest that a plaintiff must display to satisfy

Rule 23(a)(4). Surowitz dealt with the question of whether a

derivative plaintiff must personally investigate the facts underly-

ing the complaint.

In the reply brief in Parker, the plaintiffs criticize the defen-

dant for citing deposition testimony indicating that the defen-

dant’s broker, as opposed to the defendant, did not conceal the

truth about Petro-Lewis. According to the plaintiffs, this lawsuit

is against Paine Webber, not its brokers. Plaintiff Parker, however,

does not have any reason to believe that either the defendant or

its broker defrauded him:

Q. Do you think that Lee Smith [Parker's broker] in-

tended to deceive you?

B-5

A. No.

Q. Do you know of anybody at Paine Webber who in-

tended to deceive you?

A. No, sir, I don’t.

Q. Do you have any basis for believing that anybody

at Paine Webber intended to deceive you?

A. No, sir, I don't.

Q. Do you believe that Lee Smith was part of a fraud

or conspiracy to deceive you?

A. No, sir.

Q. Do you know of anybody at Paine Webber who was

part of a fraud or conspiracy to deceive you?

A. No, sir.

Deposition of Tommy E. Parker, pp. 81-82.

Finally, the plaintiffs assert that courts have tolerated wide

variances in the named plaintiffs’ understanding of and involve-

ment in class action lawsuits. They quote from Ross v. BankSouth,

N.A., [1985-86 Transfer Binder] Fed. Sec. L. Rep. (CCH) { 92,

526 (N.D. Ala. 1986), which takes a particularly lenient view of

the threshold necessary to meet Rule 23(a)(4). Some courts,

however, have been much more demanding of class represen-

tatives. For example, in Greenspan v. Brassler, 78 F.R.D. 130,

133-34 (S.D.N.Y. 1978), the court found that putative class

representatives failed to satisfy Rule 23(a)(4) for some of the same

reasons mentioned in this court’s previous order:

Although plaintiffs appear willing and able to bear

the costs of this litigation, they have demonstrated an

alarming unfamiliarity with the suit. They did not

meet with their attorney until the basic groundwork

B-6

of the action had been laid. Neither could identify any

of the defendants other than NJB. Neither was aware

of certain elements of the complaint. Indeed, plain-

tiffs appear to place undue emphasis on their counsel's

ability to conduct the litigation. Plaintiffs’ limited per-

sonal knowledge of the facts underlying this suit, as

well as their apparently superfluous role in this litiga-

tion to date, indicate their inadequacy as class represen-

tatives. (citations to deposition testimony and cases

omitted).

The court also finds that the analysis in In re Goldchip Funding

Co., 61 F.R.D. 592, 594 (M.D. Pa. 1974), which is quoted with

approval in Greenspan, applies in this case:

The class is entitled to more than blind reliance upon

even competent counsel by uninterested and inex-

perienced representatives. A proper representative can

offer more to the prosecution of a class action than

mere fulfillment of the procedural requirements of Rule

23. He can, for example, offer his personal knowledge

of the factual circumstances, and aid in rendering deci-

sions on practical and non-legal problems which arise

during the course of litigation. An attorney who pro-

secutes a class action with unfettered discretion

becomes, in fact, the representative of the class. This

is an unacceptable situation because of the possible con-

flicts of interest involved. (citation omitted).

Neither the Supreme Court nor the Eleventh Circuit has

established specific guidelines for district courts to follow in mak-

ing factual findings under Rule 23(a)(4). Determinations relating

to the adequacy of a class representative are factual in nature--

their resolution “depends on all the facts and circumstances of

a particular case and is entrusted to the discretion of the trial

court.” Dudo v. Schaffer, 93 F.R.D. 524, 531 (E.D. Pa. 1982) (cita-

tions omitted); see Freeman v. Motor Convoy, Inc., 700 F.2d 1339,

1347 (llth Cir. 1983). The plaintiffs have failed to point out any

new facts or theories that would lead this court to change its

holding.

B-7

B. Reliance and Fraud on the Market

The issue of reliance is central to a section 10(b) and Rule 10b-5

claim. The plaintiffs allege that the court’s consideration of the

issue of reliance at this point in the litigation process is an im-

proper intrusion into the merits of the case. Although the court

acknowledges that a consideration of the case on its merits is not

always appropriate in determining class certification, it is general-

ly accepted law in this circuit that the court may inquire into

the merits of the case provided the granting or denial of class

certification is not based upon whether the court believes the

plaintiff may or may not prevail in its suit. Huff v. N.D. Cass

Co. of Alabama, 485 F.2d 710 (5th Cir. 1973). Indeed, the

Supreme Court has acknowledged the need for investigation in-

to the merits of the case because “actual, not presumed, confor-

mance with Rule 23(a) remains, however, indispensable,” General

Telephone Co. of Southwest v. Falcon, 457 U.S. 147, 160, 102

S. Ct. 2364, 2372, 72 L.Ed.2d 740 (1982); in that “the class deter-

mination generally involves considerations that are ‘enmeshed in

the factual and legal issues comprising the plaintiffs cause of ac-

tion, ” Coopers & Lybrand v. Livsey, 437 U.S. 463, 469, 98 S.

Ct. 2454, 2458, 57 L.Ed.2d 351 (1978) quoting Mercantile Na-

tional Bank v. Langdeau, 371 U.S. 555, 558, 83 S. Ct. 520, 522,

9 L.Ed.2d 523 (1963)).

The plaintiffs allege that the presumption of reliance in Af-

filiated Ute Citizens v. United States, 406 U.S. 128, 92S. Ct. 1456,

31 L.Ed.2d 741 (1972), should be applied to the cases at bar. This

' The court notes that the plaintiffs are likely to assert that the reliance issue

falls within Rule 23(b)(3), as discussed by this court, as opposed to Rule 23(a)

in Falcon and that conformance with Rule 23(b) is not indispensable. However,

one of the three sections of Rule 23(b) must be met for class certification pur-

poses. Additionally, many courts have treated the issue of reliance as a typicality

or commonality requirement, ¢.g., Nelson v. U.S. Steel Corp., 709 F.2d 675

(llth Cir. 1983), which treatment would necessarily thwart class action status

as plaintiffs would fail to meet the indispensable requirements of Rule 23(a),

reliance being an issue to be handled on an individual basis. This court,

however, feels that some elements of typicality and commonality are present

in each of the class representatives and has chosen to treat the issue of reliance

under Rule 23(b).

B-8

court has thoroughly dealt with this presumption of reliance in

its previous order and will not delve into the matter further. In

an attempt to sway this court away from its prior decision deny-

ing to the plaintiffs the presumption of reliance based on the fraud

on the market theory, the plaintiffs have brought to the court's

attention several cases permitting this use of the fraud on the

market theory. See Ross v. BankSouth, N.A., Fed. Sec. L. Rep.

(1985-86 Transfer Binder] { 92,526 (N.D. Ala. 1986); Klein v. A.C.

Becker Paribas, Inc., 83 Civ. 6456 (GLG) (S.D.N.Y. March 19,

1986); Dekro v. Stern Bros. & Co., 540 F. Supp. 406 (W.D. Mo.

1982); Arthur Young ¢> Co. v. United States District Court, 549

F.2d 686 (9th Cir. 1977).

The Klein case sets forth the elements of a fraud on the market

case. The elements necessary to establish a rebuttable presump-

tion of reliance, as set out in Klein, are “that (1) an affirmative

representation affected the price of a security traded on the open

market, (2) the plaintiff relied to his detriment on the integrity

of the market price, and (3) the price of the security ‘reacted

adversely’ when the truth was revealed concerning the issuer of

the security.”

With the exception of Arthur Young, the cases cited by the

plaintiffs allowing the fraud on the market theory to stand met

the first element in Klein in that they involved sales of stocks or

bonds on the open market. Arthur Young involved securities not

traded on the open market. In fact, the securities were interests

in five oil joint ventures similar to the interests sold in the in-

stant cases. In Arthur Young, the parties were before the court

on a motion by the defendants for a writ of mandamus requir-

ing the district court to set aside its order and strike the class

allegations from the complaint. The district court in Arthur Young

had bifurcated the case allowing some issues to be certified for

class action and other issues to be held for individual adjudica-

tion. One of the issues to be tried individually was that of reliance

or causation. Arthur Young, 549 F.2d at 690. Additionally, the

misrepresentations and omissions in Arthur Young did not involve

oral misrepresentations. In fact, all claims based upon oral

misrepresentations were withdrawn by the plaintiffs from the

suit. Arthur Young, 549 F.2d at 689, n.5. Also, the court in

ail SOE LL A OLED a EN LE EE Be Maw ee

B-9

Arthur Young considered that case to be one involving only omis-

sions, where reliance can be inferred under the Ute decision,

rather than an oral misrepresentations and omissions case as are

the cases at bar. Arthur Young, 549 F.2d at 694. The fact that

reliance was held to be an individual issue, the fact that oral

misrepresentations claims were withdrawn by the plaintiffs

because of difficulties inherent in such claims in determining class

action status, and the fact that the case was an omissions case

are supportive of this court’s position denying the class action

in the instant cases and cannot be used to support the plaintiffs

in their search for a theory on which to base class action status.

The remaining cases cited by the plaintiffs in support of the

fraud on the market theory, viz., Dekro, Klein, and Ross, involved

securities sold on the open market, differentiating them from the

cases at bar, where the securities were not sold on the open

market. In Ross, the only case cited by the plaintiffs within the

jurisdiction of the Eleventh Circuit, the court went to great

lengths to outline instances where the fraud on the market

presumption of reliance cannot be allowed. That court then,

without sufficient factual analysis to support its decision, found

the fraud on the market theory viable for purposes of determin-

ing reliance. It can only be assumed by this court that Judge

Propst first determined the requirement that ihe securities be trad-

ed on the open market had been met before allowing the

presumption of reliance under the fraud on the market theory.

Shores v. Sklar, 647 F.2d 462 (5th Cir. 1981), cert. denied, 459

U.S. 1102 (1983), obviates the need for trading on the open market

if the security would not have been marketed at all but for the

fraud. The plaintiffs alleged in their complaints that “but for

the false and misleading statements contained in the registration

statements and prospectuses and material information omitted

therefrom, the Petro-Lewis partnership programs could not have

been marketed and sold to plaintiffs and members of the class.”

The plaintiffs assert that these allegations must be accepted as

* Robinson-Humphrey Amended Complaint, { 55; J.C. Bradford Amended

Complaint, * 52; Paine Webber Second Amended Complaint, { 50.

B-10

true for purposes of ruling on the class status motion but cite

no support for this assertion. The court, however, is not required

to look at and accept as true allegations of the complaint for pur-

poses of Rule 23 class certification. Huff v. N.D. Cass Co. of

Alabama, 485 F.2d 710, 713 (5th Cir. 1973). The plaintiffs’ only

support for the allegation, that but for the fraud and misleading

statements the securities would not have been sold, lies in their

reliance upon the suit filed by the Securities and Exchange Com-

mission against Petro-Lewis, see In re Petro-Lewis Securities

Litigation, (1984-85 Transfer Binder] { 91,899 (D. Colo. 1984),

and the assumption that the SEC never would have approved

the offerings had the misrepresentations been discovered prior

to approval.

First, it should be noted that the SEC does not approve nor

disapprove securities for sale; it merely reviews the prospectus

for compliance with SEC regulations. The issue then is not

whether the SEC would have approved the offerings but whether

the securities could have been sold but for the fraud. The reliance

upon In re Petro-Lewis is misplaced as that case was settled out

of court with the opinion of the court being that “in my view,

after reviewing the entire matter, there are serious questions of

law and fact which place the outcome of this action, if tried rather

than settled, in substantial doubt.” In re Petro-Lewis, { 91,899

at p. 90,470. The support for the allegations that the securities

would not have been sold but for the misrepresentations is not

present, insofar as this court can determine, in the pleadings and

evidence admitted by plaintiffs to the extent necessary to satisfy

this court that the allegation has some basis and is not just a shot

in the dark attempt to bring the case within the purview of a

fraud on the market theory.

In addition to the element requi:ing sales on the open market,

a fraud on the market claim under Klein requires that a plain-

tiff rely upon the integrity of the market in purchasing the

securities. The court is aware of no evidence presented by the

plaintiffs supporting this element. Indeed, the only information

relied upon by each of the plaintiffs was information supplied

we amt ea ne

e |

;

B-11

to them orally by their brokers.’

In light of the foregoing the court finds that the elements

necessary to support a fraud on the market theory which would

allow for a rebuttable presumption of reliance in a section 10(b)

and Rule 10b-5 action are not present. The court has determin-

ed that reliance is paramount to the cases at bar. Due to the

nature of these cases as oral misrepresentations cases the reliance

must be proven on an individual basis. This requirement is, as

stated in the court’s previous order, one more obstruction to the

granting of class status to these actions.

C. Arbitration

A third issue discussed by the court in its previous order is that

of possible arbitration of claims against the defendants. In each

of the three cases at bar the defendants have asserted that a

number of potential class members have signed arbitration

agreements with the defendants for handling of possible claims

against them. Some of the defendants have presented no con-

crete evidence of arbitration agreements with the named plain-

tiffs. However, because of the general practice of brokerage firms

to procure such agreements, the court is satisfied for purposes

of class certification that each of the defendants is able to substan-

tiate arbitration claims with some potential class members which

could greatly disrupt these proceedings should class certification

be granted.

The plaintiffs have referred the court to two recently decided

cases concerning arbitration which the court feels compelled to

address and distinguish. First, plaintiffs submit that this court

should follow the decision in McMahon v. Shearson/American

* The plaintiffs in Paine Webber have asserted in separate pleadings that they

did not rely upon oral misrepresentations of the brokers but in fact relied upon

prospectuses presented to them. However, the evidence as presented by the

plaintiff and defendants on the issue of reliance and oral versus written

misrepresentations is a defense which could be raised against these plaintiffs.

Such a defense would be atypical of defenses which could be raised against

other plaintiffs in Paine Webber and therefore would not allow for the

presumption of reliance in Paine Webber.

B-12

Express, Inc., 788 F.2d 94 (2d Cir. 1986), where Shearson sought

to compel arbitration of Rule 10b-5 claims pursuant to arbitra-

tion agreements signed by the plaintiffs in that case. In McMahon,

the Second Circuit, because of the failure of the Supreme Court

in Dean Witter Reynolds, Inc. v. Byrd, ____ U.S. ___,, 105 S.

Ct. 1238 (1985) to rule on the arbitrability of 10(b) and 10b-5

claims, ruled that that circuit would not depart from its previous

decisions that these claims are not arbitrable. While this court

acknowledges the position of the Second Circuit in following the

precedents in its circuit, it is not bound by that decision. This

court holds that arbitration agreements signed by the plaintiffs

and potential class members in the cases at bar are enforceable.

See Schultz v. Robinson-Humphrey/American Express, Inc., [Cur-

rent] Fed. Sec. L. Rep. (CCH) ¢ 92,515 (M.D. Ga. 1986);

Chandler v. Drexel Burnham Lambert, Inc., No. C85-1585A

(N.D. Ga. Oct. 28, 1985); Raiford v. Merrill Lynch, Pierce, Fenner

dz Smith, Inc., Civ. No. C83-685A (N.D. Ga. May 16, 1985). This

holding is based upon the national policy adhered to in Byrd of

favoring arbitration agreements. See also Mitsubishi Motors Corp.

v. Soler Chrysler-Plymouth, Inc., US. , 105 S. Ct. 3346

(1985). That these arbitration agreements may be readily en-

forceable leads this court to the determination that yet another

individual issue predominates over common issues of law and fact.

Additionally, these agreements provide what this court perceives

to be a better method of adjudicating a large number of claims

by potential plaintiffs against the defendants.

In a second attempt to bar the potential use of arbitration

clauses by the defendants the plaintiffs draw the court’s atten-

tion to Smokey Greenhaw Coton Co., Inc. v. Merrill Lynch,

Pierce, Fenner ¢> Smith, Inc., 785 F.2d 1274 (5th Cir. 1986). The

plaintiffs cite this case to support the proposition that Byrd can-

not be applied retroactively. The plaintiffs, however, fail to

acknowledge the bold distinction between Smokey Greenhaw and

the cases at bar. In Smokey Greenhaw, the questions to be sub-

mitted to arbitration had already been decided by a jury prior

to Byrd. To apply Byrd in that instance would have required ar-

bitration of issues already decided by a competent court of law.

The court in fact states,

B-13

Without so deciding, we might be more inclined to

direct the parties to the arbitration room had this case

been awaiting trial when the Dean Witter Reynolds

opinion was handed down. However, equity demands

that, where the trial has been completed, the propos-

ed judgment rendered, and only the relative ministerial

task of approving the form of the judgment remains,

Greenhaw should not be denied his victory and forc-

ed once again to do battle in a different forum.

Smokey Greenhaw, 785 F.2d at 1279-80. Had the cases at bar

been tried on their merits prior to the decision in Byrd, this court

might well hold that the Byrd analysis was not retroactive.

However, these cases have not yet even passed the preliminary

procedural stages. For these reasons, the court adheres to its posi-

tion as enunciated in its previous order with respect to the ar-

bitrability issue of these class certifications.

D. Rule 10b-5: Statute of Limitations

In its previous order, this court held that because the statute

of limitations is taken from state law, the claims are inappropriate

for treatment as class actions. Order at pp. 42-43; see Elster v.

Alexander, 76 F.R.D. 440, 442 (N.D. Ga. 1977), appeal dismiss-

ed, 608 F.2d 196 (5th Cir. 1979). In arguing that this court er-

red, the plaintiffs contend that the general rule in securities class

actions involving a national class is that the court should apply

a single statute of limitations for Rule 10b-5 claims. See, e.g.,

State Teachers Retirement Board v. Fluor Corp., 80 F.R.D. 142,

144-45 (S.D.N.Y. 1978); In re National Student Marketing Litiga-

tion [1981 Transfer Binder], Fed. Sec. L. Rep. (CCH) 4 97,926

(D.D.C. 1981). The plaintiffs, however, cite no circuit court

authority for this proposition,‘ and they do not attempt to

distinguish, or even discuss, Elster. Because the court continues

to believe that the analysis in Elster is correct, this court adheres

* In fact, In re National Marketing relies on the reasoning in State Teachers.

No other federal court has ever followed State Teachers.

B-14

to its prior holding. The plaintiffs have failed to cite any appellate

or Supreme Court authority that dictates another result.

E. State and Common Law Claims

The plaintiffs next argue that this court failed to engage in

the analysis mandated by Phillips Petroleum Co. v. Shutts, ___

U.S. ___, 105 S. Ct. 2965 (1985), and misapplied the holding

in that case.’ In part III of the Shutts opinion, the Supreme Court

began by establishing that Kansas contract and equity law dif-

fered from Texas and Oklahoma contract and equity law. See id.

at___, 105 S. Ct. at 2977-78. Similarly, this court outlined the

differences in the elements of a fraud claim in numerous jurisdic-

tions in this country. See Order at pp. 49-51. Like the Supreme

Court in Shutts, this court concluded that, based on the dif-

ferences in the laws of the various states, it would be unconstitu-

tional for the court to apply Georgia law to transactions in which

investors had no contact with Georgia, nor any reasonable ex-

pectation that Georgia law would apply to their purchases.* Shutts

holds that a court “may not take a transaction with little or no

‘ The plaintiffs do not address Simon v. Merrill Lynch, Pierce, Fenner & Smith,

Inc., 482 F.2d 880, 883 (5th Cir. 1973), in which the court held:

[T]he geographic dispersion of the alleged representations would

bring into issue various state common law standards. With no

single law governing the entire class, common issues of law can-

not be shown to warrant Rule 23 treatment.

That decision is binding on this court. See Bonner v. City of Prichard, 661

F.2d 1206, 1209 (llth Cir. 1981) (en banc) (adopting the law of the Fifth Cir-

cuit prior to October 1, 1981, as binding precedent). In addition, the plain-

tiffs once again failed to distinguish or even address Elster v. Alexander, 76

F.R.D. 440, 442 (N.D. Ga. 1977), appeal dismissed, 608 F.2d 196 (5th Cir.

~ 1979). See Order at pp. 48-49 (citing decisions that follow the reasoning in

Simon and Elster).

* In Sanders the defendants’ attorney indicates that his examination of client

mailing lists taken from the defendants’ business files shows that the defen-

dants sold Petro-Lewis limited partnership interests to clients maintaining ad-

dresses in 32 states, the District of Columbia, and West Germany. Supplemental

Affidavit of Peter J. Anderson, { 3.

ee ot

B-15

relationship to the forum and apply the law of the forum in order

to satisfy the procedural requirement that there be a ‘common

question of law. ” Shutts, ___ U.S. at ___, 105 S. Ct. at 2980.

The Supreme Court in Shutts also quoted from Allstate In-

surance Co. v. Hague, 449 U.S. 302, 312-13, 101 S. Ct. 633, 640

(1981), in which it had stated, “For a State’s substantive law to

be selected in a constitutionally permissible manner, that State

must have a significant contact or significant aggregation of con-

tacts, creating state interests, such that choice of its law is neither

arbitrary nor fundamentally unfair.” In the instant case, the

named plaintiffs are residents in this district and the defendants

do business here. Based on these facts alone, the court fails to

see how Georgia has “a significant contact or significant aggrega-

tion of contacts, creating siate interests” such that Georgia law

should apply to investors from other parts of the country. As the

Supreme Court stated, “Given [Georgia’s] lack of ‘interest’ in

claims unrelated to that State, and the substantive conflict with

jurisdictions such as Texas, we conclude that application of

[Georgia] law to every claim in this case is sufficiently arbitrary

and unfair as to exceed constitutional limits.” Shutts, ____ U.S.

at ___, 105 S. Ct. at 2980 (footnote omitted).

The plaintiffs contend that this court should adopt the reason-

ing in In re Pizza Time Theatre Securities Litigation, No.

C-84-20048 (A), Order Certifying Plaintiff Class (N.D. Cal.

March 18, 1986), in which a California district court interpreted

Shutts to mean that plaintiffs “must demonstrate only that

California has a sufficient aggregation of contacts to their claims

to insure that the application of California law would not be ar-

bitrary or unfair.” Slip op. at 4 (emphasis in criginal). The Pizza

Time court explained California’s interest in applying its own

law to the pendent claims in the class action:

In the instant action, California has a considerably

greater aggregate of contacts with plaintiffs’ claims

than did Kansas in the Shutts case. Here, che defen-

dant corporation was incorporated and headquartered

in California, all the non-underwriter defendants were

California residents, the alleged misrepresentations

emanated from California, and many of the plaintiffs

B-16

were California residents. The non-resident under-

writer defendants received millions of dollars in fees

from the California corporation, and the plaintiffs

allege that the underwriter defendants conspired with

the California defendants to defraud the plaintiffs. Not

only are the contacts evident, but California has a

strong interest in the allegedly fraudulent conduct of

its corporations and residents, and in protecting its

residents and others from such fraud. The application

of California law to the pendent claims in this case

would not be arbitrary. Id. at Slip Op. at 4-5.

In this case, however, Georgia has nowhere near the number of

contacts that California had with the plaintiffs’ claims in Pizza

Time: Robinson-Humphrey is the only defendant that is either

incorporated or headquartered in Georgia; the alleged

misrepresentations emanated from all over the country because

the putative class members purchased partnership interests from

brokerage houses all over the country; and many of the putative

class members are not Georgia residents. While California may

have had a sufficient aggregation of contacts to the plaintiffs’

claims in Pizza Time, that is clearly not the case here. The facts

in this action more closely resemble the facts in Shutts than Piz-

za Time.

A second reason that this court will not follow Pizza Time is

that Shutts does not overrule the reasoning in Simon, 482 F.2d

at 883, or Elster, 76 F.R.D. at 442. This court will follow these

decisions.

Finally, the Shutts court held that an important element in

deciding whether to certify a class is the expectation of the par-

ties. As in Shutts, there is no indication that when the investors

purchased the limited partnership interests outside of Georgia

they had any idea that Georgia law would control. Shutts,

U.S. at ___, 105 S. Ct. at 2980.’

7 Another reason that Pizza Time is inapposite is that the California court

concluded that “California’s aggregate contacts with, and interest in, the events

(footnote continued)

B-17

II. INTERLOCUTORY APPEAL

The plaintiffs have asked this court to amend its earlier order

to certify it for interlocutory appeal, pursuant to Rule 5, Federal

Rules of Appellate Procedure. Rule 5 provides that an order may

be amended at any time to include the statement prescribed by

28 U.S.C. § 1292(b). This statute states in part:

When a district judge, in making in a civil action

an order not otherwise appealable under this section,

shall be of the opinion that such order involves a con-

trolling question of law as to which there is substan-

tial ground for difference of opinion and that an im-

mediate appeal from the order may materially advance

the ultimate termination of the litigation, he shall so

state in writing in such order. The Court of Appeals

may thereupon, in its discretion, permit an appeal to

be taken from such order... .

First, the court finds that several controlling questions of law

exist about which substantial grounds exist for differences of opin-

ion. While a section 1292(b) review is inappropriate for challenges

to a judge's discretionary rulings, Garner v. Wolfinbarger, 433

F.2d 117, 120 (Sth Cir. 1970), the court finds that the legal issues

that it has discussed under Rule 23(b), see Order at pp. 27-51,

are by no means settled.

As to the issues of reliance and fraud on the market, the

Eleventh Circuit has accepted a presumption of reliance based

upon a fraud on the market theory, Lipton v. Documation, Inc.,

734 F.2d 740 (lth Cir. 1984); Shores v. Sklar, 647 F.2d 462 (5th

Cir. 1981) (en banc), cert. denied, 459 U.S. 1102, 103 S. Ct. 722

(1983). However, the fraud on the market presumption of reliance

has presented some ambiguities as to its application to securities

not sold on the open market; furthermore there is no clear

alleged in the complaint were self-evident at the time and sufficient to give

notice to the parties that California law might apply in any subsequent litiga-

tion.” Pizza Time, Slip op. at 5.

B-18

definition of what the “open market” actually is. See Arthur Young

¢> Co. v. United States District Court, 549 F.2d 686 (9th Cir.

1977); Ross v. BankSouth, N.A., Fed. Sec. L. Rep. [1985-86

Transfer Binder] { 92,526 (N.D. Ala. 1986). An interlocutory ap-

peal of this court’s ruling on this issue is thus warranted by the

facts of the case at bar.

In addition, while this court has held that section 10(b) and

Rule 10b-5 claims under the Securities Exchange Act of 1934 are

arbitrable, see Raiford v. Merrill Lynch, Pierce, Fenner & Smith,

Inc., C83-685A (N.D. Ga. May 16, 1985); Chandler v. Drexel

Burnham Lambert, Inc., C85-1585A (N.D. Ga. Oct. 28, 1985),

the Eleventh Circuit, sitting en banc, just heard oral argument

on this issue. Wolfe v. E.F. Hutton, No. 85-3352 (lith Cir.) (en

banc). District court decisions in this circuit are conflicting. Com-

pare Ross v. Mathis, 624 F. Supp. 110 (N.D. Ga. 1986) (holding

Rule 10b-5 claims arbitrable) with GMO V.A. Del Castillo v.

Paine Webber, Inc., C85-2A10A (N.D. Ga. Dec. 12, 1985) (holding

Rule 10b-5 claims not arbitrable).

Another reason why this case should be certified for in-

terlocutory appeal is that some courts have held that securities

class actions involving a national class require a court to apply

a single statute of limitations for Rule 10b-5 claims of the entire

class. See, e.g., State Teachers Retirement Board v. Fluor Corp.,

80 F.R.D. 142, 144-45 (S.D.N.Y. 1978); In re National Student

Marketing Litigation, [1981 Transfer Binder], Fed. Sec. L. Rep.

(CCH) { 97, 926 (D.D.C. 1981). Although this court disagrees

with the holding in those cases, the court does recognize that

this is a controlling »; estion of law as to which there is substan-

tial ground for difference of opinion.

Finally, the plaintiffs contend that this court has misinterpreted

the holding in Phillips Petroleum Co. v. Shutts, __. U.S. ___.,

105 S. Ct. 2965 (1985), and misapplied it to the facts at bar. Again,

the court believes its decision is correct but also recognizes that

there is substantial ground for difference of opinion.

The court finds that an immediate appeal from its previous

order and this order will materially advance the ultimate

B-19

termination of this litigation. Resolving the class certification on

interlocutory appeal will prevent any duplicative effort by both

sides of this litigation if investors individually proceed to bring

the same or similar claims against the defendants. An appeal will

provide an efficient mechanism for the prompt resolution of many

of the issues in this case.

For these reasons, the plaintiffs’ motion to amend this court’s

previous order to certify it for interlocutory appeal is GRANTED,

and the court hereby certifies this order for interlocutory appeal

also.

Ill. MOTION TO STAY

The final motion before this court is the plaintiffs’ motion for

an order staying this court’s previous order until the date when

the Eleventh Circuit rules on the plaintiffs’ interlocutory appeal.

The plaintiffs seek to toll the statute of limitations concerning

all claims of all putative class members. This motion is made

pursuant to 28 U.S.C. § 1292(b), which provides in part: “. . . ap-

plication for an appeal hereunder shall not stay proceedings in

the district court unless the district judge or the Court of Ap-

peals or a judge thereof shall so order.”

Under Local Rule 300-4 and this court's previous order, the

plaintiffs’ attorneys were prevented from communicating with

putative class members who contacted them concerning possi-

ble lawsuits against the defendants. These potential class members

have been deprived of the opportunity to assert their claims dur-

ing the pendency of the motions for class certification. The com-

bined effect of the Local Rule and this court’s order may be to

effectively prevent these individuals from pursuing their legal

claims. If the court does not stay its previous order, many in-

dividuals may unknowingly lose their right to bring certain causes

of action. A stay may provide additional protection for putative

class members until the Eleventh Circuit determines whether the

class action device is available. (This court does not decide

whether the stay will, in fact, toll the statute of limitations.)

In addition, many putative members of the class have not been

in contact with the plaintiffs’ attorneys and may be unaware of

B-20

the potential prejudice to their rights that may result from this

court’s previous order. Many of these individuals may be unaware

of the impending limitations deadline. This court recognizes the

potential prejudice to putative class members from its previous

order and does not want to deny these individuals due process

of law or a day in court. Accordingly, the motion to stay is

GRANTED.

IV. SUMMARY

The plaintiffs’ motion to reconsider this court’s order filed on

March 28, 1986, denying the plaintiffs’ motion for class certifica-

tion under Rule 23, Federal Rules of Civil Procedure is DENIED.

The plaintiffs’ motion to amend this court's previous order to cer-

tify this case for interlocutory appeal pursuant to Rule 5, Federal

Rules of Appellate Procedure and 28 U.S.C. § 1292(b) is

GRANTED. The plaintiffs’ motion for an order staying its

previous order is GRANTED, and proceedings are hereby

STAYED until the date on which the Eleventh Circuit denies the

plaintiffs’ request for an interlocutory appeal or, if granted, the

date on which the Eleventh Circuit issues its mandate following

the appeal.

SO ORDERED.

C-1

IN THE UNITED STATES DISTRICT COURT

FOR THE NORTHERN DISTRICT OF GEORGIA

ATLANTA DIVISION

GLENN T. SANDERS, on behalf of himself and

all others similarly situated,

Plaintiffs,

VS.

ROBINSON HUMPHREY/AMERICAN EXPRESS, INC.,

et al.,

Defendants.

CIVIL ACTION No. C 85-172 A

TOMMY E. PARKER, as custodian for KIMBERLY M.

PARKER, and JAMES L. SMITH. on behalf of themselves

and others similarly situated,

Plaintiffs,

vs.

PAINE WEBBER GROUP, INC.,

Defendant.

CIVIL ACTION No. C 85-1586 A

SUZANNE KIRKPATRICK, DOROTHY D. CASLER,

and CHARLES H. LINDSEY,

Plaintiffs,

VS.

J.C. BRADFORD & CO.,

Defendants.

CIVIL ACTION No. C 85-1891 A

March 27, 1986

C-2

ORDER

VINING, District Judge.

In these federal securities actions, the plaintiffs have filed mo-

tions for class certification, pursuant to Rule 23 of the Federal

Rules of Civil Procedure. The court already has considered and

ruled on the defendants’ motions to dismiss and numerous

discovery and procedural motions. These cases are now ripe for

a determination of whether they may proceed as class actions.’

An understanding of the history of the Petro-Lewis cases is

necessary before the court considers the motions for class

certification.

I. HISTORY OF THE PETRO-LEWIS LITIGATION

From 1970 to 1983, Petro-Lewis was the nation’s largest seller

of oil and gas income funds. These programs raised money from

investors, who became limited partners, and used the proceeds

to purchase oil and gas producing properties. Cash distributions

to the limited partners, which were paid quarterly, began almost

immediately after each partnership was formed and were to con-

tinue for 10 to 15 years or more until the wells were depleted.

Petro-Lewis, an independent oil and gas producer and manager

of petroleum investments for public and private partners, ac-

quired oil and gas properties for public limited partnerships,

shared ownership of those properties, and managed the limited

partnerships as a general partner. Over a 14-year period, Petro-

Lewis sold, through securities brokerage firms, in excess of $3

billion worth of partnerships to approximately 180,000 people.

As oil and gas prices began to decline in 1981 and 1982, Petro-

Lewis was forced to borrow funds to pay partnership distribu-

tions, service the debt it was incurring, and promote the sale

of additional programs. In February 1984 Petro-Lewis revealed

that it would sustain a substantial loss, that it was cutting

' On October 28, 1985, this court held that a companion case, Chandler v.

Drexel Burnham Lambert, Inc., C85-1585A (N.D. Ga. 1985), should be sent

to arbitration. The plaintiff has appealed that decision to the Eleventh Cir-

cuit Court of Appeals.

C-3

distributions to limited partners by as much as 50 percent, that

the company would have to sell between one quarter and one

third of its total reserves to reduce bank debt, and that Petro-

Lewis was immediately terminating all sales of partnership

programs. Numerous lawsuits against Petro-Lewis followed.

In In re Petro-Lewis Securities Litigation [1984-85 Transfer

Binder], Fed. Sec. L. Rep. ¢ 91,899 (D. Colo. 1984), the court

set forth the history of the Petro-Lewis litigation that lead to

these class actions.’ In that case, the court consolidated eleven

class actions filed between February 9, 1984, and May 9, 1984.

The defendants were the Petro-Lewis Corporation, the Petro-

Lewis Funds, Petro-Lewis Securities Corporation, and the seven

directors of Petro-Lewis Corporation. The amended consolidated

class action compiaint set forth claims under the Securities Ex-

change Act of 1934, as amended, 15 U.S.C. §§ 78a, et seq., and

the Securities Act of 1933, as amended, 15 U.S.C. §§ 77a, et seq.

The plaintiffs in the original Colorado action sought to repre-

sent two classes: (1) a “securities class,” consisting of the pur-

chasers of securities, including common stock, warrants, and

preferred stock, and (2) a “partnership class,” consisting of per-

sons who purchased, reinvested in, or otherwise acquired limited

partnership interests in over 100 partnerships formed by Petro- -

Lewis to purchase oil and natural gas producing properties be-

tween August 1975, and February 1984, and in the Petro-Lewis

deferred income program formed in 1981. The Petro-Lewis com-

plaint alleged that during the relevant times the defendants

made, or caused to be made, statements in Petro-Lewis prospec-

tuses, periodic shareholder and investor reports, filings with the

Securities and Exchange Commission, press releases, investor

letters, and other documents, that were materially false and

misleading and that the defendants omitted to disclose certain

material facts and adverse information about Petro-Lewis and

the partnerships that it managed. Some plaintiffs sought relief

in the form of rescission of their purchases of limited partner-

ship interests. All plaintiffs sought damages, interest, costs, and

disbursements.

* The facts set forth in part I are taken from Judge Carrigan’s opinion in the

Colorado litigation.

C-4

On July 3, 1984, co-lead counsel for the plaintiffs and counsel

for the defendants in the Colorado litigation executed an agree-

ment in principle to settle all eleven class actions. The settle-

ment agreement consisted of two primary components: (1) for-

mation of a royalty trust, and (2) creation by the defendants

of a settlement fund consisting of cash and non-cash considera-

tions valued at $23.5 million. Notices were sent to approximately

180,000 holders of limited partnership interests in 45 limited

partnerships, plus approximately 7,000 members of the

stockholder class. In addition, 40,000 notices were sent to brokers

for forwarding to persons on whose behalf interests were held.

According to a public announcement made December 26, 1984,

all 45 affected limited partnerships voted, by very substantial

margins, in favor of the settlement. The settlement required

Petro-Lewis, on behalf of all defendants, to contribute considera-

tion of $23.5 million to a settlement fund, which included $10

million in cash plus approximately 720,000 trust units valued

at $13.5 million.

The class members who participated in the settlement were

to sign a release form which provided that all the defendants,

and any subsidiary or affiliate of Petro-Lewis, would be released

with respect to all claims, demands, and causes of action. The

release form, however, was not intended to release any broker-

dealer in its capacity as an agent for Petro-Lewis or any of its

affiliates in connection with the issuance, purchase, or sale of

any of the securities of, or interest in, Petro-Lewis, or any of

the limited partnerships of which Petro-Lewis or any subsidiary

or affiliate of Petro-Lewis was a general partner. Counsel for

all parties agreed that the purpose and intent of the release was

solely to protect the defendants in the Colorado action and that

it was intended that all the plaintiff class members retain any

rights that they might have to proceed against and collect from

broker-dealers or other nondefendants who might be liable to

them.

The court conditionally certified the partnership class and

the securities class for purposes of settlement only. The court

indicated that there were serious questions of law and fact which

C-5

placed the outcome of the class actions, if tried rather than set-

tled, in substantial doubt. One such question was:

In view of the substantial number of distinct part-

nerships and the variations in facts relevant to, and

potential conflicts among, the claims of those part-

nerships, there is doubt whether this action could be

certified under Fed. R. Civ. P. 23 (except conditionally,

for settlement purposes) and, if certified, whether the

partnership class would have to be splintered into

numerous subclasses.

{ 91,889 at 90,470.

After carefully examining the proof of claim and release forms

and the notices to be sent out, the court approved the proposed

settlement as fair, reasonable, and adequate for all members of

the plaintiff classes.

Il. THE INSTANT LITIGATION

The plaintiffs seek to represent individuals who purchased,

reinvested in, or acquired from the defendants limited partner-

ship interests in Petro-Lewis income programs from January 1,

1981, to February 6, 1984. The amended complaints in these

three proposed class actions are divided into three parts. The

plaintiffs spend 30 pages setting forth the alleged wrongdoings

by Petro-Lewis. For example, the amended complaint alleges

that statements made in the Petro-Lewis prospectuses from 1981

to 1984 were false and misleading because they did not disclose

the risks inherent in purchasing Petro-Lewis partnership inter-

ests. Amended Complaint { 22.° Petro-Lewis also allegedly failed

to disclose excessive leveraging of all partnerships, made

unsecured loans to partnerships to inflate distributions to limited

partners and to attract new sales, made false and misleading

financial statements, annual and periodic reports, press releases

* References to paragraphs in this part of the order refer to the Sanders v.

Robinson-Humphrey amended complaint, although the other two amended

complaints are substantially similar.

C-6

and newsletters, and failed to disclose that substantial tax

benefits expected to be received by limited partnership investors

were likely to be disallowed. Id. at {4 22-23. Petro-Lewis also

allegedly failed to inform the investing public of the risks in-

volved in the Petro-Lewis method of operation, including com-

petition in the industry by less risky investment programs and

the severe difficulty of obtaining debt servicing. Id. at { 23.

A Wall Street Journal article on April 5, 1983, reported that

Petro-Lewis was “facing an apparent cash squeeze that might

lead to nasty surprises for holders.” The article stated that Petro-

Lewis had “ ‘leveraged’ or invested in a larger value of oil pro-

perties than the original cash put up.” Id. at { 24. Petro-Lewis

issued a press release denying substantially all of the statements

made in the Wall Street Journal article and allegedly maintained

artificially high distribution to the partnerships to attract new

partnership sales. Id. Finally, on February 6, 1984, Petro-Lewis

allegedly revealed the following: that it had severe losses, that

it was cutting its distribution by 50 percent, that it was reduc-

ing the price at which Petro-Lewis agreed to repurchase part-

nership interests, that it was drastically reducing its work force,

and that it was immediately terminating all sales of partner-

ship programs. Id. at {{ 35-36. At the time Petro-Lewis made

these revelations, reserves bought by many partnerships were

worth only 1/3 to 1/2 what the partnerships paid for them. Jd.

at ¢ 36.

In the second part of the complaints, the plaintiffs set forth

the defendants’ alleged roles in the sales scheme. According to

the complaints, Petro-Lewis partnership interests were marketed

by selected members of the National Association of Securities

Dealers, including the defendants in this action, pursuant to

selling agreements with Petro-Lewis securities corporation, a

wholly owned subsidiary of Petro-Lewis. Each brokerage house

allegedly received sales commissions of up to seven percent on

each partnership interest sold, plus a special sales incentive pay-

ment of 1-1/2 percent when the brokerage house’s sales in a

program exceeded $400,000. Id. at { 38. Sales of the Petro-Lewis

partnership interests allegedly were a significant source of

C-7

revenue and profit to the defendants. Id. at { 40. The plaintiffs

contend that the defendants trained and instructed their account

representatives in standard techniques to promote, solicit, sell,

and induce customers to purchase Petro-Lewis partnership in-

terests. During the class period, the defendants allegedly pro-

vided to the plaintiffs and the proposed classes the prospectuses,

financial statements, annual and periodic reports, press releases,

and other statements described in part I of the complaints. In

addition, the plaintiffs assert that the defendants made numerous

uniform statements of fact and verbal assurances to the plain-

tiffs and the members of the proposed classes to the effect that

Petro-Lewis’ public statements were worthy of the plaintiffs’ trust

and belief, that Petro-Lewis was operating soundly, and that

Petro-Lewis partnerships were good investments from which

high long-term yields could be expected at minimal risk. Id. at

q 41.

The defendants allegedly knew or recklessly disregarded in-

formation available to them which disclosed or would have

disclosed the financial problems of Petro-Lewis and its partner-

ships as described in part I of the complaints. Id. at 43. Even

though the defendants allegedly knew or should have known

these facts, they continued to market and sell Petro-Lewis part-

nership interests to the plaintiffs and members of the proposed

classes during the class period without disclosing any of the facts

asserted in part I of the complaints. The plaintiffs assert that

the defendants characterized the Petro-Lewis partnership in-

terests as relatively low risk investments when they were clear-

ly known to be high risk investments and that the defendants

uniformly dissuaded and discouraged customers, including the

plaintiffs and the members of the proposed classes, from sell-

ing or liquidating their interests in the Petro-Lewis partnership

programs. Id. at { 44. The plaintiffs allege that the defendants

knew or recklessly disregarded facts contributing to Petro-Lewis’

financial problems, the vulnerability of Petro-Lewis’ partner-

ship programs caused by the pattern of excessive leveraging in-

stituted by Petro-Lewis management, and the high degree of

risk involved in any investment in the Petro-Lewis partnership

C-8

programs. Id. at { 45. The plaintiffs and their proposed classes

allege that as a result of the foregoing, they were damaged. Id.

at { 46.

Part III of the amended complaints sets forth the seven counts

that form the basis of this lawsuit. Count I, brought pursuant

to section ll of the Securities Act of 1933, 15 U.S.C. § 77k, alleges

that the defendants issued, caused to be issued, participated in

the issuance of, or aided and abetted the issuance of materially

false and misleading statements to the investing public that ap-

peared in publicly disseminated materials relating to Petro-Lewis

and its partnership programs during the class period, including

the registration statements and the prospectuses that

misrepresented and failed to disclose the facts set forth in part

I of the complaints. Id. at { 53. Count II, brought pursuant to

section 12(2) of the Securities Act, 15 U.S.C. § 771(2), alleges that

the defendants made untrue statements of material fact or omit-

ted toe state material facts in the prospectuses, newsletters,

releases, and instruction booklets. The defendants also allegedly

used the means and instruments of transportation or com-

munication in interstate commerce or the mails to perform these

violations of section 12(2). Id. at 58.* Count III, brought pur-

suant to section 15 of the Securities Act, 15 U.S.C. § 770, the

“controlling person” liability provision for sections 11 and 12,

alleges that the named defendants directly or indirectly con-

trolled the activities of the brokerage houses as underwriters of

the Petro-Lewis partnership interests and programs and were

responsible for the content of the Petro-Lewis registration state-

ment and prospectuses during the class period, or directly or

* In all three class action cases, the defendants filed motions to dismiss, con-

tending that section 13 of the Securities Act, 15 U.S.C. § 77m, the statute of

limitations for sections ll and 12(2), barred these counts. In Sanders ov.

Robinson-Humphrey, the court dismissed the plaintiffs’ claims for their 1981

purchases. See Order filed Sept. ll, 1985. In Kirkpatrick v. J. C. Bradford,

the court dismissed Counts I and II since the claims were barred by the statute

of limitations. The court allowed the plaintiffs’ attorneys to communicate with

potential class members in an attempt to find plaintiffs not barred by the

statute of limitations. See Order filed Sept. Ll, 1985. In Parker v. Paine Webber,

(Footnote continued)

A ne Rt Ss nate ht

Ve io oat Sasitaa D1.

C-9

indirectly induced tke acts alleged in Counts I and II. Id. at

{ 64.* Count IV alleges a cause of action under sections 10 and

20 of the Securities Exchange Act of 1934, 15 U.S.C. § 78j and

§ 78t, and Rule 10b-5, 17 C.F.R. § 240.10b-5.°

In addition to the federal securities claims, the plaintiffs allege

common law fraud and deceit (Count V), negligence and

negligent misrepresemtation (Count VI), and fraudulent con-

cealment and breach of fiduciary duty (Count VII). The amend-

ed complaint in Parker v. Paine Webber also alleges a cause of

action under the Racketeer Influenced and Corrupt Organiza-

tions Act (RICO), 18 U.S.C. § 1962(c).

Each of the complaints demand judgment against the defen-

dants for compensatory damages, the costs and disbursements

of the action, including reasonable attorneys’ fees, and punitive

and exemplary damages in the amount of $10 million. In addi-

tion, the plaintiffs requested that this court determine that these

complaints may proceed as class actions under Rule 23 of the

Federal Rules of Civil Procedure.

the court dismissed Counts I and II. See Order filed Sept. 11, 1985. The plain-

tiffs amended their complaint, and the court denied the defendant’s motion

to dismiss Counts I and II of the amended complaint. See Order filed Feb.

14, 1986.

* A claim against a controlling person is governed by the same limitations period

that applies to the Securities Act claim against the controlled person. This

court held that section 13, therefore, also applied to the plaintiffs’ section 15

claim. See Herm v. Stafford, 663 F.2d 669, 679 (6th Cir. 1981). As a result,

Count III in Kirkpatrick was dismissed. See Order filed Sept. 11, 1985. The

amended complaint in Parker v. Paine Webber did not allege a cause of ac-

tion under section 15.

* The cause of action under section 20 was dismissed in Kirkpatrick v. J. C.

Bradford and not alleged in the amended complaint in Parker v.

This text is long and has been trimmed here. Open the source document for the complete record.

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.