Petition for Writ of Certiorari — Robinson Humphrey/American Express, Inc. v. Sanders
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Supreme Court, U.S.
FILED
8 %.°8 36 NOV 23 1987
JOSEPH F-SPANIOL, JR.
CLERK
IN THE
Supreme Court of the United States
OcrosBer TERM, 1987
PAINEWEBBER GROUP, INC.,
Petitioner,
Vs.
TOMMY E. PARKER, as Custodian for
KIMBERLY M. PARKER, and JAMES L. SMITH,
Respondents.
PETITION FOR A WRIT OF CERTIORARI
TO THE UNITED STATES COURT OF APPEALS
FOR THE ELEVENTH CIRCUIT
ROBERT EMANUEL ZIMET
Counsel of Record for Petitioner
RicHARD M. KIrBy SKADDEN, ARPS, SLATE,
HANSELL & Post MEAGHER & FLOM
3300 First Atlanta Tower 919 Third Avenue
Atlanta, Georgia 30383 New York, New York 10022
(404) 581-8000 (212) 735-3000
Attorneys for Petitioner
Of Counsel:
JEREMY A. BERMAN
CHARLES F. WALKER
QUESTIONS PRESENTED FOR REVIEW
1. It has long been established that in order to recover damages
under Section 10(b) of the Securities Exchange Act of 1934 and
Rule 10b-5 promulgated thereunder, the plaintiff must establish
reliance on a false and misleading statement or omission. In the
context of considering whether to certify a class bringing claims
under Section 10(b) and Rule 10b-5, in a case in which the securi-
ty does not trade on an active market such as a stock exchange,
is it proper for a district court to presume reliance on the part
of all putative class members under the “fraud-on-the-market”
theory?
2. Is it proper to certify a class under Rule 23(b)(3) of the
Federal Rules of Civil Procedure when the complaint alleges
that common issues predominate over individual issues but the
district court finds that the evidence presented at the class cer-
tification hearing demonstrates the predominance of individual
issues?
3. Is it proper for a circuit court to review the denial of class
certification under 28 U.S.C. § 1292(b) where interlocutory
review cannot, as the statute requires, “materially advance the
ultimate termination of the litigation”?
THE PARTIES
The names of the parties to the proceeding are contained in
the caption!
' Petitioner PaineWebber Group, Inc. has no parent company. PaineWebber
Group, Inc. has no subsidiaries or affiliates other than wholly-owned sub-
sidiaries with the exception of an approximately 50-percent stock ownership
interest in National Car Rental Systems, Inc.
TABLE OF CONTENTS
QUESTIONS PRESENTED FOR REVIEW......
ois ws oo 6 sca cosas ssa seds
ns
py ty ey |»
EERE ee
STATUTES AND RULES INVOLVED .........
STATEMENT OF THE CASE .................
REASONS FOR GRANTING THE WRIT.......
I.
II.
PERMITTING A PRESUMPTION OF
RELIANCE IN ORDER TO FACILITATE
CLASS CERTIFICATION OF ACTIONS
UNDER RULE 10b-5 WHERE THE
SECURITY AT ISSUE IS NOT TRADED ON
THE OPEN MARKET WILL OPEN THE
FLOODGATES TO RULE 10b-5 CLASS
RS OR re
A. This Court Should Consider This Case in
Conjunction with Basic
a
B. The Interpretation of the “Fraud-on-the-
Market” Theory by the Court Below Will
Open the Floodgates to Class Actions
I ys eh on cde sa nascd as
ALLOWING CLASS ACTIONS TO BE
CERTIFIED ON THE BASIS OF THE
PLEADINGS ALONE IRRESPECTIVE OF
THE EVIDENCE PRESENTED AT THE
CLASS CERTIFICATION HEARING WILL
TRANSFORM RULE 23 INTO A BLUD-
GEON NEVER ENVISIONED OR INTEND-
ED BY CONGRESS OR THIS COURT......
1]
iv
Page
A. The Court Below Improperly Ignored
The Evidence At The Class Action
Hearing In Contravention of This
Court’s Decision in General Telephone
Company of Southwest v. Falcon ...... 11
B. There Is A Direct Conflict Between The
Eleventh And The Fifth Circuits On
The Certification Of Ciaims F:rought
Under Rule 10b-5(b) ................. 14
III. THE COURT OF APPEALS IMPROPERLY
TOOK JURISDICTION OF THIS APPEAL
PURSUANT TO 28 U.S.C. § 1292(b)....... 16
oS SRI ECE DoE IT ORS oe een eS 19
APPENDIX
TABLE OF AUTHORITIES
Page
Basic Inc. v. Levinson, 107 S. Ct. 1284 (1987),
granting cert. to 786 F.2d 741 (1986) ......... 6, 7, 8
Blue Chip Stamps v. Manor Drug Stores, 421
oe Oe ere eres ere 6
Coopers & Lybrand v. Livesay, 437 U.S. 463
3 peewee Por ee Mor prey Poe err ry 6, 13,
16, 17
Eisen v. Carlisle & Jacquelin, 417 U.S. 156
CE 6c cc 5a tae eae Eo a eae Reeen ses 13
General Telephone Co. of Southwest v. Falcon,
gee AE gE i 4 a age li, 18,
13
Grainger v. State Security Life Insurance Co.,
547 F.2d 303 (5th Cir. 1977), cert. denied, 436
ee Fer ere foner crn ys ere 14
In re Petro-Lewis Securities Litigation, [1984-85
Transfer Binder] Fed. Sec. L. Rep. (CCH)
4 91,899 (D. Colo. Dec. 24, 1984) ........... 3
Kirkpatrick v. J.C. Bradford & Co., 827 F.2d 718
CE Ge SE ca ae ans eee eek ee oe passim
Levinson v. Basic Inc., 786 F.2d 741 (6th Cir.
1986), cert. granted, 107 S. Ct. 1284 (1987) ... 6, 10
List v. Fashion Park, Inc., 340 F.2d 457 (2d
Cir.), cert. denied sub nom., List v. Lerner,
PF RR OPE ae ere 7
Mercantile National Bank v. Langdeau, 371 U.S.
555 (1963)
Page
Sanders v. Robinson Humphrey/American
Express, Inc., 634 F. Supp. 1048 (N.D. Ga.
PROWPETUR Pree oe eee OV TERETE passim
Sanders v. Robinson Humphrey/American
Express, Inc., [1986-87 Transfer Binder] Fed.
Sec. L. Rep. (CCH) 4 92,880
ft oe RR yr error eer passim
Santa Fe Industries v. Green, 430 U.S. 462
PEN, § 6.4 4:04.65 0addas eee Vides eae eee 9
Shores v. Sklar, 647 F.2d 462 (5th Cir. 1981) (en
banc), cert. denied, 459 U.S. 1102 (1983) ..... 8
Simon v. Merrill Lynch, Pierce, Fenner & Smith,
Inc., 482 F.2d 880 (5th Cir. 1973) ........... 15
Shivangi v. Dean Witter Reynolds, Inc., 825 F.2d
er a i ca nnnd bas ateuses ees 16
STATUTES, RULES AND REGULATIONS
28 U.S.C. § 1254(1) (1982) .................... 2
28 U.S.C. § 1292(b) (1982) .................... 2, 16, 17
Section 11 of the Securities Act of 1933, 15
as SPU a 466 bs ae ceeseineanesees 2,4
Section 12(2) of the Securities Act of 1933, 15
Si thas b-SORED MED 505 hbk ch. 68S s cescnceese 2,4
Section 10(b) of the Securities Exchange Act of
1934, 15 U.S.C. § 78j(b) (1982) .............. passim
Rule 10b-5, 17 C.F.R. § 240.10b-5 (1987) ....... passim
Rule 425, 17 C.F.R. § 230.425 (1987)........... 9
Rule 23 of the Federal Rules of Civil Procedure .. passim
OTHER AUTHORITIES
Black, Fraud On The Market: A Criticism of
Dispensing With Reliance Requirements in
Certain Open Market Transactions, 62 N.C.L.
I SE hab nacewescasesssicecccccces
Note, The Fraud-On-The-Market Theory, 95
Harv. L. Kiev. 1143 (1982) ...............--.
Rapp, Rule 10b-5 And “Fraud-On-The-Market”
— Heavy Seas Meet Tranquil Shores, 39 Wash.
& Lee L. Rev. 861 (1982) ...................
C. Wright, A. Miller & E. Cooper, Federal
Practice and Procedure § 3911 (1976).........
Page
9, 10
13
No.
IN THE
Supreme Court of the United States
Octroser TerRM, 1987
PAINEWEBBER GROUP, INC.,
Petitioner,
vs.
TOMMY E. PARKER, as Custodian for
KIMBERLY M. PARKER, and JAMES L. SMITH,
Respondents.
PETITION FOR A WRIT OF CERTIORARI
TO THE UNITED STATES COURT OF APPEALS
FOR THE ELEVENTH CIRCUIT
Petitioner, PaineWebber Group, Inc. (“PaineWebber”),
respectfully prays that a writ of certiorari issue to review a judg-
ment of the United States Court of Appeals for the Eleventh
Circuit which reversed in part, affirmed in part and remand-
ed an order of the United States District Court for the Northern
District of Georgia denying plaintiffs’ motion for class
certification.
OPINIONS BELOW
The opinion of the United States Court of Appeals for the
Eleventh Circuit is set forth as Appendix Exhibit A. The de-
cision is reported as Kirkpatrick v. J.C. Bradford & Co., 827
F.2d 718 (11th Cir. 1987). The order of the Court of Appeals
2
y
denying a petition for rehearing and suggestion of rehearing en
banc is not reported and is set forth as Appendix Exhibit B. The
order staying the mandate of the Court of Appeals is not reported
and is set forth as Appendix Exhibit C.
The opinion of the United States District Court for the Nor-
thern District of Georgia denying plaintiffs’ motion for class cer-
tification is set forth as Appendix Exhibit D. It is reported as
Sanders v. Robinson Humphrey/American Express, Inc., 634 F.
Supp. 1048 (N.D. Ga. 1986). The District Court’s opinion de-
nying plaintiffs’ motion for reconsideration, granting plaintiffs’
motion to certify the case for interlocutory appeal pursuar.t to
28 U.S.C. § 1292(b) (1982) and staying the District Court’s order
denying class certification is set forth as Appendix Exhibit E.
It is reported as Sanders v. Robinson Humphrey/American Ex-
press, Inc., [1986-87 Transfer Binder] Fed. Sec. L. Rep. (CCH)
{ 92,880 (N.D. Ga. July 8, 1986).
The order of the Court of Appeals granting plaintiffs permis-
sion to appeal, pursuant to 28 U.S.C. § 1292(b)(1982), the District
Court’s order denying class certification is not reported and is
set forth as Appendix Exhibit F.
JURISDICTION
The judgment of the Court of Appeals was entered on
September 15, 1987. (Appendix Exhibit A). Rehearing was
denied by an order dated October 21, 1987. (Appendix Exhibit
B). The mandate of the Court of Appeals was stayed on
November 17, 1987. (Appendix Exhibit C). This Court’s jurisdic-
tion is invoked pursuant to 28 U.S.C. § 1254(1)(1982).
STATUTES AND RULES INVOLVED
The statutes and rules involved in the case are Section 10(b)
of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) (1982)
(“Section 10(b)”); Securities and Exchange Commission Rule
10b-5, 17 C.F.R. § 240.10b-5 (1987) (“Rule 10b-5”); Rule 23 of
the Federal Rules of Civil Procedure; 28 U.S.C. § 1292(b)(1982);
and Sections 1] and 12(2) of the Securities Act of 1933. 15 U.S.C.
§§ 77k, 771(2) (1982). (Appendix Exhibit G).
STATEMENT OF THE CASE
This case arises out of the sales of Petro-Lewis Corporation
(“Petro-Lewis”) oil and natural gas limited partnership interests.
From 1970 to 1983, Petro-Lewis was the nation’s largest seller
of oil and natural gas investment funds. Over this period, Petro-
Lewis, through numerous brokerage firms, including defendant
PaineWebber, sold in excess of $3 billion in partnership interests
to approximately 180,000 people. Sanders, 634 F. Supp. at 1050
(App. D-2).?
Suffering from oil and natural gas price declines, in February
1984 Petro-Lewis announced that its financial condition had
seriously deteriorated. Eleven class actions against Petro-Lewis,
brought under various provisions of the federal securities laws,
were filed between February 9, 1984 and May 9, 1984. These
class actions were subsequently settled and the settlement was
approved by the United States District Court for the District
of Colorado. See In re Petro-Lewis Securities Litigation, [1984-85
Transfer Binder] Fed. Sec. L. Rep. (CCH) 4 91,899 (D. Colo.
Dec. 24, 1984).
In the wake of the settlement of these class actions, defend-
ant PaineWebber and a number of other brokerage firms were
sued in separate class actions involving the sale of Petro-Lewis
partnership interests. This is one of those actions. Plaintiffs allege
that defendant PaineWebber violated, inter alia, Section 10(b)
and Rule 10b-5 by making false and misleading statements regar-
ding Petro-Lewis’ financial condition. Plaintiffs seek to repre-
sent a class of plaintiffs who, between January 1, 1981 and
February 6, 1984, purchased, reinvested in or otherwise acquired
Petro-Lewis limited partnership interests through defendant
PaineWebber. Sanders, 634 F. Supp. at 1052 (App. D-5).
In March, 1986, the District Court denied plaintiffs’ motion for
class certification, finding that individual issues predominated
2 References to “App. ___” are to the Appendix submitted with this petition.
over common issues. In September, 1987, the Eleventh Circuit
reversed the District Court’s denial of class certification as to
the Section 10(b) and Rule 10b-5 claims.
The District Court held that the plaintiffs had failed to carry
their burden under Fed. R. Civ. P. 23(b)(3) of demonstrating
that individual issues predominated over common issues with
respect to their Section 10(b) and Rule 10b-5 claims. The District
Court found that because the putative class plaintiffs relied on
oral representations of their individual account executives and
plaintiffs presented insufficient evidence to establish that these
account executives employed a uniform sales pitch, individual
issues of reliance predominated among the class members.
Sanders, 634 F. Supp. at 1061-63 (App. D-23-27). The District
Court rejected the “fraud-on-the-market” theory as a basis for
presuming reliance because it found (1) the limited partnerships
were not sold on the open market and (2) there was no basis
in the record for plaintiffs’ allegations that Petro-Lewis part-
nership programs could not have been marketed but for a fraud.
Sanders, 634 F. Supp. at 1063-64; [1986-87 Transfer Binder] Fed.
Sec. L. Rep. (CCH) { 92,880, at 94,271 (App. D-27-29; E-10-11).
The District Court also found that individual issues
predominated because many of the class members had signed
arbitration agreements that obligated them to arbitrate their
grievances; the statute of limitations for Section 10(b) claims
varied from state to state; and the common law claims of the
class members differed depending on their states of residence.’
Sanders, 634 F. Supp. at 1064-69 (App. D-29-38).
The Court of Appeals reversed the District Court’s denial of
class certification on the Section 10(b) and Rule 10b-5 claims.
Instead of deferring to the District Court’s factual finding that
plaintiffs had presented insufficient evidence to demonstrate
the predominance of common issues, the Eleventh Circuit
* The District Court also denied class certification as to plaintiffs’ claims
under Sections 11 and 12(2) of the Securities Act of 1933, 15 U.S.C. §§ 77k,
1(2)(1982) and found the plaintiffs would be inadequate class representatives.
Sanders, [1986-87 Transfer binder] Fed. Sec. L. Rep. (CCH) 4 92,880, at
94,269-70 (App. E-3-6).
improperly relied solely on the allegations of plaintiffs’ com-
plaint in holding that common issues predominated. The Court
of Appeals held that because “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,” the Rule
10b-5(a) and 10b-5(c) claims were properly subject to class ac-
tion treatment under the “fraud-on-the-market” theory.
Kirkpatrick, 827 F.2d at 722 (emphasis added) (App. A-7).
The Court of Appeals took a similar deferential view of plain-
tiffs’ complaint in concluding that the District Court improperly
found that the plaintiffs’ 10b-5(b) misrepresentation claims were
not suited for class treatment. Kirkpatrick, 827 F.2d at 724
(App. A-10). The Court of Appeals certified the Rule 10b-5(b)
claims because “the complaints alleged that the defendant
brokerage firms and individual officers engaged in a common
course of conduct” to misrepresent the financial condition of
Petro-Lewis. Id. (Emphasis added).* The Court of Appeals found
that common issues predominated with respect to the
misrepresentation claims on the basis of an alleged common
course of conduct, even though the District Court had found
insufficient evidence of such a common course of conduct.
* The Court of Appeals also affirmed the District Court’s denial of class cer-
tification as to the plaintiffs’ state law claims; reversed the District Court's
denial of class certification as to the plaintiffs’ claims under Sections 11 and
12(2) of the Securities Act of 1933; held that “purchasers whose 10b-5 claims
are subject to arbitration . . . [can]not be considered members of the class,”
Kirkpatrick, 827 F.2d at 725 n.5 (App. A-ll n.5); and held that the District
Court applied an erroneous standard in determining that the named plain-
tiffs would not be adequate class representatives and remanded this issue to
allow the District Court to apply the standard set out therein by the Eleventh
Circuit. PaineéWebber is not petitioning for a writ of certiorari as to any of
these issues.
REASONS FOR GRANTING THE WRIT
I
PERMITTING A PRESUMPTION OF RELIANCE IN
ORDER TO FACILITATE CLASS CERTIFICATION
OF ACTIONS UNDER RULE 10b-5 WHERE THE
SECURITY AT ISSUE IS NOT TRADED ON THE
OPEN MARKET WILL OPEN THE FLOODGATES
TO RULE 10b-5 CLASS ACTIONS
A. This Court Should Consider This Case
in Conjunction with Basic Inc. v. Levinson
This case presents the same issues with regard to class cer-
tification, the “fraud-on-the-market” theory and the propriety
of permitting a presumption of reliance under Rule 10b-5 as are
currently being considered by this Court in Basic Inc. v. Levin-
son, 107 S. Ct. 1284 (1987), granting cert. to 786 F.2d 741 (1986).
Reliance on a defendant's alleged deception has historically been
a required element of a fraud claim under Section 10(b) and
Rule 10b-5. As argued in Basic, the “fraud-on-the-market”
theory, by permitting a presumption of reliance in Rule 10b-5
actions so as to facilitate class certification, ignores this long stan-
ding requirement and requires only a showing that a
misrepresentation or omission is material in order to obtain class
certification. The “fraud-on-the-market” theory thereby great-
ly increases the potential for abuse of the class action device by
transforming this procedural rule into a substantive weapon
which can be used by plaintiffs against issuers of securities
brokerage firms.‘
Indeed, affording a presumption of reliance for purposes of
class certification is far less supportable in this case than in Basic.
* In Coopers & Lybrand v. Livesay, 437 U.S. 463, 476 (1978), this Court
noted its concern with the potential abuse of class actions, stating: “Certifica-
tion of a large class may so increase the defendant’s potential damages liabili-
ty and litigation costs that he may find it economically prudent to settle and
_ to abandon a meritorious defense.” Similarly, in Blue Chip Stamps v. Manor
' Drug Stores, 421 U.S. 723, 747-48 (1975) — a securities fraud action under
Rule 10b-5 — this Court stated that “the inexorable broadening of the class
of plaintiff who may sue in this area of the law will ultimately result in more
harm than good.”
In Basic, the argument that reliance should be presumed was
arguably plausible because the securities at issue were actively trad-
ed on an open market, thereby permitting the contention that
plaintiffs relied on the market price of those securities. No similar
argument can be made where, as here, there was no developed
market in which to trade the limited partnership interests.
The long-standing requirement under Rule 10b-5 that a plain-
tiff show actual reliance on the defendant’s alleged deception
in making the decision to purchase or sell the security at issue
insures the existence of a causal relation between that conduct
and the plaintiff's injury so as to prevent Rule 10b-5 from becom-
ing a “scheme of investors’ insurance”. List v. Fashion Park, Inc.,
340 F.2d 457, 463 (2d Cir.), cert. denied sub nom., List v. Lerner,
382 U.S. 811 (1965). As in common-law fraud, the reliance re-
quirement of Rule 10b-5 insures that the defendant’s actions were
in fact the actual cause of plaintiffs injury. This requirement
plays an even more important role in limiting and defining the
scope of liability of securities issuers and brokerage firms under
Rule-0b-5 as they market and sell securities in the national and
international economic sphere.
In Basic, the Sixth Circuit permitted a presumption of reliance
under Rule 10b-5, in the form of the “fraud-on-the-market” theory,
in order to “facilitate” the class action against an issuer of securities.
Under this theory, a plaintiffs reliance on the purported fraud
is presumed, on the grounds that, in an open and developed
securities market, the price of a company’s stock is determined
by the publicly available information regarding the company and
that the plaintiff “relied” on the “integrity” of the market when
dealing in that stock. Basic, 786 F.2d at 750. This presumption
facilitates certification of class actions by pretermitting an other-
wise necessary finding that common questions of reliance
predominate over individual questions under Fed. R. Civ. P. 23(b).
As argued to this Court in Basic, this use of a presumption
of reliance as a substitute for the otherwise required showing
by a plaintiff of actual reliance on the alleged deception in mak-
ing the decision to purchase or sell the security, has led to an
abuse of the class action device by expanding the class of plain-
tiffs who may sue by means of a class action under Rule 10b-5.
This case presents those same issues and, should this Court re-
ject the “fraud-on-the-market” theory in Basic, that holding will
be dispositive in this case. On this basis alone, this Court should
grant this petition.
However, even if the “fraud-on-the-market” theory at issue
in Basic were to be accepted by this Court, this case presents
nationally important issues that should be considered and de-
cided in conjunction with that case. The court below: held that
the District Court was required to apply a presumption of
reliance in the form of a “fraud-on-the-market” theory to
securities not traded on an open market. Kirkpatrick, 827 F.2d
at 723 (App. A-8-9). Thus, the present case takes the “fraud-
on-the-market” theory a step further and creates an even greater
potential for abuse of the class action device than that created
by the court in Basic by even further expanding the class of plain-
tiffs who may take advantage of the class action device.
This Court should therefore consider, in conjunction with its
consideration of Basic, the propriety of applying the “fraud-on-
the-market” theory to undeveloped securities markets, as the con-
tinued expansion of this theory presents an issue of growing na-
tional importance to securities issuers and brokerage firms which
ought to be resolved.
B. The Interpretation of the “Fraud-on-the-Market”
Theory by the Court Below Will Open the
Floodgates to Class Actions Under Rule 10b-5
The court below applied the “fraud-on-the-market” theory
to plaintiffs’ claims to facilitate class certification, even though
the Petro-Lewis partnership interests purchased were not trad-
ed on the open market, on the grounds that “plaintiffs alleged
that the Petro-Lewis shares . . . could not have been marketed
but for the defendants’ fraud.” Kirkpatrick, 827 F.2d at 722 (App.
A-7). The court purported to reached this conclusion on the basis
of Shores v. Sklar, 647 F.2d 462 (5th Cir. 1981) (en banc), cert.
denied, 459 U.S. 1102 (1983). Shores and the decision below both
erred in applying the “fraud-on-the-market” theory to the con-
text of the undeveloped market. This error is likely to
significantly impact securities issuers and brokerage firms.
Moreover, the decision below went beyond Shores and other Cir-
cuit Court opinions which have interpreted the “fraud-on-the-
market” theory, and has improperly created an irrebuttable
presumption of reliance in class certification motions under Rule
10b-5.
Shores’ application of the “fraud-on-the-market” theory to the
undeveloped market has been repeatedly and consistently
criticized, and for good reason.° First, the decision of the court
below brings the concept of substantive fairness into the domain
of Rule 10b-5 — a concept that is foreign to the federal securities
laws. The federal securities laws and Rule 10b-5 are not intended
to insure the general fairness of securities issuances and the
Securities and Exchange Commission does not pass on the quality
or soundness of any new securities issuances. See, e.g., 17 C.F.R.
§ 230.425 (1987). Rather, as settled by this Court a decade ago,
the federal regulatory scheme and Rule 10b-5 govern only the
adequacy of disclosure. See Santa Fe Industries v. Green, 430
USS. 462, 478 (1977). The decision below — extending Rule 10b-5
to allow an action to proceed because a security would have been
“unmarketable” “but for” the fraud — brings the issue of substan-
tive fairness back into the sphere of the federal securities laws.
See Note, The Fraud-On-The-Market Theory, 95 Harv. L. Rev.
1143, 1158 (1982).
Second, the rationale of the decision below and Shores
eliminates the requirement of proximate cause — effectively
creating a strict liability standard once materiality and scienter
are shown. As one commentator has stated:
the “but for” causation rationale begs the ultimate
question of proximate or legal cause. As is apparent
from the Shores decision itself, a mechanical standard
* See, e.g., Note, The Fraud-On-The-Market Theory, 95 Harv. L. Rev. 1143,
1156-58, 1161 (1982); Black, Fraud On The Market: A Criticism of Dispens-
ing With Reliance Requirements in Certain Open Market Transactions, 62
N.CLL. Rev. 435, 453, 472 (1984); Rapp, Rule 10b-5 And “Fraud-On-The-
Market”— Heavy Seas Meet Tranquil Shores, 39 Wash. & Lee L. Rev. 861, 881-88
(1982).
10
of “but for” causation would allow recovery no mat-
ter how attenuated the connection between defendant
and plaintiff.
Note, supra, 95 Harv. L. Rev. at 1158. Whether a defendant’s
action bears any relation to a plaintiff's decision to engage in
the transaction resulting in his loss is now irrelevant. The
common-law concept of fraud is now removed from Rule 10b-5
jurisprudence.
Moreover, the decision below goes even further than Shores
and creates an irrebuttable presumption of reliance and causa-
tion in deciding whether to certify Rule 10b-5 cases. Under the
holding of the court below, one need only allege that a security
could not have been marketed but for the fraud in order to show
that common questions predominate on a motion for class cer-
tification under Fed. R. Civ. P. 23. This position directly con-
flicts with other Courts of Appeals’ decisions regarding the
“fraud-on-the-market theory,” which permit only a rebuttable
presumption of reliance under Rule 10b-5. See, e.g. Levinson
v. Basic Inc., 786 F.2d 741, 750 (6th Cir. 1986), vert. granted,
107 S. Ct. 1284 (1987). If allowed to stand, the decision below
will open the floodgates to class action litigation because, in every
instance where the price of a security falls, class certification
will be assured whenever a plaintiff alleges that the securities
could not have been marketed but for a fraud.
In short, the decision below is a radical departure from prior
Rule 10b-5 jurisprudence. Class actions under Rule 10b-5 will
now be brought and certified every time an issuer issues or a
brokerage firm markets a security that subsequently drops in
price. The substantive fairness of securities issuances will be
regulated under federal law. And business corporations and
financial institutions will be the ones to bear the burden of this
new jurisprudence.
11
Il
ALLOWING CLASS ACTIONS TO BE CERTIFIED
ON THE BASIS OF THE PLEADINGS ALONE
IRRESPECTIVE OF THE EVIDENCE PRESENTED
AT THE CLASS CERTIFICATION HEARING WILL
TRANSFORM RULE 23 INTO A BLUDGEON
NEVER ENVISIONED OR INTENDED BY CON-
GRESS OR THIS COURT
A. The Court Below Improperly Ignored The
Evidence At The Class Action Hearing In
Contravention of This Court’s Decision in General
Telephone Company of Southwest v. Falcon
The decision of the court below contravenes an entire body
of Rule 23 jurisprudence. Under the Eleventh Circuit’s analysis,
a plaintiff need only allege that common issues predominate
over individual issues under Rule 23(b)(3) and that allegation
must be accepted as true by the District Court for purposes of
the class certification motion. Adoption of the Eleventh Circuit's
analysis will lead to abuse of the class action device because it
will encourage plaintiffs with little hope of ultimately prevail-
ing on the merits, but with knowledge that their lawsuit will
invoke massive discovery and fear of large damages liability by
the defendant, in their attempts to extort huge settlement sums
from defendants.
In holding that common issues predominated on plaintiffs’
Rule 10b-5 claims, the Court of Appeals relied solely on the
allegations of the complaint and ignored the evidence presented
at the class certification hearing. The court below required that
a class be certified on the claims brought pursuant to Rule
10b-5(a) and 10b-5(c) under the “fraud-on-the-market” theory
because “plaintiffs alleged that the Petro-Lewis shares, which
were not traded on the open market, could not have been
marketed but for defendants’ fraud.” Kirkpatrick, 827 F.2d at
722 (emphasis added) (App. A-7).
12
Similarly, the decision of the court below required that a class
action be certified under Rule 10b-5(b) because the complaint
alleged that the defendant engaged in a common course of con-
duct, without regard to the sufficiency of the evidence.
Kirkpatrick, 827 F.2d at 724 (emphasis added) (App. A-10). The
District Court had specifically found that there was no evidence
of a common course of fraudulent conduct by defendant ap-
plicable to the putative class. Sanders, 634 F. Supp. at 1062 (App.
D-25). The Eleventh Circuit improperly ignored the factual fin-
ding of the District Court and relied solely on the allegations
of the complaint.
The decision of the court below effectively eliminates the need
for any evidentiary showing on a class certification motion. It
creates a standard contrary to policy and precedent — including
this Court's decision in General Telephone Co. of Southwest v.
Falcon, 457 U.S. 147, 160 (1982), requiring a “rigorous analysis”
of motions under Fed. R. Civ. P. 23 ~ and is likely to lead, as
here, to unjust results.
A “rigorous analysis” of a class certification motion under Rule
10b-5 must include an analysis of whether plaintiffs have met
their burden of proving that common questions of law and fact
predominate over individual questions affecting only individual
members. The court below failed to take this approach. Instead,
it ended its Rule 23 analysis at the four corners of the complaint.
Such a failure to examine the evidence on a motion under
Fed. R. Civ. P. 23 was specifically criticized by this Court in
Falcon. The Court there reversed the Court of Appeals’ affir-
mance of an order granting a motion for class certification where
the District Court did not conduct an evidentiary hearing and
[the] complaint provided an insufficient basis for con-
cluding that the adjudication of [plaintiff s] claim
.. .. would require the decision of any common ques-
tion . . . . Without any specific presentation identi-
fying the questions of law or fact that were comuon
to the claims of respondent and of the members of
the class he sought to represent, it was error for the
13
District Court to presume that [the plaintiff's) claim
was typical of other claims against [defendant by other
purported class members. ]
General Telephone Co. of Southwest v. Falcon, 457 U.S. at
158-59. Falcon reaffirmed this Court's longstanding position that
“the class determination generally involves considerations that
are ‘enmeshed in the factual and legal issues comprising the
plaintiff's cause of action. ” Coopers & Lybrand v. Livesay, 437
US. at 469 (quoting Mercantile National Bank v. Langdeau,
371 U.S. 555, 558 (1963)). As stated in Livesay:
Evaluation of many of the questions entering into
determination of class action questions is intimately
involved with the merits of the claims. The typicali-
ty of the representative's claims or defenses, the ade-
quacy of the representative, and the presence of com-
mon questions of law or fact are obvious examples.
The more complex determinations required in Rule
23(b)(3) class actions entail even greater entanglement
with the merits... .
Id. at 469 n.12 (quoting 15 C. Wright, A. Miller & E. Cooper,
Federal Practice and Procedure § 3911, at 485 n.45 (1976)).
In reaching the conclusion that the District Court had con-
ducted an “inappropriate inquiry into the merits,” the Court
of Appeals purported to rely on this Court's decision in Eisen
v. Carlisle ¢ Jacquelin, 417 U.S. 156, 177-78 (1974). However,
Eisen held that the District Court erred in imposing the cost
of notice to class members on the defendant on the basis of a
finding, after “a preliminary hearing on the merits of the case,
that petitioner was ‘more than likely’ to prevail on his claims.”
Eisen, 417 U.S. at 177. The Court criticized this procedure
because it “allow{s] a representative plaintiff to secure the
benefits of a class action without first satisfying the requirements
for it.” Id. In the present case, the District Court took specific
cognizance of Eisen and examined the evidence solely in terms
of the Rule 23 issues and not in terms of the merits of plaintiffs’
claims. Eisen does not preclude this sort of inquiry.
14
The Eleventh Circuit's policy permits class certification on
the mere filing of the “well pled” complaint with no showing
that the requirements of Rule 23 have been met. Adoption of
the Eleventh Circuit's view will therefore undoubtedly spawn
more securities fraud class actions against securities issuers and
brokerage firms. These cases — often initiated for their settle-
ment value or in terrorem effect — rarely reach trial, much less
review in this Court. The stakes are too high to permit the risks
of final adjudication of these claims no matter how little ac-
tual merit the suit may have. And it is the certification of a class
of plaintiffs which raises those stakes to that intolerable level.
Extensive abuse of this procedural device — with large reper-
cussions on the national economy — is inevitable under the stan-
dard set forth by the Eleventh Court.
B. There Is A Direct Conflict Between The Eleventh
And The Fifth Circuits On The Certification Of
Claims Brought Under Rule 10b-5(b)
Not only is the decision of the court below — that class cer-
tification is proper as to claims brought under Rule 10b-5(b)
where the complaint alleges a common course of conduct
although the evidence does not show a common course of con-
duct — in conflict with Supreme Court precedent, but it is also
in direct conflict with the holdings of the Fifth Circuit on this
precise issue. The Fifth Circuit requires that a plaintiff
demonstrate, not merely allege, the predominance of common
issues.
In Grainger v. State Security Life Insurance Co., 547 F.2d
303 (5th Cir. 1977), cert. denied, 436 U.S. 932 (1978), the Fifth
Circuit held, in the context of a putative 10b-5 class action in-
volving alleged oral misrepresentations, that the plaintiff must
meet his burden of proving that standardized class representa-
tions were made, and that otherwise certification should be
denied:
the key concept in determining the propriety of class
action treatment is the existence or nonexistence of
material variations in the alleged misrepresentations.
15
It is possible, although unlikely, that oral misrepres-
entations can be uniform, e.g., through use of a stan-
dardized sales pitch by all the company’s salesmen.
Plaintiffs in the present case should be given the op-
portunity to demonstrate the existence and use of such
a device. If plaintiffs cannot do this, then the district
court may quite properly refuse to certify a class on
the grounds that common questions of law or fact do
not predominate.
547 F.2d at 307-08.
Similarly, in Simon v. Merrill Lynch, Pierce, Fenner & Smith,
Inc., 482 F.2d 880 (5th Cir. 1973), also a class action against
a brokerage firm alleging Rule 10b-5 misrepresentations which
were not demonstrated to be standardized, the Fifth Circuit af-
firmed the denial of class certification, stating:
If there is any material variation in the representa-
tions made or in the degrees of reliance thereupon,
a fraud case may be unsuited for treatment as a class
action. See Rule 23, Advisory Committee's Official
Note, 39 F.R.D. 98, 107 (1966). Thus, courts usually
hold that an action based substantially, as here, on
oral rather than written misrepresentations cannot be
maintained as a class action.
Even if plaintiff had established that the alleged
misrepresentations were primarily written, a class ac-
tion would not be appropriate unless he could prove
the similarity of the writings. His failure to prove any
standardized representations by Merrill Lynch bars
a class action whether it is based on Rule 10b-5 or the
state common law.
482 F.2d at 882-83.
a
16
The Fifth Circuit, subsequent to the split between the Fifth
and the Eleventh Circuit, has adhered to its holdings in Simon
and Grainger. In Shivangi v. Dean Witter Reynolds, Inc., 825
F.2d 885 (5th Cir. 1987), the court properly affirmed the district
court’s denial of class certification in an oral representations case
under Rule 10b-5 where the plaintiffs failed to prove standar-
dized representations by the defendant brokerage firm. 825 F.2d
at 890.
Given the District Court’s factual finding (undisputed by the
Court of Appeals (see Kirkpatrick, 827 F.2d at 724 (App. A-10))
that the plaintiffs relied on the oral representations of their in-
dividual account executives and that there was insufficient
evidence of standardized representations, the Court of Appeals’
legal conclusion that common issues predominated — made solely
on the basis of the allegations of the complaint — directly con-
travenes the Fifth Circuit’s holdings in Grainger, Simon and
Shivangi. This split in the circuits highlights the Court of Ap-
peals’ error in its Rule 23 analysis and mandates this Court’s
intervention to restore uniformity and coherence to this area
of the law.
Il
THE COURT OF APPEALS IMPROPERLY TOOK
JURISDICTION OF THIS APPEAL PURSUANT TO
28 U.S.C. § 1292(b)
The Court of Appeals improperly took jurisdiction of this case
pursuant to 28 U.S.C. § 1292(b). Under that statute, certifica-
tion of a non-final order is proper only if that order “involves
a controlling question of law as to which there is substantial
ground for difference of opinion and...an immediate appeal from
the order may materially advance the ultimate termination of
the litigation.” (Emphasis added)
This Court has unequivocally stated that “an order denying
class certification is subject to effective review after final judg-
ment at the behest of the named plaintiff or intervening class
17
members” and that only “exceptional circumstances justify a
departure from the basic policy of postponing appellate review
until after entry of a final judgment.” Coopers & Lybrand v.
Livesay, 437 U.S. at 469, 475 (citation omitted). Accordingly,
interlocutory appeals from denials of class certification should
be granted only under the most unusual circumstances.
The essence of a class action is that the representative plain-
tiffs’ claims are typical of the claims of the class and that the
questions of law or fact common to the members of the class
predominate over questions affecting only individual members.
Accordingly, if a class is properly certifiable under Rule 23, the
representative plaintiffs’ proof at trial as to their claims must
be identical to the class’s proof as to the class claims. Inter-
locutory review by a court of appeals of the denial of class ac-
tion certification therefore cannot materially advance the
ultimate termination of the litigation.
Suppose, arguendo, that class certification is improperly
denied by the district court. Under Section 1292(b), the order
denying class certification would be properly appealable only
if that appeal “may materially advance the ultimate termina-
tion of the litigation.” However, the litigation of the case could
not be advanced by interrupting the normal litigation process
with an interlocutory appeal because such an appeal would
result in no more than transposing the appellate review of this
limited issue of certification from the end of the process to the
very middle. There would be no net advancement of the litiga-
tion because if the plaintiffs’ claims were typical and common
questions predominated, plaintiffs’ proof would have to typify
the class’s proof. It would be more expeditious if plaintiffs first
pursued their individual claims, which would bethe same as
the class’s claim, and thereafter — without the lengthy interim
delay of an interlocutory appeal — appealed the denial of class
certification. Indeed, at that point, with the benefit of a trial
record, a court of appeals would be in a better position to assess
whether the case should have been maintained as a class action.
On the other hand, if class action status is properly denied
by the district court, an appeal of that denial pursuant to Section
18
1292(b) would by definition delay the ultimate termination of
the litigation.
The District Court in this case properly denied class certifica-
tion on the grounds that individual questions predominated over
common questions. Thus, the standard under Section 1292(b)
was not (and could not have been) met and this case was im-
properly accepted for review by the Court of Appeals under Sec-
tion 1292(b). Petitioner briefed and argued this point to the court
below. However, the Court of Appeals did not address this issue
in its opinion.
19
CONCLUSION
For the foregoing reasons, petitioner respectfully requests that
this Court issue a writ of certiorari to review the decision of the
United States Court of Appeals for the Eleventh Circuit.
Dated: New York, New York
November 23, 1987
RoBERT EMANUEL ZIMET
Counsel of Record for Petitioner
RicHARD M. Kirsy SKADDEN, ARPS, SLATE,
HANSELL & Post MEAGHER & FLOM
3300 First Atlanta Tower 919 Third Avenue
Atlanta, Georgia 30383 New York, New York 10022
(404) 581-8000 (212) 735-3000
Attorneys for Petitioner
Of Counsel:
JEREMY A. BERMAN
CHARLES F. WALKER
APPENDIX
+ ih CPC ss
TABLE OF CONTENTS
Opinion of the Court of Appeals for the Eleventh
Circuit (September 15, 1987) ................
Order of the Court of Appeals Denying Petition
for Rehearing and Suggestion of Rehearing en
S| ae
Order Staying the Mandate of the Court of
Appeals (November 17, 1987) ................
Opinion of the District Court for the Northern
District of Georgia Denying Plaintiffs’ Motion
for Class Certification (March 27, 1986).......
Opinion of the District Court Denying Plaintiffs’
Motion for Reconsideration, Granting Plaintiffs’
Motion to Certify the Case for Interlocutory
Appeal Pursuant to 28 U.S.C. § 1292(b) (1982)
and Staying the District Court’s Order Denying
Class Certification (July 8, 1986) .............
Order of the Court of Appeals Granting Plaintiffs
Permission to Appeal Pursuant to 28 U.S.C.
§ 1292(b) (1982) (August 21, 1986) ...........
ee a aa eleee's
B-1
C-1
D-1
F-]
G-1l
Suzanne KIRKPATRICK; Dorothy D. Casler and Charles H.
Lindsey, on behalf of themselves and alfothers similarly situated,
Plaintiffs-Appellants,
v.
J.C. BRADFORD & CO.,
Defendant-Appellee.
Glenn T. SANDERS on behalf of himself and all others similarly
situated, and Leslie D. Sanders,
Plaintiffs-Appellants,
V.
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,
v.
PAINE WEBBER GROUP, INC.,
Defendant-Appellee.
Nos. 86-8624 to 86-8626.
United States Court of Appeals,
Eleventh Circuit.
Sept. 15, 1987.
A-2
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.
eT
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-+
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
. 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 ll 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 predecessor 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 (Lith 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 revd 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 (lth 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
(11th 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
d> 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
> ae)
AS
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.I1.1982). 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, inciuding 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-9
a eh
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) misrepresenia-
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 those 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,
giver: 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 (11th
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 ll 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 soid. 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 (lth 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
claims 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 ll 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 1] 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
ll and 12(2) claims. Although there is some overlap between
section 10(b) and sections 1] 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), aff'd, 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.III.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.I1.1977).
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 ». 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
a SS ee! he
” 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 (Lith 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.
hi oeeeeerereeeeenennanmanmaimaaniaaadiiaiaaaaaamaael
tN i alt
—— ins
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
UNITED STATES COURT OF APPEALS
Eleventh Circuit
56 Forsyth Street, N.W.
Atlanta, Georgia 30303
October 21, 1987
Miguel J. Cortez In Replying Give Number
Clerk Of Case and Names Of Parties
MEMORANDUM TO COUNSEL OR PARTIES LISTED
BELOW:
NOS. 86-8624, 86-8625 & 86-8626
SUZANNE KIRKPATRICK, et al. v. J.C. BRADFORD &
CO.
(Nos. C85-1891A, C85-172A & C85-1586A)
The enclosed order has been entered on petition(s) for rehearing.
See Rule 41, Federal Rules of Appellate Procedure, and Eleventh
Circuit Rule 41-1 for information regarding issuance and stay of
mandate.
Sincerely,
MIGUEL J. CORTEZ, Clerk
By: /s/ Pam Holloway
Deputy Clerk
Encl.
Brenda M. Nelson Robert E. Boston
Kenneth A. Jacobsen Lloyd S. Clareman
Richard D. Greenfield Harvey D. Myerson
Richard M. Kirby Bradley C. Twedt
Robert E. Zimet Timothy J. Carey
Glenn Delk Peter J. Anderson
Ames Davis Mack Young
B-2
IN THE UNITED STATES COURT OF APPEALS
FOR THE ELEVENTH CIRCUIT
No. 86-8624
SUZANNE KIRKPATRICK;
DOROTHY D. CASLER and
CHARLES H. LINDSEY, on
behalf of themselves and
all others similarly situated,
Plaintiffs-Appellants,
versus
J.C. BRADFORD & CO.,
Defendant-Appellee.
No. 86-8625
GLENN T. SANDERS on behalf
of himself and all others
similarly situated, and
LESLIE D. SANDERS,
Plaintiffs-Appellants,
versus
ROBINSON HUMPHREY/AMERICAN
EXPRESS, INC., and SHEARSON/AMERICAN
EXPRESS, INC.,
Defendants-Appellees.
———— eee
La
NO. 86-8626
TOMMY E. PARKER, as custodian
for KIMBERLY M. PARKER and JAMES L.
SMITH, on behalf of themselves and
all others similarly situated,
Plaintiffs-Appellants,
versus
PAINE WEBBER GROUP, INC.,
Defendant-Appellee.
Appeals from the United States District Court for the
Northern District of Georgia
ON PETITION(S) FOR REHEARING AND SUGGESTION(S)
OF REHEARING IN BANC
(Opinion September 15, 11 Cir., 1987, __.. F.2d ___).
(October 21, 1987)
Before VANCE and KRAVITCH, Circuit Judges, and BROWN’,
Senior Circuit Judge.
PER CURIAM:
(x) The Petition(s) for Rehearing are DENIED and no member
of this panel nor other Judge in regular active service on the
Court having requested that the Court be polled on rehearing
in banc (Rule 35, Federal Rules of Appellate Procedure; Eleventh
Circuit Rule 35-5), the Suggestion(s) of Rehearing In Banc are
DENIED. :
( ) The Petition(s) for Rehearing are DENIED and the Court
having been polled at the request of one of the members of the
Court and a majority of the Circuit Judges who are in regular
active service not having voted in favor of it (Rule 35, Federal
B-4
Rules of Appellate Procedure; Eleventh Circuit Rule 35-5), the
Suggestion(s) of Rehearing In Banc are also DENIED.
( ) Amember of the Court in active service having requested
a poll on the reconsideration of this cause in banc, and a ma-
jority of the judges in active service not having voted in favor
of it, Rehearing In Banc is DENIED.
ENTERED FOR THE COURT:
/s/ Phyllis Kravitch
United States Circuit Judge
* Honorable John R. Brown, Senior U.S. Circuit Judge for
the Fifth Circuit, sitting by designation.
a a nn el
7 a
C-l
UNITED STATES COURT OF APPEALS
Eleventh Circuit
56 Forsyth Street, N.W.
Atlanta, Georgia 30303
Miguel J. Cortez In Replying Give Number
Clerk Of Case And Names Of Parties
November 17, 1987
TO: ALL COUNSEL LISTED BELOW:
No. 86-8624, 86-8625 & 86-8626
KIRKPATRICK, et al. v. BRADFORD, et al.
MANDATE STAYED TO AND INCLUDING November 23,
1987.
The court has this day granted a stay of the mandate to the date
shown above. If during the period of the stay there is filed in
this court a notice from the Clerk of the Supreme Court that
the party who has obtained the stay has filed a petition for writ
of certiorari in the Supreme Court, the stay shall continue un-
til final disposition by the Supreme Court. Upon the filing of
a copy of an order of the Supreme Court denying the petition
for writ of certiorari, the mandate shall issue forthwith. See
Fed.R.App.P. 41.
The Clerk of the Supreme Court has requested the clerks of the
federal courts of appeal to retain the record on appeal until the
Supreme Court requests that it be transmitted. Parties will be
advised when this occurs. Accordingly, please refrain from
routinely requesting transmittal of the record. See Supreme
Court Rule 19.1.
A copy of this court’s opinion (or Rule 36-1 decision), the judg-
ment, and any order on rehearing should be attached as an ap-
pendix to any petition for writ of certiorari (or jurisdictional
statement) filed. See Supreme Court Rules 21(k), 15(j).
C-2
( ) This court has also directed recall of the mandate. By copy
of this letter the clerk of the district court is requested
to return the opinion and judgment previously issued as
mandate.
Sincerely,
MIGUEL J. CORTEZ, Clerk
By: /s/ Pam Holloway
Deputy Clerk
Glenn Delk
Kenneth A. Jacobsen
Richard D. Greenfield
Ames Davis
Robert E. Boston
Lloyd S. Clareman
Harvey D. Myerson
Bradley C. Twedt
Timothy J. Carey
Peter J. Anderson
Mack Young
Brenda M. Nelson
Richard M. Kirby _
Robert E. Zimet
MDT-2
7/87
C-3
IN THE UNITED STATES COURT OF APPEALS
FOR THE ELEVENTH CIRCUIT
No. 86-8624
SUZANNE KIRKPATRICK;
DOROTHY D. CASLER and
CHARLES H. LINDSEY, on
behalf of themselves and
all others similarly situated,
Plaintiffs-Appellants,
versus
J.C. BRADFORD & CO.,
Defendant-Appellee.
7
| No. 86-8625
GLENN T. SANDERS on behalf
of himself and all others
similarly situated, and
LESLIE D. SANDERS,
Plaintiffs-Appellants,
versus
ROBINSON HUMPHREY/AMERICAN
EXPRESS, INC., and SHEARSON/AMERICAN
EXPRESS, INC.,
Defendants-Appellees.
C-4
No. 86-8626
TOMMY E. PARKER, as custodian
for KIMBERLY M. PARKER and JAMES L.
SMITH, on behalf of themselves and
all others similarly situated,
Plaintiffs-Appellants,
versus
PAINE WEBBER GROUP, INC.,
Defendant-Appellee,
FILED
U.S. COURT OF APPEALS
ELEVENTH CIRCUIT
NOV 17
MIGUEL J. CORTEZ, CLERK
Appeal from the United States District Court for the
Northern District of Georgia
ORDER:
( ) The motion of Appellees, J.C. BRADFORD & CO., et
al. for (xx) stay (__) recall and stay of the issuance of the
mandate pending petition for writ of certiorari is
DENIED.
(x) The motion of Appellees, J.C. BRADFORD & CO., et al.
for (xx) stay (_) recall and stay of the issuance of the man-
date pending petition for writ of certiorari is GRANTED
to and including Nov. 23rd 1987, the stay to continue in
force until the final disposition of the case by the Supreme
Court, provided that within the period above mention-
ed there shall be filed wtih the Clerk of this Court the
ot abe ticle stl teas. Veer
(
)
C-5
certificate of the Clerk of the Supreme Court that the cer-
tiorari petition has been filed. The Clerk shall issue the
mandate upon the filing of a copy of an order of the
Suprer ‘e Court denying the writ, or upon expiration of
the stay granted herein, unless the above mentioned cer-
tificate shall be filed with the Clerk of this Court within
that time.
The motion of
for a further stay of the issuance of the mandate is
GRANTED to and including , under
the same conditions as set forth in the preceding
paragraph.
IF IS ORDERED that the motion of
for a further stay of the issuance of the mandate is
DENIED.
/s/ Phyllis Kravitch
UNITED STATES CIRCUIT JUDGE
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Poet ae ae
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D-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
D.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.
we
D-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 complaint 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.
D-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
wen tabs
———
D-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
pumerous 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.
D-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 {{ 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.” Jd. 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. Id.
at 4 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
tor SL Reh Eee A att Mi a abe
D-7
revenue and profit to the defendants. Jd. 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. Jd. 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
D-8
programs. Id. at { 45. The plaintiffs and their proposed classes
allege that as a result of the foregoing, they were damaged. Id.
at 4 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 11 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 4 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 to 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 ll 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 11 and 12(2), barred these counts. In Sanders v.
Robinson-Humphrey, the court ¢‘smissed the plaintiffs’ claims for their 1981]
purchases. See Order filed Sept. il, 1985. In Kirkpatrick v. J. C. Bradford,
the court dismissed Counts I and IL 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. 11, 1985. In Parker v. Paine Webber,
(Footnote continued)
D-9
indirectly induced the acts alleged in Counts I and II. Id. at
{ 64.5 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 misrepresentation (Count VI), and fraudulent con-
cealment and breach of fiduciary duty (Count Vil). 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. Paine Webber.
The defendants, in their motions to dismiss this count, alleged that the plain-
tiffs failed to plead fraud with sufficient particularity to satisfy Rule 9(b) of
the Federal Rules of Civil Procedure. The court declined to dismiss on this
ground. See Orders filed Sept. 11, 1985.
D-10
The parties have engaged in extensive preliminary discovery
on the class certification question. The court held an eviden-
tiary hearing on Febraury 27, 1986, and the parties submitted
briefs before and after the hearing.
Ill. FRAMEWORK OF ANALYSIS
A party that seeks to invoke Rule 23 has the burden of prov-
ing that all of the prerequisites to utilizing the class action pro-
cedure have been satisfied. Zeidman v. J. Ray McDermott &
Co., 651 F.2d 1030, 1038 (5th Cir. 1981).”7 The burden of satis-
fying the requirements of Rule 23 falls on the party who seeks
to maintain a class action. Amswiss International Corp. v.
Heublein, Inc., 69 F.R.D. 663, 665 (N.D. Ga. 1975). Questions
concerning class certification are left to the sound discretion of
the trial court. Freeman v. Motor Convoy, Inc., 700 F.2d 1339,
1347 (llth Cir. 1983).
The question of class certification is a procedural one, distinct
from the merits of the action. Garcia v. Gloor, 618 F.2d 264,
267 (5th Cir. 1980), cert. denied, 449 U.S. 1113, 101 S.Ct. 923,
66 L.Ed.2d 842 (1981). The court may not inquire into the merits
of this case because the Supreme Court has held that “nothing
in either the language or history of Rule 23 . . . gives a court
any authority to conduct a preliminary inquiry into the merits
of a suit in order to determine whether it may be maintained
as a class action.” Eisen v. Carlisle & Jacquelin, 417 U.S. 156,
177, 94 S. Ct. 2140, 2152, 40 L.Ed.2d 732 (1974). “[T]he ques-
tion is not whether the plaintiff or plaintiffs have stated a cause
of action or will prevail on the merits, but rather whether the
requirements of Rule 23 are met.” Id. at 178, 94 S. Ct. at 2153.°
7 In Bonner v. City of Prichard, 661 F.2d 1206, 1209 (lith Cir. 1981)(en banc),
the Eleventh Circuit adopted the law of the Fifth Circuit prior to October
1, 1981, as binding precedent.
* After citing Eisen, however, Professor Arthur Miller points out that “there
is no way the judge can make the ... findings required by Rule 23 without
(Footnote continued)
D-1l
The court must make seven affirmative findings before this
case may be certified as a class action. First, the plaintiffs must
establish two prerequisites not expressly stated in Rule 23 that
have been developed by the courts. Then, the plaintiffs must
demonstrate that they have met the requirements of Rule 23(a).
Finally, the plaintiffs must prove that these cases fall within one
of the three categories of class actions in Rule 23(b).
Although not specifically mentioned in Rule 23, the first essen-
tial prerequisite of a class action is that there must be a class.
7 C. Wright & A. Miller, Federal Practice and Procedure: Civil
§ 1760 at 579 (1972). The class action complaints allege that these
actions were brought on behalf of individuals who purchased,
reinvested in, or acquired limited partnership interests in Petro-
Lewis income programs from January 1, 1981, to February 6,
: 1984. These individuals form the class. Once a court determines
that a class exists, it then must ascertain whether the named
representatives are members of the class they purport to repre-
; sent. Id. at § 1761, at 584; see East Texas Motor Freight v.
Rodriguez, 431 U.S. 395, 403, 97 S. Ct. 1891, 1896, 52 L.Ed2d
453 (1976) (holding that “a class representative must be part of
the class and ‘possess the same interest and suffer the same
at least a preliminary exploration of the merits. This will not be to ascertain
who is going to win and who is going to lose, but simply to develop some feel
for the contours of the case.” A. Miller, An Overview of Federal Class Actions:
Past, Present and Fet+:re, 15 (Federal Judicial Center 2 ed. 1977). The Eleventh
Circuit agrees with Miller:
While it is true that a trial court may not properly reach the
merits of a claim when determining whether class certification
is warranted, Miller v. Mackey International, Inc., 452 F.2d 424,
428 (5th Cir. 1971), this principle should not be talismanically
invoked to artifically limit a trial court’s examination of the fac-
tors necessary to a reasoned determination of whether a plaintiff
has met her burden of establishing each of the Rule 23 class ac-
tiog requirements. Love v. Turlington, 733 F.2d 1562, 1564 (11th
Cir. 1984).
alii aticietaeaeaaail
D-12
injury’ as the class members”). Because the plaintiffs clearly pur-
chased their limited partnership interests within the class period,
they are clearly members of the class.
Having satisfied the two implied prerequisites for a class ac-
tion, the plaintiffs have the burden of making a positive show-
ing that they fulfill all the requirements of Rule 23(a) and that
_the action falls within one of the categories of Rule 23(b). See
Amswiss International Corp. v. Heublein, Inc., 69 F.R.D. 663,
665-66 (N.D. Ga. 1975). The court now turns to Rule 23.
IV. RULE 23(a)
A class action “may only be certified if the trial court is
satisfied, after a rigorous analysis, that the prerequisites of Rule
23(a) have been satisfied.” General Telephone Co. of the
Southwest v. Falcon, 457 U.S. 147, 161, 102 S. Ct. 2364, 2372,
72 L.Ed.2d 740 (1982). Rule 23(a) provides:
Prerequisites to a Class Action. One or more
members of a class may sue or be sued as represen-
tative parties on behalf of all only if (1) the class is
so numerous that joinder of all members is imprac-
ticable, (2) there are questions of law or fact common
to the class, (3) the claims or defenses of the represen-
tative parties are typical of the claims or defenses of
the class, and (4) the representative parties will fair-
ly and adequately protect the interests of the class.
The court addresses each of these subdivisions in turn.
A. Rule 23(a)(1): Numerosity
Numerosity is not in dispute in this case. Joinder of all class
members clearly would be impracticable. A plaintiff need not
specify an exact number of class members, but must show only
that joinder is impracticable through “some evidence or
reasonable estimate of the number of purported class members.”
See Zeidman v. J. Ray McDermott & Co., 651 F.2d 1030, 1038
See et senna. ales ig laes
)
{
D-13
(5th Cir. 1981). The plaintiffs in Kirkpatrick and Sanders have
offered evidence showing that there are approximately 8,000 in-
dividuals who are potential class members. None of the de-
fendants contends that the plaintiffs have not met the numerosity
requirement.
B. Rule 23(a)(2): Commonality
To satisfy Rule 23(a)(2) the plaintiff must establish the ex-
istence of questions of law or fact common to the class. This
provision does not require that all class members share the ex-
act same legal claims. Johnson v. American Credit Co. of
Georgia, 581 F.2d 526, 532 (5th Cir. 1978). The commonality
requirement is satisfied where the questions of law or fact link-
ing the class members are substantially related to the resolu-
tion of the litigation even though the individuals are not iden-
tically situated. See Kleiner v. First National Bank of Atlanta,
97 F.R.D. 683, 691 (N.D. Ga. 1983). The court notes that because
Rule 23(a)(2) requires “questions of law or fact,” more than one
issue of law or fact must be common to the members of the class.
The plaintiffs list numerous questions of law or fact that clear-
ly satisfy this requirement: (1) whether the prospectuses and
other sales literature distributed by the defendants to the plain-
tiffs and the class contain material misrepresentations of fact
or omit material facts concerning the safety and investment
worth of the Petro-Lewis partnerships; (2) whether, during the
class period, the defendants concealed material information
about the precarious financial condition of Petro-Lewis and its
partnerships; (3) whether the defendants concealed the truth
about the historical performance of the Petro-Lewis partner-
ships; (4) whether the defendants misrepresented the future
business prospects of Petro-Lewis and its partnerships programs;
and (5) whether the defendants violated the federal securities
laws and the common law in connection with their sales of
limited partnership interests in the Petro-Lewis programs dur-
ing the class period.
In most cases, neither the parties nor the courts spend much
time discussing the commonality requirement. In general, courts
D-14
that have focused on Rule 23(a)(2) have given it a permissive
application so that common questions have been found to exist
in a wide range of contexts. 7 C. Wright & A. Miller, Federal
Practice and Procedure: Civil § 1763 at 604 (1972).°
C. Rule 23(a)(3): Typicality
Rule 23(a)(3) insists that the class representatives have typical
claims or defenses.” A representative's claim is typical of the class
if it arises from the same event, practice, or course of conduct
that gives rise to the claims of the absent class members and
if the individual claims are based on the same legal or remedial
theory. Davis v. Northside Realty Associates, Inc., 95 F.R.D. 39,
43 (N.D. Ga. 1982); see Gonzales v. Cassidy, 474 F.2d 67, 71
n.7 (5th Cir. 1973)(holding that representative was “typical of
the class within the meaning of Rule 23(a)(3) because he did
not have interests which conflicted with those of the class, . . .”).
The Supreme Court has held that typicality is met when a “class
representative [is] part of the class and ‘possess[es] the same in-
terests and suffer[s] the same injury’ as the class members.” East
Texas Motor Freight System, Inc. v. Rodriguez, 431 U.S. 395,
403, 97 S. Ct. 1891, 1896, 52 L.Ed.2d 453 (1976).
* It is important to distinguish between Rule 23(a)(2) and Rule 23(b)(3). Rule
23(b)(3) provides that common questions must predominate to have a class
action under Rule 23(b)(3). This requirement is discussed more fully in part V.
” Professor Arthur Miller is skeptical about the usefulness of this requirement:
But in the case of subdivision (a)(3), there does not seem to be
any function it performs that is not accomplished by some other
portion of the Rule.... But if the plaintiffs are class members
(an implied requirement), and there are common questions (Rule
23(a)(2)), and the class is adequately represented (Rule 23(a)(4)),
it is very, very difficult to identify anything that is added by
“typicality.” The other prerequisites will ensure “typicality” among
the class members’ claims or defenses.
A. Miller, An Overview of Federal Class Actions: Past, Present and Future,
26 (Federal Judicial Center 2 ed. 1977) (emphasis in original).
D-15
The degree of investment experience or sophistication of the
class representatives is irrelevant. Kennedy v. Tallant, 710 F.2d
711, 717 (11th Cir. 1983). The complaints allege that the defen-
dant committed the same unlawful acts by the same method
against an entire class. All members of the class, therefore, may
have similar claims. Thus, the plaintiffs have met the typicality
requirement. See id. Even though class members purchased dif-
ferent Petro-Lewis limited partnership interests, the plaintiffs
allege that the defendants engaged in a uniformly fraudulent
course of conduct, disseminated virtually identical false prospec-
tuses, financial statements, and other financial information, and
failed to disclose material information regarding the operations
of Petro-Lewis to purchasers during the class period. When
plaintiffs have alleged such a common course of conduct, courts
consistently have found no bar to class certification even though
members of a class may have purchased different types of
securities or interests, or purchased similar securities at different
times.
When weighing the prerequisites of Rule 23, the Eleventh Cir-
cuit has held that “subsection (a)(3) primarily,directs the district
court to focus on whether named representatives’ claims have
the same essential characteristics as the claims of the class at
large. Moreover, “the typicality requirement may be satisfied
even if there are factual distinctions between the claims of the
named plaintiffs and those of other class members.” Appleyard
v. Wallace, 754 F.2d 955, 958 (llth Cir. 1985)(citations omit-
ted). The court clearly finds that the plaintiffs’ claims are typical
of the classes they seek to represent. “[T]he typicality require-
ment is not so rigid as to comprehend only similar fact situa-
tions ... it would be a better test of typicality to consider
whether the types of facts or evidence were typical of the class.”
Walker v. Jim Dandy Co., 638 F.2d 1330, 1336 (5th Cir. 1981).
D. Rule 23(a)(4): Adequacy of Representation
Rule 23(a)(4) is the most important prerequisite in Rule 23(a).
See A. Miller, An Overview of Federal Class Actions: Past, Pre-
sent and Future, 27 (Federal Judicial Center 2 ed. 1977). This
provision requires a showing that the class representative will
D-16
fairly and adequately protect the interests of the class. By far
it is the most heavily litigated of the prerequisites. Id. at 28.
Professor Miller states:
The class or representative action represents an ex-
ception to the principle of an individual right to a day
in court. The justification for permitting it is that con-
siderations of efficiency and economy and good prac-
tice permit issuing an order or rendering a judgment
that binds everyone in a defined group who was pro-
perly represented before the court and therefore has
had a day in court vicariously. It is Rule 23(a)(4) that
ensures the quality of that representation and the in-
tegrity of the system. Unless there has been fair and
adequate representation, due process has not been
satisfied and any attempt at binding the absentee is
improper. Id.
See Hansberry v. Lee, 311 U.S. 32, 44-46, 61 S. Ct. 115, 119-20,
85 L.Ed. 22 (1940) (discussing due process under Rule 23(a)(4)).
Courts traditionally hold that to satisfy Rule 23(a)(4) the
plaintiff must meet two tests. First, the plaintiff's attorney must
be qualified, experienced, and generally able to conduct the pro-
posed litigation. Gonzales v. Cassidy, 474 F.2d 67, 73 n.10 (5th
Cir. 1973); Schatzman v. Talley, 91 F.R.D. 270, 273 (N.D. Ga.
1981}. Based on the plaintiffs’ attorneys’ performance in these
cases thus far, as seen through the discovery, briefs, and mo-
tions, and the hearing before the court, the court has no reason
to question the-sompetency of the plaintiffs’ attorneys. They have
demonstrated a clear understanding of the issues in these cases
and the competence and ability to conduct sophisticated
securities litigation.
The second requirement under Rule 23(a)(4) is that the plain-
tiffs must not have interests antagonistic to those of the class.
Gonzales, 474 F.2d at 73 n.10; Schatzman, 91 F.R.D. at 373.
Courts interpreting this prerequisite have held that “the primary
criterion is the forthrightness and the vigor with which the
representative party can be expected to assert and defend the
D-17
interests of the members of the class.” See Schatzman, 91 F.R.D.
at 273. The named plaintiffs have failed to impress the court
that they will vigorously prosecute these class actions. The
representatives are not sufficiently interested in the outcome of
these actions to protect adequately the rights of the potential
class members. The plaintiffs’ failure in this respect is fatal to
their motions for class certification.
The court notes that while each of the reasons given below
is not determinative, the “totality of the circumstances” indicates
that the plaintiffs have failed to satisfy Rule 23(a)(4).
First, in the hearing the court stated: It concerns me
deeply today that as far as I know none of the named
plaintiffs showed up for this hearing and in fact when
a subpoena was issued for them they resisted. I did
not require them to appear simply because I thought
if they were interested in the litigation they ought not
to have to be subpoenaed to appear. Transcript of
hearing, Feb. 27, 1986, at 114-15.
The plaintiffs contend that the defendants subpoenaed the plain-
tiffs merely to harass them. At the hearing, the court was not
concerned with the potential for harassment, but rather with
the plaintiffs’ reluctance to vigorously prosecute these class ac-
tions. The plaintiffs’ failure to show up for the hearings indicates
a lack of interest.
Second, the plaintiffs cannot act as representatives for the state
and common law claims because these claims vary from state
to state. In addition, different state statutes of limitation govern
the section 10(b) claims. These differences are discussed more
fully in part V, sections C and D.
In Sanders, Glenn Sanders stated that he had little or no in-
volvement in preparing the complaint, which was investigated
and drafted exclusively by his attorneys. Deposition of Glenn
Sanders, pp. 85-86, 92-93. Sanders also was uncertain whether
to proceed with this action if the class was not certified. Id. at
D-18
p. 114. Sanders did not know the identity of the individual defen-
dants named in the complaint. Jd. at pp. 94-96.
Leslie Sanders, the other named plaintiff in the Sanders case,
indicated that she did not want to be involved in this case and
did not agree to become one of the named plaintiffs until counsel
for the plaintiffs called her one month before her deposition.
Deposition of Leslie Sanders, pp. 49-52. Ms. Sanders did not
contribute to the complaint or the amended complaint, and she
never saw the amended complaint until a couple of days before
the deposition. Jd. at p. 50. In addition, Ms. Sanders did not
know the name of one of the firms that was representing her.
id. at p. 3. Furthermore, Ms. Sanders stated that her claim does
not concern her initial decision to purchase securities, as the
complaint alleges, but that in 1983 Robinson-Humphrey pur-
portedly told her not to sell her securities. Jd. at pp. 43, 54. Ms.
Sanders also did not know the identity of the individual defen-
dants. Id. at pp. 55-56. Chip Traynor, the broker who alleged-
ly fraudulently sold securities to Ms. Sanders, still acts as a broker
for her and almost all her family. Deposition of Chip Traynor,
p. 232. If the Sanders truly felt that their broker defrauded them,
presumably he would no longer be their broker.
In Kirkpatrick, plaintiff Charles Lindsey purchased limited
partnership interests through his brother, a broker for J.C. Brad-
ford. In deposition, Lindsey stated:
Q. Is it your belief that they [the defendants] tried
to defraud the investing public, or do you think they're
just guilty of mismanagement, or do you have —
A. I don’t know. I don’t think you can say that
somebody was really planning to defraud me. Petro-
Lewis was a reputable firm and was on the New York
Stock Exchange and what have you. Petro-Lewis is
not a fly-by-night. I mean, they were a pretty
reputable firm. I don’t think Bradford's people kept
up with it. That’s pure and simple what happened.
D-19
Q. You think they were negligent?
A. Absolutely, positively. . ..
Deposition of Charles Lindsey, pp. 60-61. Lindsey was careful
to point out that the allegations of paragraph 5 of the complaint
—to the effect that he purchased pursuant to a prospectus —
were in error. While insisting that he would let the chips fall
where they might against his brother, Lindsey admitted that
his family would be upset if he sued his brother. Jd. at p. 57.
Similarly, plaintiff Suzanne Kirkpatrick still has an account
with the person from whom she purchased her partnership in-
terests in Petro-Lewis, although he no longer works for J. C.
Bradford. Deposition of Suzanne J. Kirkpatrick, p. 6. In her
deposition, Kirkpatrick stated:
Q. .. .Is it your belief or your contention that Brad-
ford was trying to defraud you or was trying to sell
you something they knew or should have known was
no good?
A. No, sir, but I think they should have done their
homework before they made the sales.
Q. You think they were negligent in failing to find this
out?
A. Yes.
Id. at p. 69.
The other named plaintiff in Kirkpatrick, Dorothy Casler,
purchased her interests in Petro-Lewis from her son. In deposi-
tion, she testified:
Q. Have you sued your son over his selling you this
Petro-Lewis?
A. No.
D-20
Q. Well, you sued Bradford and I was wondering if
you sued him since he’s the one that put you into it?
A. No.
Q. Is there any reason why you haven't?
A. Because I think he —in his mind he thought it was
the best thing that I could do.
Deposition of Dorothy Casler, p. 8. In addition, Casler’s son did
not disclose to her the risks which, as the complaint alleges, were
disclosed in the prospectus concerning a possible decline in the
price of oil and the fact that Petro-Lewis was borrowing money
to make the property acquisitions. Jd. at pp. 48-49. In fact,
Casler says she thought there were virtually no risks involved
because her son knew that she could not take risks. Id. at p.
38. Casler expressed shock at the possibility that her claim might
give rise to a lawsuit against her son. Id. at p. 42.
In summary, the court finds that the plaintiffs in their deposi-
tion testimony in Sanders and Kirkpatrick demonstrate a lack
of interest in the vigorous prosecution of this lawsuit. Glenn and
Leslie Sanders are not involved or knowledgeable enough to ef-
fectively prosecute a class action. See Schatzman v. Talley, 91
F.R.D. 270, 273 (N.D. Ga. 1981). The plaintiffs in Kirkpatrick
do not believe, or are unwilling to prosecute, their fraud claims.
For these reasons, the plaintiffs would not fairly and adequate-
ly represent the other class members. See Rothenberg v. Security
Management Co., 667 F.2d 958, 962-63 (lith Cir. 1982).
V. RULE 23(b)
If the four prerequisites of Rule 23(a) are satisfied, a suit may
be maintained as a class action only if it falls within one of the
three categories set forth in Rule 23(b). See George v. United
Federal Savings and Loan Association, 63 F.R.D. 631, 636 (N.D.
Ga. 1974). Even assuming that the plaintiffs satisfy Rule 23(a)(4),
the court holds that they cannot satisfy Rule 23(b).
D-21
Rule 23(b) prescribes the various types of class actions that
are permitted under the Federal Rules. It provides:
(b) Class Actions Maintainable. An action may be
maintained as a class action if the prerequisites of sub-
division (a) are satisfied, and in addition:
(1) the prosecution of separate actions by or against
individual members of the class would create a risk of
(A) inconsistent or varying adjudications with
respect to individual members of the class which
would establish incompatible standards of conduct for
the party opposing the class, or
(B) adjudications with respect to individual
members of the class which would as a practical mat-
ter be dispositive of the interests of the other members
not parties to the adjudications or substantially im-
pair or impede their ability to protect their interests; or
(2) the party opposing the class has acted or refus-
ed to act on grounds generally applicable to the class,
thereby making appropriate final injunctive relief or
corresponding declaratory relief with respect to the
class as a whole; or
(3) the court finds that the questions of law or fact
common to the members of the class predominate over
any questions affecting only individual members, and
that a class action is superior to other available
methods for the fair and efficient adjudication of the
controversy. The matters pertinent to the findings in-
clude: (A) the interest of members of the class in in-
dividually controlling the prosecution or defense of
separate actions; (B) the extent and nature of any
litigation concerning the controversy already com-
menced 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 manage-
ment of a class action.
At the outset, the court notes that the parties do not rely on
or discuss Rule 23(b)(1) or (b)(2). Because the plaintiffs do not
D-22
allege that these subdivisions apply, " the court turns to sub-
division (b)(3).
Rule.23(b)(3) sets out two prerequisites that the plaintiffs must
satisfy to maintain a class action under this subdivision: (1) ques-
tions of law or fact common to the members of the class must
predominate over any questions affecting only individual
members; and (2) the class action must be superior to other
available methods for the fair and efficient adjudication of the
controversy. A plaintiff must satisfy Rule 23(b)(3) to have a class
action that involves securities fraud.
The court holds that because common questions of law and
fact do not predominate, the plaintiffs cannot satisfy Rule
23(b)(3). The court arrives at this conclusion for four reasons.
First, and most importantly, the alleged statements upon which
the plaintiffs relied in purchasing Petro-Lewis securities were
primarily oral rather than written and misrepresentations rather
than omissions. The court, therefore, cannot imply the element
of reliance central to the issue of this case. “[T]he most signifi-
cant problem facing the [class] representatives under subdivi-
sion (b)(3) is to demonstrate that the representations made to
and the reliance by each of the class members is not so divergent
that common questions do not predominate.” 7A C. Wright &
A. Miller, Federal Practice and Procedure: Civil, § 1781 at 90
(1972). The plaintiffs have failed to overcome this problem.
Second, many of the potential class members have signed ar-
bitration agreements that oblige them to arbitrate their
grievances. Third, the statute of limitations for section 10(b)
varies from state to state, and in some states it is unknown. Last,
because the purchasers of Petro-Lewis limited partnerships are from
most of the 50 states, this court would be forced to apply the state
and common law from each state in which a potential class member
resides. The court addresses each of these problems in turn.
" The plaintiffs may not rely on Rule 23(b)(2) because this subdivision only
applies to injunctive or declaratory relief. “The subdivision does not extend
to cases in which the appropriate final relief relates exclusively or predominate-
ly to money damages.” Rule 23, Notes of Advisory Committee. The plaintiffs
seek money damages.
D-23
A. Oral Representations and Reliance
The principal claims asserted by the plaintiffs are based upon
alleged violations of section 10(b) and Rule 10b-5 of the Securities
Exchange Act of 1934. To support a claim under section 10(b)
and Rule 10b-5 the plaintiff must establish the following
elements: (1) that a misstatement or omission has been made,
(2) that the misstatement or omission pertains to material facts,
(3) that the misstatement or omission was made with scienter,
(4) that the plaintiff relied upon the misstatement or omission,
and (5) that the misstatement or omission was the proximate
cause of the injury to the plaintiff. Huddleston v. Herman &
MacLean, 640 F.2d 534 (5th Cir. 1981)(en banc), modified on
other grounds, 650 F.2d 815 (1981), affd in part and rev‘ in
part on other grounds, 459 U.S. 375, 103 S. Ct. 683, 74 L.Ed.2d
548 (1983). Each of these elements of a section 10(b) and Rule
10b-5 cause of action must be proven for the plaintiff to prevail.
Although a determination of class action generally does not
permit investigation into the merits of a case, it is necessary in
this situation in order to determine whether the common ques-
tions of law or fact predominate over individual questions of
law or fact concerning the section 10(b) and Rule 10b-5 claims.
The key factor in determining whether class action is appropriate
is the matter of reliance. If it is determined that reliance is com-
mon to all members of the class, the class action will stand. If,
however, reliance is found to be an individual element whereby
each plaintiff must prove reliance upon misstatements and omis-
sions, the class action status will not be available.
The element of reliance and its effect upon class certifica-
tion have been handled by the courts in several different fashions.
Reliance may be implied where the plaintiff alleges a course
of fraudulent conduct common to all members of the class where
misrepresentations or omissions upon which the fraud is based
are uniform throughout the class. Jn re Home Stake Production
Co. Securities Litigation, 76 F.R.D. 351 (N.D. Okla. 1977). It
may be implied where the course of fraudulent conduct is
perpetrated by way of oral representations where information
material to the decision to purchase has been omitted.
D-24
Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128,
92S. Ct. 1456, 31 L.Ed.2d 741 (1972); Kennedy v. Tallant, 710
F.2d 711 (llth Cir. 1983); Shores v. Sklar, 647 F.2d 462 (5th Cir.
1981)(en banc), cert. denied, 459 U.S. 1102, 103 S. Ct. 722, 74
L.Ed.2d 949 (1983). Finally, reliance may be implied under the
“Fraud on the Market” theory. Lipton v. Documation, Inc., 734
F.2d 740 (lth Cir. 1984).
In an attempt to refute the requirement of reliance, the plain-
tiffs allege the following: (1) that the defendants have perpetrated
a course of fraudulent conduct upon all members of the pro-
posed classes by use of a uniform sales pitch in marketing Petro-
Lewis securities, (2) that this is not a case of oral misrepresen-
tations and omissions but one of written misrepresentations and
omissions found in the prospectuses and other written materials
issued by Petro-Lewis, and (3) that the defendants have
perpetrated a “Fraud on the Market” with regard to Petro-Lewis
securities.
The court finds that none of these allegations falls within the
bounds required for implying the element of reliance necessary
to justify class certification in a section 10(b) and Rule 10b-5
action.
The plaintiffs state that the defendants followed a fraudulent
course of conduct in making sales of Petro-Lewis securities to
the potential class members and rely upon Kennedy and Home
Stake to support these allegations. A distinction must be made,
however, between these two cases and the instant case. First,
the suits in Home Stake and Kennedy were brought against the
company issuing the securities involved rather than against the
broker selling the securities. Second, the securities in Home Stake
and Kennedy were sold by salesmen employed by the company
issuing the securities rather than by brokerage firms promoting
sales between the issuer and the purchaser as in the instant case.
In circumstances such as those in Home Stake and Kennedy,
the issuer has direct control over what information is
disseminated to the purchasers as well as control over the means
by which the information is transferred. In Home Stake, for in-
stance, the issuer had a sales force promoting sales by use of.
a “black book,” which was the central selling tool in each
D-25
presentation. The plaintiffs in the instant cases allege that a
uniform sales program was used in presentations to prospective
buyers who are potential class members. However, all the briefs,
as well as information in the complaint, presented by the plain-
tiffs in support of a class action status assert facts pertinent on-
ly to the sales pitch by Petro-Lewis to each of the individual
brokerage houses. Granted, the defendants could have used the
sales materials presented by Petro-Lewis (and in the case of plain-
tiff Parker, did by way of a joint seminar presented by Petro-
Lewis and Paine Webber). However, the plaintiffs have presented
no materials whatsoever, developed through discovery or asserted
by the individual plaintiffs, indicating a uniform presentation
or “sales pitch” by the defendants to all the members of the pro-
posed classes. Had the plaintiffs shown evidence of the uniform _
sales pitch by each of the defendants to the members of the pro-
posed classes, then a fraudulent course of conduct by the defen-
dants might be at issue and class action status might be war-
ranted. The sales suggestions presented by Petro-Lewis to the
defendant brokerage firms provide no guarantee that the
brokerage firms would use the sales materials provided. The
plaintiffs have failed to show that the materials provided were
in fact used on a uniform basis or used at all by the defendants.
The alleged common course of conduct was conduct between
Petro-Lewis and the defendants rather than the defendants and
the plaintiffs and cannot form the basis for dispensing with the
reliance required in a section 10(b) and Rule 10b-5 action. Hence,
the uniform scheme required to assume the element of reliance
has not been alleged.
The plaintiffs contend that the defendants misrepresented and
omitted certain facts from presentations made in sales of the
Petro-Lewis securities and rely upon the prospectuses as the
uniform sales tool used in the misrepresentations and omissions.
The named plaintiffs acknowledge that they either did not read
the prospectuses and relied entirely upon the information pro-
vided by their brokers.” or state that they read or looked through
2 In Sanders v. Robinson-Humphrey, both plaintiffs stated that they did not
read the prospectus and in fact relied totally upon oral representations by their
(Footnote continued)
D-26
the prospectuses, but could not recall any specifics and also relied
upon representations made by their brokers in deciding to pur-
chase the Petro-Lewis partnership interests.“ The plaintiffs assert
that because the prospectuses were used in the sales of the
securities, the misrepresentations and omissions presented in
them provide a uniform presentation upon which common
reliance can be based, and class certification need not depend
upon whether the plaintiffs actually read the prospectuses. Ken-
nedy v. Tallant, 710 F.2d 711 (lth Cir. 1983); Affiliate Ute
Citizens of Utah v. United States, 406 U.S. 128, 92 S. Ct. 1456,
31 L.Ed.2d 741; Shores v. Sklar, 647 F.2d 462 (5th Cir. 1981)(en
banc), cert. denied, 459 U.S. 1102, 103 S. Ct. 722, 74 L.Ed.2d
949 (1983); Sharp v. Coopers & Lybrand, 70 F.R.D. 544 (E.D.
Pa. 1976). If misrepresentations are both oral and written and
the plaintiffs relied upon the oral representations of their brokers,
there is no standardized communication by the defendants and
no basis for the assumption of reliance. Simon v. Merrill Lynch,
brokers. See Deposition of Glenn Sanders, pp. 28-32, 35-36, 42, 46-49, 51-56;
deposition of Leslie Sanders, pp. 19-29, 24-26, 31-32, 46. In Kirkpatrick v.
J.C. Bradford, plaintiff Suzanne Kirkpatrick did not read a prospectus until
after she made her purchase, deposition of Suzanne Kirkpatrick, p. 38, and
relied totally upon J.C. Bradford’s remarks concerning the Petro-Lewis invest-
ment. Id. at pp. 71-72. Plaintiff Dorothy Casler relied totally on her son, a
broker for J.C. Bradford, in making her decision to purchase. Deposition of
Dorothy Casler, pp. 35-36. As to plaintiff Charles Lindsey, Mr. Lindsey in-
vested through his brother and relied totally upon what his brother told him.
Deposition of Charles Lindsey p. 8.
* In Parker v. Paine Webber, both plaintiffs state that they looked at the pro-
spectus. However, James Smith did not review the prospectus until after his
first purchase of Petro-Lewis securities, deposition of James S. Smith, pp.
193-94, and when he finally did review the prospectus, was unable to point
to specifics in the prospectus. When asked which portions of the prospectus
were false and misleading, Mr. Smith stated, “I’m not able to do that, because
it was an overall impression I got after talking to my broker, after this (in-
dicating), it was may overall impression of the investment rather than the
specifics from this document.” Jd. at p. 234. When Mr. Parker was questioned
about reading the prospectus he.stated, “I reviewed the prospectus. To be frank,
you know, I was more interested in the pamphlet they had with all the pretty
pictures in it.” Deposition of Tommy E. Parker, p. 123. Smith later stated that
in making his decision to purchase he relied on what Petro-Lewis and his broker
said at the seminar which Mr. Parker attended. Jd. at p. 39.
D-27
Pierce, Fenner ¢- Smith, Inc., 482 F.2d 880 (5th Cir. 1973). The
distinction here is that the cases relied upon by the plaintiffs
were omissions cases whereas the instant cases primarily involve
misrepresentations. The allegations stated in the complaints are
almost entirely allegations of misrepresentations of material in-
formation presented in the prospectuses rather than the omis-
sion of material facts in the sale of Petro-Lewis securities. Where
the misrepresentations and omissions are oral, precluding the
uniformity of sales, rather than written, the court may infer
reliance by the plaintiff in a section 10(b) and Rule 10b-5 ac-
tion only where the defendant fails to disclose information
material to the sale of the security. Where failure to disclose
is material, the case is an omissions case. Affiliated Ute, supra;
Huddleston v. Herman ¢> MacLean, 640 F.2d 534 (5th Cir. 1981)
(en banc modified on other grounds, 650 F.2d 815 (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)); Simon, supra; Shores v. Sklar,
647 F.2d 462 (5th Cir. 1981). “Where a 10b-5 action alleges defen-
dant made positive misrepresentations of material information,
proof of reliance by the plaintiff upon misrepresentations is re-
quired. Upon an absence of proof on the issue, plaintiff loses.
On the other hand, where a plaintiff alleges deception by defen-
dant’s nondisclosure of material information, the Ute presump-
tion obviates the need for plaintiff to prove actual reliance on
the omitted information.” Rifkin v. Crow, 574 F.2d 256, 262
(5th Cir. 1978) (footnote omitted).
This court has determined that the instant case is primarily
one of a “misstatement or failure to state the facts necessary to
make those statements made not misleading.” Huddleston, 640
F.2d at 548. Because this case is one of misrepresentation, it is
necessary that each class member prove his individual reliance
upon the material misrepresentations made to him. Certifica-
tion as a class action, therefore, is highly inappropriate. Cavalier
Carpets, Inc. v. Caylor, 746 F.2d 749 (lth Cir. 1984); Hud-
dleston, supra.
The plaintiffs’ final attempt to procure a basis for the assump-
tion of reliance is based upon the Fraud on the Market theory.
D-28
If the Fraud on the Market theory is accepted by the court, the
element of reliance in a section 10(b) and Rule 10b-5 action is
assumed because the reliance is based upon the integrity of the
open market and sales of the security on the open market. Lip-
ton v. Documation, Inc., 734 F.2d 740 (llth Cir. 1984). This
court has recognized the Fraud on the Market theory in Shores
and Lipton, but has applied the theory only to securities trad-
ed on the open market. Although Shores involved the sales of
new issue bonds, the bonds were traded on the secondary market
after the original issue was released. Additionally, the plaintiff
in Shores alleged that, but for the fraud, the bonds would not
have been offered at all. Proof that they would have been issued
at a higher or lower price would not have been sufficient for
the plaintiff to recover.
The case at bar does not fall under the realm of the Fraud
on the Market theory of Shores or Lipton. In the current action
the plaintiffs do not allege that the securities would not have
been sold had the misrepresentations not been present, nor have
they shown that the securities were sold on the open market at
the time of the purchases. The securities in fact were limited
partnerships where liquidity was spelled out in the prospectus
as being nonexistent except for the ability of Petro-Lewis to
repurchase the interest. Petro-Lewis additionally set the price,
the number of sales that were to be made, and also looked at
the ability of each purchaser to withstand any losses that might
recult from a purchase of this nature. Hence these securities were
not traded on the open market where such factors would not
be present. In an open market the issuer would have no contact
whatsoever with the purchaser, the issuer would not set the price
for sale of the securities, and the issuer would not provide for
repurchase of the security in the event the purchaser desired to
sell. Moreover, in an open market, in order to sell, the purchaser
only would have to set a price for sale of the security and have
a broker place the order. These characteristics of an open market
are not present in this cause of action. The plaintiffs, therefore.
cannot rely upon the Fraud on the Market theory to provide
the necessary reliance element of section 10(b) and Rule 10b-5
of the 1934 Act.
D-29
The court finds that the plaintiffs have not met the reliance
requirement of section 10(b) and Rule 10b-5 of the Securities
Exchange Act of 1934 and, therefore, cannot meet the
predominance requirement of Rule 23(b)(3). This is an oral
misrepresentation case and because the reliance requirement
cannot be implied, each member of the class would be required
to prove his reliance upon the misrepresentations and ornissions
in the purchase of Petro-Lewis securities.
B. Arbitration
In addition to the requirement of predominance of common
issues over individual issues, Rule 23(b)(3) requires that the class
action be “superior to other available methods for the fair and
efficient adjudication of the controversy.” At issue in both of these
contexts is the right of the defendants to enforce arbitration
agreements with members of the proposed classes. Each defen-
dant has available the arbitration forum with some members
of the proposed classes.’ |
As to all state claims where defendants have executed an ar-
bitration agreement with purchasers of Petro-Lewis securities
who fall into the proposed classes, it has been determined that
the “Arbitration Act requires district courts to compel arbitra-
tion of pendent arbitrable claims where one of the parties files
a motion to compel, even where the result would be the possi-
ble inefficient maintenance of separate proceedings in different
forums.” Dean Witter Reynolds, Inc. v. Byrd, 470 U.S. 213, 105
S. Ct. 1238, 1241, 84 L.Ed.2d 158 (1985). Should any of the
defendants move to arbitrate any of the class members’ claims
where a valid arbitration agreement is in existence, the court
“ Each of the defendants has alleged the existence of arbitration agreements
with some members of the proposed classes. Although defendants Paine Webber
and J.C. Bradford and Co. have not indicated the numbers that could be poten-
tially involved in arbitration, Robinson-Humphrey has stated that those class
members that could reach arbitration are between 50 and 70 percent of the
total number of potential class members in the Sanders v. Robinson-Humphrey
action.
D-30
would be required to compel arbitration and stay the current
proceedings until such time as the arbitration is completed with
regard to the state issues involved therein. See Harris v. Shear-
son Hayden Stone, Inc., 82 A.D.2d 87, 441 N.Y.S.2d 70 (1981),
aff'd, 56 N.Y.2d 62, 450 N.Y.S.2d 482, 435 N.E. 2d 1097 (1982);
Vernon v. Drexel Burnham & Co., 52 Cal.App. 3d 706, 125 Cal.
Rptr. 147 (1975). Such a situation would be untenable, par-
ticularly in Sanders, where upwards of 70 percent of the pro-
posed class members have executed arbitration agreements.
The plaintiffs assert that, because the Securities Act of 1933
is part of the litigation, arbitration of the federal claims is not
enforceable. The 1933 Act claims are not subject to arbitration.
Wilko v. Swan, 346 U.S. 427, 74S. Ct. 182, 98 L.Ed. 168 (1953).
However, the 1933 Act claims do not comprise the major issues
in these cases. The plaintiffs contend that the claims under sec-
tion 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934
are also not subject to arbitration pursuant to the Eleventh Cir-
cuit ruling in Gorman v. Merrill Lynch, Pierce, Fenner & Smith,
Inc., 780 F.2d 1032 (llth Cir. 1985). That case, however, is now
en banc and no longer binding upon this court. This court is
of the opinion, as stated in Raiford v. Merrill Lynch, Pierce,
Fenner & Smith, Inc., Civil Action No. C83-685A (N.D. Ga.
May 16, 1985), and Chandler v. Drexel Burnham Lambert, Inc.,
633 F.Supp. 760 (N.D. Ga. 1985), that the 1934 Act claims are
subject to the Arbitration Act and to arbitration agreements ex-
ecuted by the defendants and potential class members and must
be sent, along with any state claims, to arbitration upon mo-
tion by the defendants. This opinion is supported by a number
of recent Supreme Court cases including Byrd, Moses H. Cone
Memorial Hospital v. Mercury Construction Corp., 460 U.S. 1,
103 S.Ct. 927, 74 L.Ed.2d 765 (1983), and Mitsubishi Motors
Corp. v. Soler Chrysler-Plymouth, Inc., US. , 105 S.
Ct. 3346, 87 L.Ed.2d 444 (1985). The Supreme Court has
established a strong tendency to favor use of the arbitration
forum in the context of federal statutory claims. Indeed, in Mit-
subishi the Court stated:
We find no warrant in the Arbitration Act for implying
in every contract within its ken a presumption against
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arbitration of statutory claims. . . . Nor is there any
reason to depart from the federal policy favoring ar-
bitration where a party bound by an arbitration agree-
ment raises claims founded on statutory rights. Mit-
subishi, 105 S. Ct. at 3355.
This policy favoring the arbitration agreement is based upon
the “ ‘preeminent concern . . . to enforce private agreements in-
to which parties had entered; a concern which ‘requires that
we rigorously enforce agreements to arbitrate. ” Jd. at 3356,
citing Dean Witter Reynolds v. Byrd, 470 U.S. 213, 105 S. Ct.
1238, 1243, 84 L.Ed.2d 158 (1985).
In conjunction with the strong tendency of the courts to favor
enforcement of arbitration agreements is the express provision
in 28 U.S.C. § 2072 of the enabling act of the Federal Rules of
Civil Procedure whereby Congress stated that the “rules shall
not abridge, enlarge, or modify any substantive right . . . ” Rule
23 is a procedural device provided by Congress to allow the court
discretion in applying class action status to plaintiffs and those
other clas: members similarly situated. The right to arbitration
is contractual and therefore substantive. Congress did not in-
tend that procedural class action certification be used to abrogate
the contractual rights employed in the execution of the arbitra-
tion agreements by the defendants and some members of the
proposed classes. To allow class certification where such arbitra-
tion agreements exist would not only be unduly burdensome and
inefficient should defendants move to compel arbitration but
would also violate the requirement of Rule 23(b)(3) that the class
action be “superior to other available methods for the fair and
efficient adjudication of the controversy.” Fed. R. Civ. P. 23(b)(3).
C. Rule 10b-5 Statute of Limitations
Although the moment at which a section 10(b) action accrues
and the statute of limitations begins to run is a matter of federal
law, the time period itself is taken from state law. Kennedy v.
Tallant, 710 F.2d 711, 716 (11th Cir. 1983). Under Phillips Petro-
leum Co. v. Shutts, __. U.S. ___., 105 S. Ct. 2965, 2980, 86
L.Ed.2d 628 (1985), this court “may not take a transaction with
little or no relationship to [Georgia] and apply [Georgia law]
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in order to satisfy the procedural requirement that there be a
‘common question of law. ” If the court certifies these class ac-
tions, it must apply the state statute of limitations for every state
in which a class member resides. This court has held that where
“the applicable statute of limitations . . . is dependent on state
law . . . [the claims] are inappropriate for treatment as class
actions because they present substantial and predominate [sic]
individual questions.” Elster v. Alexander, 76 F.R.D. 440, 442
_.(N.D. Ga. 1977), appeal dismissed, 608 F.2d 196 (5th Cir. 1979).
The time period within which a section 10(b) action must
be brought varies from state of state. Courts have applied a one-
year statute of limitations, see, e.g., O’Hara v. Kovens, 625 F.2d
15, 17 (4th Cir. 1980), cert. denied, 449 U.S. 1124, 101 S.Ct. 939,
67 L.Ed.2d 109 (1981) (Maryland); a two-year statute of limita-
tions, see, e.g., Diamond v. Lamotte, 709 F.2d 1419, 1424 (ilth
Cir. 1983) (Georgia); Gurley v. Documation, Inc., 674 F.2d 253,
259 (4th Cir. 1982) (Virginia); White v. Sanders, 650 F.2d 627,
633 (5th Cir. 1981) (Alabama); Cook v. Avien, Inc., 573 F.2d
685, 694 (Ist Cir. 1978) (Massachusetts); Dupuy v. Dupuy, 551
F.2d 1005, 1024 n.31 (5th Cir.), cert. denied, 434 U.S. 911, 98
S.Ct. 312, 54 L.Ed.2d 197 (1977) (Louisiana); Nortek v. Alex-
ander Grant & Co., 532 F.2d 1013, 1015 (5th Cir. 1976), cert.
denied, 429 U. S. 1042, 97 S.Ct. 742, 50 L.Ed 2d 742 (1977)
(Florida); Dirksen v. Hynes > Howes Insurance Counselors, Inc.,
423 F. Supp. 1290, 1293 & n.4 (S.D. Iowa 1976) (Iowa); a three-
year statute of limitations, see, e.g., Herm v. Stafford, 663 F.2d
669, 677-78 (6th Cir. 1981) (Kentucky); Jablon v. Dean Witter
& Co., 614 F.2d 677, 682 (9th Cir. 1980) (California); Nemkov
v. O'Hare Chicago Corp., 592 F.2d 351, 355 (7th Cir. 1979) (Il-
linois); Hilton v. Mumaw, 522 F.2d 588, 601 (9th Cir. 1975)
(Washington); Burns v. Ersek, 591 F. Supp. 837, 839 (D. Minn.
1984) (Minnesota); Mid-Carolina Oil, Inc. v. Klippel, 526 F.
Supp. 694, 697 (D. S.C. 1981), affd. mem., 673 F.2d 1313 (4th
Cir.), cert. denied, 457 U.S. 1107, 102 S.Ct. 2906, 73 L.Ed.2d
1315 (1982) (South Carolina); Ohio v. Peterson, Lowry, Rall,
Barber & Ross, 472 F. Supp. 402, 405-06 (D. Colo. 1979), affd,
651 F.2d 687 (10th Cir.), cert. denied, 454 U.S 895, 102 S. Ct.
392, 70 L.Ed.2d 209 (1981) (Colorado); a four-year statute of
D-33
limitations, see, e.g., Gaudin v. KDI Corp., 576 F.2d 708, 711-12
(6th Cir. 1978) (Ohio); and six-year statute of limitations, see,
e.g., Roberts v. Magnetic Metals Co., 611 F.2d 450, 452 (3d Cir.
1979) (New Jersey); IDS Progressive Fund, Inc. v. First of
Michigan Corp., 533 F.2d 340, 344 (6th Cir. 1976) (Michigan);
Bartels v. Algonquin Properties Ltd., 471 F. Supp. 1132, 1147,
1149 (D. Vt. 1979) (Vermont).
In Hawaii, North Dakota, South Dakota, West Virginia, and
Wyoming courts have not yet determined the applicable statute
of limitations in a section 10(b) case. If this court were to cer-
tify a class, it would have to make that determination if a class
member resided in one of these states." In several states, the
courts have applied different statutes of limitation. For exam-
ple, in Connecticut the statute of limitations may be two years
or three years. Compare Clute v. Davenport Co., 584 F. Supp.
1562, 1577 (D. Conn. 1984) (two years) with Klock v. Lehman
Bros. Kuhn Loeb, Inc., 584 F. Supp. 210, 215-16 (S.D.N.Y. 1984)
(holding Connecticut law has three-year statute of limitations).
Nevada has a three-year limitation period for fraud, a two-year
Blue Sky limitation period for fraud in the sale of securities,
and a catch-all limitation period of four years. See Nev. Rev.
Stat. §§ 11.190, 11.220, 90.200. This court, therefore, would have
to determine which Nevada statute to apply. Finally, in Rhode
Island, a court has indicated that either a six-year general statute
of limitations or a three-year personal injury statute of limita-
tions may apply. See Holmes
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