Petition for A Writ of Certiorari — Clement A. Evans & Co. v. A. M. Kidder & Co.

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- ME. COURT, U. Ss.

IN THE

SUPREME COURT OF THE UNITED STATES

OCTOBER TERM, 1970

448

CLEMENT A. EVANS & COMPANY, INC.,

Petitioner,

VS.

A. M. KIDDER & COMPANY, INC., EDWARD M. GARRETT and

WILLIAM J. McALPIN, JR.,

Respondents.

PETITION FOR A WRIT OF CERTIORARI

To the United States Court of Appeals

For the Fifth Circuit

ALLEN W. POST

HUGH M. DORSEY, JR.

J. CLIFTON BARLOW, JR.

3300 First National Bank Tower

Atlanta, Georgia 30303

Attorneys for Petitioner

Of Counsel

HANSELL, POST, BRANDON & DORSEY

3300 First National Bank Tower

Atlanta, Georgia 30303

St. Louis Law Printing Co., Inc., 411-15 N. Eighth St. 63101 314-231-4477

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| POPE TTTITICTTTIPT errr ie ieee

Statute wad TUS TAVOIUOE occ ck ccc wccacecsecscccacs

ee Gr SE GE nec bucctd bans kee ousssuenpens

Reasons for granting the writ ...............+-ee00-

PS Pee ere OPP ETO T TT TTT eT CT ee TS

1.

Il.

III.

The court of appeals, in adopting a minority

common law view, has given the Statute

and rule the narrowest possible construction

whereby the rights of a plaintiff to recover

thereunder are more circumscribed than are the

rights of a plaintiff to recover for intentional

fraud at common law in a great majority of

PND nos ba hetanernsderesadvasacadenas

The court of appeals, in adopting a restrictive

minority view, has decided an important issue

of federal law in a way that conflicts, directly

or in principle, with decisions rendered by this

court, other courts of appeal and other United

States district courts ...............ccceeeees

The question presented is vitally important in

the administration of the securities laws en-

acted for the purpose of avoiding frauds ......

li

IV. The court of appeals has misapprehended and

misapplied the principle of law enunciated in

City National Bank of Ft. Smith, Ark. v. Van-

derboom, 422 F. 2d 221 (8th Cir.), cert. denied,

399 U.S. 905, 90 S. Ct. 2196 (1970) ........... 20

WN ic ee ae 24

Appendix A—Opinion of United States Court of Ap-

peals for the Fifth Circuit ...................... A-1

Appendix B—Judgment ............... cece eee eee A-11

Appendix C—Order denying petition for rehearing ..A-12

Appendix D—28 U\S.C.A., § 1254 ................... A-13

Appendix E—15 U.S.C.A., § 78} .......... cece eee A-14

Appendix F—17 C.F.R., § 240.10b-5 ................ A-15

Appendix G—15 U.S.C.A., § 78aa ............. 000 ee A-16

Cases Cited

Archer v. SEC, 138 F. 2d 795 (8th Cir.), cert. denied,

319 U.S. 767, 63 S. Ct. 13830 (1943) ............... 19

City National Bank of Ft. Smith, Ark. v. Vander-

boom, 422 F. 2d 221 (8th Cir.), cert. denied 399 US.

905, 90 S. Ct. 2196 (1970) ................. 8, 21, 22, 23

Ellis v. Carter, 291 F. 2d 270, 274 (9th Cir. 1961)...12, 14

Heit v. Weitzen, 402 F. 2d 909 (2d Cir. 1968), cert.

denied 395 U.S. 903, 89 S. Ct. 1740 (1969)......... 22

Hooper v. Mountain States Sec. Corp., 282 F.2d 195

(5th Cir. 1960), cert. denied, 365 U. S. 814, 81 S. Ct.

Ge SUED Sc we daks vs asa ceaeke der anbaseas cei: 15

J. I. Case Co. v. Borak, 377 U.S. 426, 84 S. Ct. 1555

FE chi REMC eee Rae CSMOLAD dine Ki 19

lii

Johns Hopkins Univ. v. Hutton, 297 F. Supp. 1165

(D. Md. 1968), modified, 422 F.2d 1124 (4th Cir.

err TPE err ree ore? Perr OTT ro rT Pee fy y 16

Judd v. Walker, 215 Mo. 312, 114 S.W. 979 (1908)... 11

Kahan v. Rosenstiel, 424 F. 2d 161 (3rd Cir.), cert.

denied, 398 U.S. 950, 90 S. Ct. 1870 (1970) ....... 13, 14

Kuehnert v. Texstar Corp., 412 F.2d 700 (5th Cir.

SEE Gch liskidaddnnanaeoedacane st erdepe weakest 17,18

a ea aes aca dae tis cata 10

McClure v. Borne Chem. Co., 292 F. 2d 824 (3rd Cir.),

cert. denied, 368 U.S. 939, 82 S. Ct. 382 (1961)..... 11

Mills v. Electric Auto-Lite Co., 396 U.S. 375, 90 S. Ct.

i Bi: | errerrrerer errr ry Tic tr rrr cree rity er 13, 14

Perma Life Mufflers, Inc. v. International Parts Corp.,

392 U.S. 134, 88 S. Ct. 1981 (1968) .............. 18, 19

SEC v. Capital Gains Research Bureau, Inc., 375 U.S.

180, 84 S. Ct. 275 (1963) .... ccc ccccccccccccces 14,17

SEC v. Gulf Intercontinental Fin. Corp., 223 F. Supp.

GOW GEA Bee TD vince vivcievecccectcivecsss 14

SEC v. Texas Gulf Sulphur Co., 258 F. Supp. 262 (S.D.

N.Y. 1966), modified, 401 F.2d 833 (2d Cir. 1968),

cert. denied, 394 U.S. 976, 89 S. Ct. 1454 (1969).... 15

SEC v. Texas Gulf Sulphur Co., 401 F. 2d 833 (2d

Cir. 1968), cert. denied 394 U.S. 976, 89 S. Ct. 1454

CE 00h 00 ass cheeks sd 4 Caeh Nr eeh eds oes ecens 21

Ne als regs eR oa 14

Tobacco & Allied Stocks, Inc. v. Transamerica Corp.,

143 F. Supp. 323 (D.Del. 1956), aff’d, 244 F. 2d 902

og a rere rey ee ee ey eee eee 20

7

iv

Statutes and Rules Cited

17 C.F.R., § 240.10b-5 .............. 2, 12, 13, 14, 15, 17, 20

Ses ae EE hin 6x bd «ahd si mabab cose ed dance 3

WD UR A 6216 Fh 8 RR 2, 17, 20

SD Ts GUD iF bitedic ici ese eee beciasel 14, 15 |

Tides 6 TOMO ob od kde c da veda foo et dake tte 16 |

Oe I ee oy, sv asad 2 |

Texts Cited

37 Am. Jur. 2d, Fraud and Deceit, §§ 250, 384, 408

I ae as i sec das bk eddeuen 9, 16, 21

37 C.J.S., Fraud, § 30(c) (1943) ................000. 10

1 Harper & James, Torts, $7.12 ...............0005- 10

Bromberg, Securities Law: Fraud—SEC Rule 10b-5,

COR SE8 CE ois dn icncdhinnecdiieiives 17,19

III Loss, Securities Regulation (1961) .......... re

Prosser, Torts, § 89 (2d Ed. 1955) .................. 10

Prosser, Torts, § 103 (3rd Ed. 1964) ................ 16

a

IN THE

SUPREME COURT OF THE UNITED STATES

OCTOBER TERM, 1970

WO endvdiuaes

CLEMENT A. EVANS & COMPANY, INC.,

Petitioner,

VS.

A. M. KIDDER & COMPANY, INC., EDWARD M. GARRETT and

WILLIAM J. McALPIN, JR.,

Respondents.

PETITION FOR A WRIT OF CERTIORARI

To the United States Court of Appeals

For the Fifth Circuit

Petitioner, Clement A. Evans & Company, Inc., prays

that a writ of certiorari issue to review the judgment of

the United States Court of Appeals for the Fifth Circuit

entered in the above-entitled case on November 5, 1970.

OPINION BELOW

The opinion and judgment rendered by the United

States Court of Appeals for the Fifth Circuit on Novem-

ber 5, 1970, is reported at 434 F. 2d 100 (5th Cir. 1970).

A copy of said opinion and judgment is appended to this

petition in the Appendix at pp. A-1—A-11.

to

JURISDICTION

The opinion and judgment of the United States Court

of Appeals for the Fifth Circuit was entered on November

5, 1970 (Appendix pp. A-1-A-11). Rehearing was de-

nied on December 9, 1970 (Appendix p. A-12). The juris-

diction of this Court is invoked under 28 U.S.C.A., § 1254

(1) (Appendix p. A-13). Said statutory provision con-

fers on this Court the jurisdiction to review the opinion

and judgment of the United States Court of Appeals for

the Fifth Circuit by writ of certiorari.

QUESTION PRESENTED

Whether, in a private civil action for a willful and in-

tentional fraud based on Section 10(b) of the Securities

Exchange Act of 1934 and Rule 10b-5 promulgated there-

under, a plaintiff’s contributory negligence or failure to

exercise reasonable diligence to discover the fraud and

protect itself therefrom will bar recovery?

STATUTE AND RULE INVOLVED

The statute and rule involved in this case are: Section

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

§ 78j, and Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated

thereunder. Said statute and rule are set forth in the Ap-

pendix at pp. A-14-A-15.

STATEMENT OF THE CASE

This is an action brought under Section 10(b) of the

Securities Exchange Act of 1934 and Rule 10b-5 promul-

gated thereunder in which the petitioner sues for the sum

of $308,133.95, plus interest, on account of an alleved con-

tinuing conspiracy by the respondents to defraud the peti-

tioner.

=

The petitioner filed its Complaint in the United States

District Court for the Northern District of Georgia, At-

lanta Division, on December 6, 1963, the basis for Federal

Jurisdiction being 15 U.S.C.A., § 78aa (Appendix p. A-16).

The action came on for trial before the court and a jury,

Hon. Albert J. Henderson, Jr., United States District

Judge presiding, on May 5, 1969. At the conclusion of the

trial on May 9, 1969, the jury having rendered its verdict,

judgment was entered against the petitioner and in favor

of all three respondents. From this judgment the peti-

tioner appealed to the United States Court of Appeals for

the Fifth Cireuit on May 29, 1969. The decision of the

Court of Appeals was rendered on November 5, 1970 (Ap-

pendix pp. A-1-A-10). Rehearing was denied on December

9, 1970 (Appendix p. A-12).

At all times material to the question presented, both

the petitioner and respondent A. M. Kidder & Company,

Ine. (hereinafter sometimes referred to as ‘‘Kidder &

Co.’’), were engaged in the business of a stockbroker and

respondent Edward M. Garrett (hereinafter sometimes re-

ferred to as ‘‘Garrett’’) was employed by and actively en-

gaged in the business of Kidder & Co. as a registered

representative of that firm. Respondent William J. Me-

Alpin, Jr. (hereinafter sometimes referred to as ‘‘McA\l-

pin’’) was a customer of both the petitioner and Kidder

& Co.

The facts surrounding the fraud involved a complex

scheme whereby the respondents created a false appear-

ance of financial responsibility on ihe part of McAlpin

so as to enabie him to trade large volumes of securities

with the petitioner. As noted in the decision rendered by

the Fifth Circuit Court of Appeals, said facts are not in

dispute.

In carrying out the conspiracy, Garrett advised McAlpin

of various fraudulent schemes which enabled McAlpin to

obtain large bank loans and trade large volumes of se-

os aaa

curities with little or no capital, each of which schemes

formed an integral part of and was executed pursuant to

the overall conspiracy. Each of these fraudulent schemes,

including its conception and execution, was admitted

upon trial by McAlpin and, in many instances where

McAlpin’s testimony was corroborated by documentary

evidence, by Garrett.

The evidence upon trial revealed the details of each

transaction which was consummated by the respondents

pursuant to the fraudulent schemes initially concocted

by Garrett. While these details showed, without question,

that the fraud perpetrated upon the petitioner by the

respondents was willful and intentional, it is impossible

to give a meaningful summary in brief form. The fol-

lowing examples, however, will serve to illustrate the

deliberateness with which the fraud was perpetrated.

Prior to August 3, 1961, the date on which Magnavox

stock was to split three-for-one, Garrett advised McAlpin

of a means by which MeAlpin could temporarily raise

$20,000.00 with which to pay an outstanding debt. The

operation of the scheme was to the effect that McAlpin

would sell through the petitioner prior to August 3, 1961,

300 shares of old Magnavox stock; that, subsequent to said

date, Garrett would purchase for McAlpin’s account with

Kidder & Co. 900 shares of the new Map iavox stock (the

equivalent «f 300 old shares); and that McAlpin would

then deliver 500 shares of the new Magnavox stock to the

petitioner and sell the remaining 600 shares through

another stockbroker so as to have the use of the sales

proceeds for several weeks.

This scheme was executed as planned and when the

petitioner discovered that it was entitled to receive from

McAlpin 600 additional shares of new Magnavox stock

and inquired of their whereabouts, Garrett falsely stated

that there had been a mistake in Kidder & Co.’s New

Pen en

York office and continued to cover for McAlpin until he

was ablc to make delivery of the 600 additional shares to

the petitioner, said scheme furthering and adding to Mc-

Alpin’s appearance of financial responsibility.

Another fraudulent scheme employed by the respondents

involved the kiting of securities whereby McAlpin, in

accordance with plans previously formulated by Garrett,

sold through the petitioner securities which he did not

then owr. Pursuant to this scheme, Garrett delayed the

petitioner and covered for McAlpin when the petitioner

demanded delivery of said securities. Thereafter, Gar-

rett purchased the securities for McAlpin and delivered

same to him without receiving payment therefor in order

to enable McAlpin to make delivery to the petitioner. This

scheme enabled McAlpin to appear as the owner of said

securities when in fact he was not. It also enabled Garrett

and Kidder & Co. to receive additional commissions. A

part of the loss ultimately sustained by the petitioner

was due to the operation of this scheme in that, in wind-

ing up McAlpin’s pending securities transactions, the

petitioner was forced to purchase some $305,000.00 worth

of securities for the purpose of making delivery against

McAlpin’s previous sales. ° |

The remainder of the petitioner’s loss was due to the

termination of a check kiting operation conceived of by

Garrett and executed by McAlpin which enabled McAlpin

to trade securities with no capital to back up his pur-

chases. Upon the termination of this operation, the pe-

titioner was left holding five checks drawn by McAlpin,

issued in payment of securities purchased, in the aggre-

gate amount of $377,443.38.

The evidence upon trial also revealed that over a three

to four month period prior to the issuance by McAlpin

of the five checks referred to above, the petitioner had

four of McAlpin’s checks returned by the drawee bank

ee

due to uncollected (as distinguished from insufficient)

funds in his account. The evidence further revealed,

however, that no part of the petitioner’s loss was attribu-

table to these checks in that each was made good by

McAlpin who furnished to the petitioner a plausible rea-

son as to why each such check had been returned.

Upon the conclusion of the trial, the court instructed

the jury, in pertinent part, as follows:

Now, the defendants also contend that the plaintiff

did not exercise reasonable diligence to discover the

existence of the alleged fraud. In that connection, I

charge you that it is impossible to lay down any gen-

eral rule as to the amount of evidence or number of

evidential facts admitting discovery of fraud. But,

facts in the sense of indisputable proof or any proof

at all, are different from facts calculated to excite

inquiry which impose a duty of reasonable diligence

and which, if pursued, would disclose the fraud. Facts

calculated to excite inquiry merely constitute objects

of direct experience and, as such, may comprise

rumors or vague charges if of sufficient substance to

arouse suspicion. Thus, the duty of reasonable dili-

gence is an obligation imposed by law solely under

the peculiar circumstances of each case, including ex-

istence of a fiduciary relationship, concealment of the

fraud, opportunity to detect it, position in the in-

dustry, sophistication and expertise in the financial

community, and knowledge of related proceedings.

If you find from the evidence in this case that the

plaintiff had knowledge of facts sufficient to excite its

inquiry, and that the peculiar circumstances of this

case were sufficient to impose upon the plaintiff a

duty of reasonable diligence, and that the plaintiff

failed to exercise this duty, then you should — a

verdict for the defendants.

—

After having deliberated for several hours, the jury re-

turned and requested a recharge concerning reasonable

diligence whereupon the trial court recharged the jury in

the language above set forth over the repeated objection

of the petitioner. Inquiry was then made by the jury as to

whether it could apportion the petitioner’s loss. To this

inquiry, the court replied in the negative,

The jury then retired and, within less than 30 minutes

thereafter, returned with a verdict in favor of all three of

the respondents, including McAlpin who had admitted

under oath that he had intentionally defrauded the peti-

tioner out of some $308,000.00.

tt is the above-quoted excerpt from the trial court’s

charge to which the petitioner objects and which con-

stitutes the basis of the sole question presented for re-

view.

REASONS FOR GRANTING WRIT OF CERTIORARI

There are compelling reasons why this Court should

grant a writ of certiorari to review the opinion and judg-

ment rendered by the Fifth Circuit Court of Appeals on

November 5, 1970 (Appendix pp. A-1-A-11), affirming

the judgment of the trial court entered on May 9, 1969.

First and foremost, the Court of Appeals has given the

statute and rule here involved the narrowest possible con-

struction whereby the rights of a plaintiff to recover

thereunder are severely circumscribed. As thus construed,

‘the rights of a plaintiff to recover for intentional fraud

at common law in a great majority of jurisdictions are

far superior to the rights of a plaintiff under the statute

and rule.

Secondly, the Court of Appeals has decided an import-

ant issue of Federal law in a way that ec aflicts, directly or

aay es

in principle, with decisions rendered by this Court, other

Courts of Appeal and other United States District Courts.

In addition, this case involves an important question of

Federal law which has not been, but should be, settled by

this Court. The question is vitally important in the ad-

ministration of the securities laws enacted for the pur-

pose of avoiding frauds and is a matter of grave import-

ance to all persons for whose protection the statute and

rule were adopted and who daily incur the risk of manip-

ulative and deceptive devices in the trading of intricate

merchandise.

Finally, the Court of Appeals has misapprehended and

misapplied the principle of law enunciated in City Na-

tional Bank of Ft. Smith, Ar’ v. Vanderboom, 422 F. 2d

221 (8th Cir.), cert. denied, 399 U.S. 905, 90 S. Ct. 2196

(1970), in that it borrowed an unrelated ‘‘in connection

with’’ test and imposed it as a condition to the right of a

plaintiff to recover for intentional fraud contrary to the

established common law rule in a majority of jurisdictions.

The reasons relied upon for the allowance of the writ

of certiorari are amplified upon in the Argument which

follows immediately hereafter.

The Court of Appeals, in Adopting a Minority Common

Law View, Has Given the Statute and Rule the Narrowest

Possible Construction Whereby the Rights of a Plaintiff

to Recover Thereunder Are More Circumscribed Than Are

the Rights of a Plaintiff to Recover for Intentional Fraud

at Common Law in a Great Majority of Jurisdictions,

The holding of the court below adopts, in effect, the

minority common law view of reliance as an element of

actionable fraud, which view requires that the defrauded

party allege and prove that he exercised reasonable care,

or due diligence, in discovering the misrepresentation and

protecting himself therefrom. While all jurisdictions re-

quire that there be reliance on a misrepresentation before

it is actionable as fraud, the great majority does not allow

a lack of diligence in discovering the misrepresentation

to protect one guilty of intentional fraud. In support

thereof, the various authorities cite some 35 jurisdictions

(including England) which hold, directly or indirectly,

that a defrauded party can recover for damages from

willful fraud or misrepresentation without a showing of

due diligence. See, 37 Am. Jur. 2d, Fraud and Deceit,

§ 250 (1968):

In consideration of the effect of negligence of a

representee on the right to rely, the policy of the law

toward aciual fraud must always be considered, since,

under modern judicial concepts of social relationship,

the actual wrongdoing of the representor is considered

to outweigh the carelessness of the representee, at

least in instances of actual machination and deception.

It has frequently been stated or held that the doctrine

of negligence does not authorize deception in what is

—_

said or unsaid, and hence, the effect of negligence on

the part of the party deceived may be tolled by the

active fraud of the other party. In other words, the

rule sanctioned by most of the courts is that where

one party to a transaction induces the other party to

enter into it by wilful misrepresentation, he cannot

escape liability for his fraud by showing that such

party could have investigated the representations

mace and would then have found that they were un-

true. According to this view, negligence in trusting

a representation will not excuse a positive wilful

fraud. . . . [Citations omitted. ]

See, also, 37 C.J.S., Fraud, § 30(¢c) (1943); 1 Harper &

James, Torts, § 7.12; Prosser, Torts, § 89, at 552 (2d ed.

1955).

In Georgia, vere the minority view continues to pre-

vail under the doctrine of stare decisis, the State Court

of Appeals has openly expressed its dissatisfaction with

the rule. See, Lariscy v. Hill, 117 Ga. App. 152, 153, 159

S.E.2d 433, 444 (1968), where the court stated:

The allegations of the complaint present us with the

problem of alleged fraud on the part of the defendants

and lack of diligence on the part of the plaintiff. ‘‘The

policy of the courts is on the one hand, to suppress

fraud and, on the other, not to encourage negligence

and inattention to one’s own interests. The rule of

law is one of policy. It is better to encourage negli-

gence in the foolish, or fraud in the deceitful? Either

course has obvious dangers.’’ . . . The majority of

jurisdictions hold that ‘‘judicial experience exempli-

fies that the former is less objectionable and hampers

less the administration of pure justice.”’ . . . Never-

theless, in Georgia a plaintiff cannot recover where

he could have prevented the fravd by the exercise of

ordinary care. . . . ‘‘In seeking to choose between

ian Nhat

a fraudfeasor and a negligent party, the Georgia law

unfortunately goes with the alleged crook.’’

[Citations omitted. ]

Perhaps the most cogent expression of the majority

view is that found in Judd v. Walker, 215 Mo. 312, 114

S.W. 979 (1908), where Judge Lamm, after stating that

the minority view would be ‘‘neither good ethics nor good

law’’, concluded that:

[U]ntil there be written into the law some precent or

rule to the effect that the heart of man is as prone

to wickedness as is the smoke to go upward and that

every one must deal with his fellow man as if he

was a thief and a robber, it ought not to be held that

trust cannot be put in a positive assertion of a ma-

terial fact, known to the speaker and unknown to the

hearer, and intended to be relied on. [114 S.W. at

981.]

Upon considering that line of cases, cited infra at p. 15,

wherein it is expressly stated that the statute and rule

are not limited to circumstances which would give rise to

a common law action for fraud and deceit, it is apparent

that Congress has established its own standard which is

to be measured by Federal law interpreting the Federal

statute and rule unhindered by restrictive anplications of

state common law. This is necessary due to the need for

uniform rules regulating transactions governed by Federal

law. See McClure v. Borne Chem. Co., 292 F. 2d 824, 833

(3rd Cir.), cert. denied, 368 U.S. 939, 82 S. Ct. 382 ( 1961).

The court below, however, has completely disregarded

these and other cases hereinafter cited and, by its narrow

construction of the statute and rule, has condoned, with

no apologies or regrets, conduct by means of which one

party to a securities transaction willfully, maliciously and

with cunning design defrauded the other party out of some

—_ See

$308,000.00, pocketed the fruits of his success and walked

away leaving his victim with no recourse whatsoever—a

situation which the statute and rule were intended to dis-

courage and prevent.

II

The Court of Appeals, in Adopting a Restrictive Min-

ority View, Has Decided an Important Issue of Federal

Law in a Way That Conflicts, Directly or in Principle,

With Decisions Rendered by This Court, Other Courts of

Appeal and Other United States District Courts.

Neither the statute nor the rule involved in the case

at bar attempts to define the type of fraud proscribed

thereby. In fact, due to the absence of ‘‘fraud’’ language

in subparagraph (b) of the rule, it has been said that

fraud need not be implied in an action based thereon. See

Ellis v. Carter, 291 F. 2d 270, 274 (9th Cir. 1961), where

the court, in discussing the Securities Exchange Commis-

sion’s authority to promulgate Rule 10b-5, stated:

It would have been difficult to frame the authority to

prescribe regulations in broader terms. Had Congress

intended to limit this authority to regulations pro-

scribing common-law fraud, it would probably have

said so.

Thus, under the theory advanced by the Ninth Circuit

Court of Appeals, to make out a case under the statute

and rule the plaintiff must allege and prove only (a) use

of the mails or instrumentalities of interstate commerce,

(b) purchase or sale of a security, and (c) use of a ma-

nipulative or deceptive device. In other words, the Ninth

Circuit, unlike the Fifth Circuit in the case at bar, has

ruled that it is not necessary to allege or prove fraud in

a cause of action based on subparagraph (b) of the rule

whether it be of the common law variety or otherwise.

—)

In reference to reliance as an element of actionable

fraud, under which the plaintiff’s diligence is a factor

according to the minority common law view, the decision

rendered by the court below is in direct conflict with

Kahan v. Rosenstiel, 424 F. 2d 161 (3rd Cir.), cert. denied,

398 U.S. 950, 90 S. Ct. 1870 (1970). Here, the Third Cir-

cuit Court of Appeals recently held that proof of reliance

is not an independent element which must be alleged to

establish a cause of action under Section 10(b) of the

Securities Exchange Act of 1934 and Rule 10b-5 promul-

gated thereunder. In reaching its decision, the Third

Cireuit noted that, in Mills v. Electric Auto-Lite Co., 396

U.S. 375, 90 S. Ct. 616 (1970), this Court ruled that reli-

ance on false or misleading proxy statements was not re-

quired in order to set forth a cause of action under Section

14(a) of the Securities Exchange Act, primarily because:

Where the misstatement or omission in a proxy

statement has been shown to be ‘‘material’’, as it was

found to be here, that determination itself indubitably

embodies a conclusion that the defect was of such a

character that it might have been considered im-

portant by a reasonable shareholder who was in the

process of deciding how to vote [Id. at 384, 90 S. Ct.

at 621].

The Third Circuit also noted that a further reason for

the Mills decision was that it would not be feasible to

require proof of actual reliance by numerous persons and

that reliance on the nondisclosure of a fact would be

extremely difficult to define or prove. The Third Circuit

thus reasoned that:

Since Rule 10b-5 also prohibits only misrepresenta-

tions which are ‘“‘material’’, the reasoning of the

Supreme Court in Mills applies with equal force to

suits brought for violation of that Rule. This is in

accord with the view of the Second and Sixth Cir-

oe

cuits in Crane Co. v. Westinghouse Air Brake Co.,

419 F. 2d at 797, and Britt v: Cyril Bath Co., 417

F. 2d at 436. [424 IF. 2d at 174.]

It, thus, becomes apparent that the decision of the court

below in the case at bar is in direct conflict with Ellis

v. Carter, supra, decided by the Ninth Cireuit, and Kahan

v. Rosenstiel, supra, decided by the Third Circuit. And,

in view of the reasoning employed by this Court in Mills

v. Electric Auto-Lite Co., supra, a conflict in principle is

found to exist there. .

The decision below also conflicts, in principle, with the

views expressed by this Court in SEC v. Capital Gains

Research Bureau, Inc., 375 U.S. 180, 84 S. Ct. 275 (1963),

where, in dealing with the meaning of clauses 1 and 3 of

Section 206 of the Investment Advisers Aci of 1940 [15

U.S.C.A., § 80b-6], the Court commented on the develop-

ing relaxations of the common law of fraud and con-

cluded that, even if Congress intended to codify the com-

mon law, it did so ‘‘remedially’’ and not ‘‘technically’’.

Congress intended the Investment Advisers Act of

1940 to be construed like other securities legislation

‘‘enacted for the purpose of avoiding frauds,’’ not

technically and restrictively, but flexibly to effectu-

ate its remedial purposes. [/d. at 195, 84 S. Ct. at

284-83. ]

Similar conclusions have been reached in cases expressly

concerning Section 10(b) of the Secnrities Exchange Act

of 1934 and Rule 10b-5 promulgated thereunder. See,

Tcherepnin v. Knight, 389 U.S. 332, 336, 88 S. Ct. 548,

553 (1967) (‘‘[RJemedial legislation should be construed

broadly to effectuate its purposes. The Securities Ex-

change Act quite clearly falls into the category of re-

medial legislation.’’); SEC v. Gulf Intercontinental Fin.

Corp., 223 F. Supp. 987, 995-96 (S.D. Fla. 1963) (‘‘The

—

courts of this nation have consistently repeated that the

acts shall be given a likeral construction to accomplish

their purpose.’’).

The decision below, being expressive of the minority

common law view, also conilicts, in principle, with an-

other line of cases wherein the courts have repeatedly

stated that the fraud provisions contained in the various

securities laws are not limited to circumstances which

would give rise to a common law action for fraud and

deceit. See, e. g., Hooper v. Mountain States Sec. Corp.,

282 F.2d 195 (5th Cir. 1960), cert. denied, 365 U.S. 814,

81S. Ct. 695 (1961); SEC v. Texas Gulf Sulphur Co., 258

F. Supp. 262 (S.D.N.Y. 1966), modified, 401 F.2d 833 (2d

Cir. 1968), cert. denied, 394 U.S. 976, 89 S. Ct. 1454 (1969).

While these cases were based on Section 10(b) and Rule

10b-5, the type of fraud proscribed by the statute and the

rule was nowhere defined with specificity.

The courts have traditionally refused, whether at

common law deceit or under securities laws, to de-

fine fraud with specificity. Were any hard and fast

rule to be laid down as to what constitutes fraud .. .

‘fa certain class of gentlemen of the ‘J. Rufus Wall-

ingford’ type—‘they toil not neither do they spin’—

would lie awake nights endeavoring to conceive some

devious and shadowy way of evading the law. [III

Loss, Securities Regulation 1436 (1961).]

Professor Loss does state, however, that, in reference to

the several anti-fraud provisions and because of the leg-

islative background, ‘‘it seems reasonable to assume at

the very least that the most liberal common law views

on these questions should govern under the statutes”. Ill

Loss, op. cit. supra at 1435.

Though the decision rendered by the Fifth Cireuit in

the case at bar does not speak in terms of **eontributory

negligence’’, its practical effect is to permit such an af.

weil nn

firmative defense to be successfully asserted in a private

cause of action arising under Section 10(b) and Rule

10b-5. When viewed in this manner, the decision below

runs counter to the majority common law view which

does not permit the negligence of the party wronged or

defrauded to be interposed as a defense to a charge of

positive, willful fraud.

The general rule is that contributory negligence is

not a defense to an action for fraud and deceit. Where

fraud is the basis of the relief sought, the negligence

of the defrauded party is not an answer. At any rate,

to a charge of positive, wilful fraud, the negligence

of the party wronged or defrauded may not be inter-

posed as a defense . .. One who has perpetrated a

fraud should not be permitted to say to the party de-

frauded when he demands relief that he ought not

to have believed or trusted him and was negligent in

doing so. [37 Am. Jur. 2d, Fraud and Deceit, § 384

(1968).]

See, also, cases cited in Prosser, Torts, § 103, at 731-32 (3rd

ed. 1964).

Upon viewing the decision below as permitting contribu-

tory negligence to be asserted as a defense, such decision

conflicts in principle, with Johns Hopkins Univ. v. Hutton,

297 F. Supp. 1165, 1221 (D. Md. 1968), modified, 422 F.2d

1124 (4th Cir. 1970), where the court expressly ruled that

the defense of contributory negligence, not being available

to a defendant at common law with regard to actions of

deceit, was certainly not available to a defendant in a pri-

vate cause of action based on Section 12(2) of the Securities

Act of 1933 [15 U.S.C.A., § 771(2)] for misrepresentations

and omissions of material facts made by an employee of

the defendant.

In view of the foregoing, the petitioner submits that the

decision below conflicts not only with those cases concern-

om

ing the proper construction of the statute and rule but,

also, with those cases having to do with affirmative com-

mon law defenses being asserted with respect to Federally

created rights.

III

The Question Presented Is Vitally Important in the Ad-

ministration of the Securities Laws Enacted for the Pur-

pose of Avoiding Frauds.

Insofar as the petitioner has been able to determine, this

is the first case in which any court has recognized con-

tributory negligence as a defense to a private civil action

for intentional fraud under Section 10(b) and Rule 10b-5.

Defenses to such actions are generally matters of denying

or disproving subject-matter jurisdiction, jurisdictional

ineans and whatever elements turn out to be necessary in

the trial court’s interpretation. Bromberg, Securities Law:

Fraud—SEC Rule 10b-5, §11.5, at 253 (1969), and cases

cited therein. The Fifth Circuit, however, has recently in-

voked broad common law barriers to relief in such actions.

See, Kuehnert v. Texstar Corp., 412 F.2q 700 (5th Cir.

1969), where, in 1969, the court permitted the defense of

in pari delicto, and, of course, the case at bar where, in

1970, the same court permitted the defense of contributory

negligence.

As a result of the decisions rendered by the Fifth Circuit

Court of Appeals, the class of investors who may recover

in a Rule 10b-5 action for damages has been severely re-

stricted. This, it is most strongly submitted, frustrates

severely the objective of the securities laws to increase the

protection afforded the investing public and violates the

injunction of this Court, as expressed in SEC v. Capital

Gains Research Bureau, Inc., 375 U.S. 180, 195, 84 S. Ct.

279, 284-85 (1963), that securities legislation enacted for

the purpose of avoiding frauds is to be construed, not tech-

oh NE os

nically and restrictively, but rather flexibly to effectuate its

remedial purposes.

Though application of the statute and rule was some-

what narrowed by the Texstar decision, such does not war-

rant the further erosion which will result if the decision

below is permitted to stand. Viewed in light of the case

at bar, the issue is clearly drawn: Will the objective of the

securities laws be better promoted by protecting, at the

expense of the negligent victim, the perpetrator of a suc-

cessful and intentional fraud?

This Court has often indicated the inappropriateness of

invoking broad common law barriers to relief where a

private suit serves important public purposes. See, e.g.,

Perma Life Mufflers, Inc. v. International Parts Corp.,

392 U.S. 134, 139, 88 S. Ct. 1981, 1984 (1968), where, in

the field of antitrust law, this Court rejected the defense

of in pari delicto and stated:

[T]he purposes of the antitrust laws are best served

by insuring that the private action will be an ever-

present threat to deter anyone contemplating business

behavior in violation of the antitrust laws. The plain-

tiff who reaps the reward of treble damages may be

no less morally reprehensible than the defendant, but

the law encourages his suit to further the overriding

public policy in favor of competition. A more fastidi-

ous regard for the relative moral worth of the parties

would only result in seriously undermining the use-

fulness of the private action as a bulwark of antitrust

enforcement. And permitting the plaintiff to recover

a windfall gain does not encourage continued viola-

tions by those in his position since they remain fully

subject to civil and criminal penalties for their own

illegal conduct.

Just as the private action in the field of antitrust law

serves as a powerful deterrent, private actions under the

cans

securities laws appear to be a major, and perhaps the

most important, weapon in attainment of the policies ex-

emplified by the statute and rule. As stated by Profes-

sor Bromberg: ‘‘private suits pursuant to the implied

right of action are the biggest part of 10b-5’s development -

and significance.’? Bromberg, Securities Law: Fraud—

SEC Rule 10b-5, § 8.1, at 195 (1969). See, also, J. I. Case

Co. v. Borak, 377 U.S. 426, 432, 84 S. Ct. 155¢, 1560 (1964),

where this Court, in dealing with proxy requirements un-

der the securities laws, stated:

Private enforcement of the proxy rules provides a

necessary supplement to Commission action. As in

antitrust treble damage litigation, the possibility of

civil damages or injunct‘ve relief serves as a most

effective weapon in the enforcement of the proxy re-

quirements.

Just as the m pari delicto defense was viewed as being

a hindrance to the enforcement of the antitrust laws

through the medium of ‘private attorneys general,’’

Perma Life Mufflers, Inc. v. Internationa] Parts Corp.,

supra, application of it and the contributory negligence

defense as judicially imposed restraints on Rule 10b-5 liti-

gation will hinder in similar fashion the effective weapon

of the private suit in the securities field.

As stated in Archer v. SEC, 133 F. 2d 795, 803 (8th

Cir.), cert. denied, 319 U.S. 767, 63 S. Ct. 1330 (1943),

‘“‘the business of trading in securities is one in which

opportunities for dishonesty are of constant recurrence

and ever present.’? The impact of the decision rendered

by the court below thus has no boundaries for, if permitted

to stand, it will act as a haven for the deceitful whether

they be brokers or customers.

We are not unmindful that, here, the announced prin-

ciple of law is being applied at the expense of a securities

broker. It must be assumed, however, that the courts of

—

this nation will dispense even handed justice by applica-

tion of the same principle in future cases arising under

the statute and rule where the injured party may, and

probably will, be a broker’s customer. Whether viewed

in this light or in light of the case at bar, it is impossible

to believe that the decision below will further the pur-

poses for which the statute and rule were formulated.

IV

The Court of Appeals Has Misapprehended and Misap-

plied the Principle of Law Enunciated in City National

Bank of Ft. Smith, Ark. v. Vanderboom, 422 F. 2d 221

(8th Cir.), cert. denied, 399 U.S. 905, 90 S. Ct. 2196 (1970).

An examination of the trial court’s charge here com-

plained of reveals that it was taken, practically verbatim,

from Tobacco & Allied Stocks, Inc. v. Transamerica Corp.,

143 F. Supp. 323 (D.Del. 1956), aff’d, 244 F. 2d 902 (3rd

Cir. 1957), a case which is totally inapplicable to the case

at bar. While based on Section 10(b) of the Securities

Exchange Act of 1934 and Rule 10-5 promulgated there-

under, Transamerica was not in any manner concerned

with any obligation of the plaintiff to exercise reasonable

diligence to discover the alleged fraud and protect itself

therefrom. Instead, the case concerned itself with the

date on which the plaintiff’s cause of action accrued so

as to determine whether suit was filed within the ap-

plicable period of limitations. The court eventually con-

cluded that the plaintiff’s cause of action accrued and the

running of the applicable statute of limitations commenced

at such time as the plaintiff could have discovered the

alleged fraud by the exercise of reasonable diligence. /d.

at 328-29.

The conclusion thus reached by the court in Trans-

america is representative of the general rule as to when

a cause of action based on fraud will acerue. See, 37 Am.

ital Chea

Jur. 2d, Fraud and Deceit, ¢ 408 (1968). It is the conten-

tion of the petitioner, however, that the rule has no ap-

plication to the case at bar inasmuch as the respondents

have made no contention to the effect that the petitioner’s

cause of action was barred by any statute of limitations.

The error thus committed by the trial court in borrow-

ing a principle of law totally u~related to the case at bar

and imposing it as a condition io the right of a plaintiff

to recover for intentional fraud under Section 10(b) and

Rule 10b-5 has been compounded by the Court of Ap-

peals since the appellate court has sought to justify the

ill-conceived charge by borrowing another unrelated prin-

ciple of law from:a totally different line of cases. Thus,

should the decision below be permitted to stand, an im-

portant principle of law will have evolved by means of

two distinct errors, each of which seeks to borrow from

opposite directions a principle of law totally inapplicable

to the question presented.

In attempting to justify the charge here complained of,

the Fifth Circuit has undertaken to borrow the “in con-

nection with’’ test set forth in City National Bank of Ft.

Smith, Ark. v. Vanderboom, 422 F.2d 221 (8th Cir.), cert.

denied 399 U.S. 905, 90 S. Ct. 2196 ( 1970), which test we3

fashioned for the purpose of determining whether the

‘in connection with’’ clause of Section 10(b) and Rule

10b-5 had been complied with.

The test, relied upon so heavily by the court below,

appears to have evolved from SEC v. Texas Gulf Sulphur

Co., 401 F. 2d 833 (2d Cir. 1968), cert. denied 394 US.

976, 89 S. Ct. 1454 (1969), where the court broadly con-

strued the ‘‘in connection with’’ clause in order to hold

that proof of negligence was sufficient to sustain an action

for injunctive relief under the statute and rule and stated

that:

pom

Congress when it used the phrase ‘‘in connection with

the purchase or sale of any security’’ intended only

that the device employed, whatever it might be, be

of a sort that would cause reasonable investors to

rely thereon, and, in connection therewith, so relying,

cause them to purchase or sell a corporation’s se-

curities. [Jd. at 860.]

The Second Circuit employed this test again in Heit v.

Weitzen, 402 F. 2d 909 (2d Cir. 1968), cert. denied 395

U.S. 903, 89 S. Ct. 1740 (1969), in holding that the plain-

tiff had met the requirements of the ‘‘in connection with’’

clause.

Thereafter, the test was adopted and expanded upon

by the Eighth Circuit in Vanderboom where the issue was

whether the alleged fraud was ‘‘in connection with’’ the

purchase or sale of any security since the party against

whom recovery was sought did not sell or offer to sell

any security of any kind to the aggrieved parties. In

expanding upon the test earlier fashioned by the Second

Circuit, the Vanderboom court stated its interpretation of

the test as being in material part:

With regard to misrepresentations, the question is

whether a reasonable investor, in light of the facts

existing at the time of the misrepresentation and in

the exercise of due care, would have been entitled to

rely upon the misrepresentation. With regard to non-

disclosures, the issue becomes whether a reasonable

investor, in light of the facts existing at the time of

the nondisclosure and in the exercise of due care,

would have been entitled to receive full disclosure

from the party charged and would have acted differ-

ently had the alleged nondisclosure not occurred [422

F. 2d at 230. Emphasis added.]

It, thus, becomes apparent that the language added by

the Eighth Circuit in stating its interpretation of the

a TEE Eee

=

test, viz., ‘‘in the exercise of due care,’’ not only has no

relationship to the case at bar, but is utterly without

precedent. Obviously, such language was not employed

by the Second Circuit in either of the ‘‘in connection

with’’ cases cited by the Vanderboom court in support

of the test.

In none of these cases, cited with approval by the court

below, was any attempt made to consider the proper con-

struction of the statute and rule in reference to a private

civil action for damages involving intentional fraud. Nor

was any attempt made to determine what would constitute

a valid legal defense to such an action. Instead, each of

these cases involved a serious question as to whether the

alleged fraud (concerning negligent misrepresentations

only) was ‘‘in connection with’’ the purchase or sale of

any securities due to the remoteness of the securities

transactions in relation to the alleged fraud. In the case

at bar, however, no such question is presented and none

of the respondents have ever contended otherwise.

The petitioner submits that it would be patently absurd

in the case at bar were it contended that the willful and

intentional fraud perpetrated by the respondents was not

‘in connection with’? the purchase or sale of securities.

As a result, it is no less absurd to borrow the ‘‘in con-

nection with’’ test and apply it as a condition to the right

of a plaintiff to recover for intentional fraud contrary,

as we have seen, to the established rule in a majority of

jurisdictions.

CONCLUSION

It is respectfully submitted that this Court should not

permit to stand the decision rendered by the court below

which adopts a restrictive minority common law view

so as to thwart the objectives of the statute and rule to

—

protect those who may become victims of intentional

fraud in the conduct of securities transactions. For this

and other reasons set forth hereinabove, it is respectfully

submitted that this petition for a writ of certiorari should

be granted.

ALLEN W. POST

HUGH M. DORSEY, JR.

J. CLIFTON BARLOW, JR.

3300 First National Bank Tower

Atlanta, Georgia 30303

Attorneys for Plaintiff

Of Counsel

HANSELL, POST, BRANDON & DORSEY

3300 First National Bank Tower

Atlanta, Georgia 30303