Petition for Writ of Certiorari — General Motors Acceptance Corp. v. Eason

IN THE

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Supreme Court of tye GQnited S

OCTOBER TERM, 1973

' Ee

tates

GENERAL MOTORS ACCEPTANCE CORPORATION

AND DAVE WAITE PONTIAC, INC..

Petitioners.

vs.

WILLARD D. EASON, M. O. SATROM. anpD

JEAN M. SATROM.,

Respondents.

PETITION FOR WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE SEVENTH CIRCUIT

ALAN W. BOYD

HENRY J. PRICE

1313 Merchants Bank Building

Indianapolis. Indiana 46204

DAVID B. HUGHES

Room 800, 130 East Washington Street

Indianapolis, Indiana 46204

Attorneys for Petitioner General Motors

Acceptance Corporation

JAMES M. SECREST

1100 Circle Tower Building

Indianapolis. Indiana 46204

Attorney for Petitioner Dave Wain

Pontiac, Inc.

FRAZER F. HILDER

LAWRENCE W. MIDDLETON

JOHN J. HIGGINS

General Motors Acceptance Corp.

767 Sth Avenue

New York, New York 10022

Of Counsel

Gunthorp-Warren Printing Company, Chicago e 346-1717

SESE ES LIE SI OT ER a SS ES TS PEP STE Re

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We a en OR Nae Rn ae are ee ec RT

ania PAGE

Opinions nigh eee Le ak eee ae SRA Se 1

NR en ae ce ge wire he ae Nie gel es 2

NE cas chk kn ckns ch Whee vee ee aes 2

Statute and Regulation Involved ................-:. 2

Statement of the Case, Including Basis for Federal

ER ga ow in <a chee kik es abele Ma 40 ha nb 3

Reasons for Granting the Writ .............2.0000-- 6

1. The Decision of the Court of Appeals for the Seventh

Circuit Is in Conflict with the Decision of Every

Other Court of Appeals That Has Considered the

EE I ce sw aivekedc eebeee sae ne 6

The Decision of the Court of Appeals for the Seventh

Circuit Cannot Be Rationalized Under Even the

Most Liberal Application That the Birnbaum doc-

tv

trine Has Heretofore Been Given. .............. 10

3. This Court Has Not Heretofore Passed Upon the

Correctness of the Birnbaum Doctrine. .......... 15

4. The Decision of the Court of Appeals for the Seventh

Circuit Involves an Important Question of Federal

Law Requiring Resolution by This Court. ........ 17

wa Avene tee Rena eee es es bra es 19

Appendix I—Opinion of the Court of Appeals ........ Al

Judgment of the Court of Appeals ....... Al4

Denial of Petitioners’ Petition for Rehearing Al5

Appendix I]—-Orders of District Court of the Southern

District of Indiana Sustaining Petitioners’

Motions to Dismiss the Action ....A16 & 17

TABLE OF AUTHORITIES

Cases

Birnbaum v. Newport Steel Corporation, 193 F. 2d 461,

463 (2 Cir.), cert. den. 343 U. S. 956 (1952) .......

SD Ree ee se SL ee 5,7, 14, 16, 17, 18

City National Bank v. Vanderboom, 422 F. 2d 221 (8

Cir.) cert. denied 399 U. S. 905 (1970) ........... 7

Dudley v. Southeastern Factor & Finance Corp., 446 F.

2d 303 (5 Cir. 1971), cert. den. 404 U. S. 838 (1971) 6

Erling v. Powell, 429 F. 2d 795 (8 Cir. 1970) ........ 7

Haberman v. Murchison, 468 F. 2d 1305, 1311 (2d Cir.

PY owe PERG eae bu rear ean Lees alana ners 6, 16

Herpich v. Wallace, 430 F. 2d 792, 802, 806 (5 Cir.

Sr ees encod a eee ee eee 7, 8,10, 12

Heyman v. Heyman, 356 F. Supp. 958, 964 (S. D. N. Y.

2, MESA peeing Earnie ee Hae St Satie UGA ge Ad BR aE 7,8

International Controls Corp. v. Vesco et al. (2d Cir. Jan.

15, 1974) Nos. 73-2202, 73-2255, 73-2568, Slip

SE RUD 65 cake shaven tices cee aneae is 13, 14

Iroquois Industries, Inc. v. Syracuse China Corp., 417 F.

2d 763 (2d Cir. 1969), cert. den. 399 U. S. 909 (1970) 7,9

James v. Gerber Products Co., 483 F. 2d 943, 944, 948

ee Se cass cc as ss oe eae he eke 13,17

Landy v. Federal Deposit Insurance Corporation, 486 F.

2d 139, 155, 156, 157, 158 (3d Cir. 1973) Petition for

certiorarifiled 42 USLW 3336 (No. 73-819, Nov. 23,

ie anaes ee 6, 7,9, 10, 11, 17, 18

Lino v. City Investing Co., 487 F. 2d 689 (3d Cir. 1973). 15

McClure v. First National Bank, 352 F. Supp. 454 (N. D.

| ee ee ree Sr rer ren 15

SSL IE IR BETS tt ED DM Oc REIS EL 2 te IH

il

Mount Clemens Industries, Inc. v. Bell, 464 F. 2d 339,

PR, Say. Oe Oe OED, 8 os cease sn tiesess 6, 10, 17

Mutual Shares Corporation v. Genesco, Inc., 384 F. 2d

See Ae ee. et SS oo eo £ os eases kenecees 7

Ruckle v. Roto American Corporation. 339 F. 2d 24 (2d

PUR arias ae aes eee oe eR A a 14

SEC v. National Securities. Inc., 393 U. S. 453, 466, 467

OG sae hak eA ae Rane ev ea en eee ts, 32, 35

Simmons v. Wolfson. 428 F. 2d 455 (6 Cir.) cert. den. 400

ee Panes cs eee eek eee eee sans aaa 7

Superintendent of Insurance v. Bankers Life & Casualty

Co, S08 2. 6.6 D. UES CURED vs ancy esses 15, 16

United States Statutes

ee ee ey ch ese ee ene eo a a

a a EE Chk oh oe ene eee wasaee

Securities Exchange Act of 1934

15 U. S. C. § 78j(b), 48 Stat. 891, Section 10(b) 2

SSS. ee Ee a cus oS tees aos 5

Regulation of the Securities & Exchange Commission

Rule 10b-5, 17 C. F. R. § 240.10b-5 .......... a3

N tv

i lth a ae AM Pac ae PR 8 ees ice —

23 BGI 8 FIO RE AS OTN

IN THE

Supreme Court of the Anited States

OcToBER TERM, 1973

GENERAL MOTORS ACCEPTANCE CORPORATION

AND DAVE WAITE PONTIAC, INC.,

Petitioners,

Ve.

WILLARD D. EASON, M. O. SATROM. anbD

JEAN M. SATROM,

Respondents.

PETITION FOR WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE SEVENTH CIRCUIT

The petitioners request that a Writ of Certiorari issue to

review the judgment of the Court of Appeals for the Seventh

Circuit entered in the above cause on December 28, 1973.

OPINIONS BELOW

The opinion of the Court of Appeals has not been reported.

A copy is appended as Appendix I. No opinion was written

by the District Court but copies of its orders sustaining peti-

tioners’ motions to dismiss respondents’ action for want of

standing to maintain it under § 10(b) of the Securities Ex-

change Act of 1934 and Rule 10b-5 promulgated thereunder

by the Securities Exchange Commission are appended as

Appendix Il.

JURISDICTION

The judgment of the Court of Appeals was entered December

28, 1973. A petition for rehearing was filed by petitioners

January 11, 1974, and was denied January 23, 1974. See

Appendix 1. The jurisdiction of this Court is invoked under

28 U. S.C. §§ 1254(1) and 2101(c).

QUESTION PRESENTED

The question presented for review is whether, notwithstanding

respondents were neither purchasers nor sellers of any security,

they may nevertheless maintain a private action under § 10(b)

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

promulgated thereunder by the Securities Exchange Commission.

STATUTE AND REGULATION INVOLVED

Section 10(b) of the Securities Act of 1934, 48 Stat. 891,

15 U. S. C. § 78j(b) provides:

“It shall be unlawful for any person, directly or indirectly,

by the use of any means or instrumentality of interstate com-

merce or of the mails, or of any facility of any national

securities exchange—

* * s * *

“(b) To use or employ, in connection with the pur-

chase or sale of any security registered on a national

securities exchange, or any security not so registered, any

manipulative or deceptive device or contrivance in contra-

vention of such rules and regulations as the Commission

may prescribe as necessary or appropriate in the public

interest or for the protection of investors.”

Rule 10b-5 provides:

“It shall be unlawful for any person, directly or indirectly,

by the use of any means or instrumentality of interstate

commerce, or of the mails or of any facility of any national

securities exchange,

“(a) To employ any device, scheme, or artifice to

defraud,

0 RI A St RO Oe

3

“(b) To make any untrue statement of a material

fact or to omit to state a material fact necessary in order

to make the statements made, in the light of the circum-

stances under which they were made, not misleading, or

“(c) To engage in any act, practice or course of

business which operates or would operate as a fraud or

deceit upon any person, in connection with the purchase

or sale of any security.” 17 C. F. R. § 240. 10b-5.

STATEMENT OF THE CASE INCLUDING BASIS FOR

FEDERAL JURISDICTION

The petitioners are General Motors Acceptance Corporation

(“GMAC”), a New York corporation, and Dave Waite Pon-

tiac, Inc. (“Waite Pontiac”), an Indiana corporation and a

General Motors Corporation (“GM”) automobile dealer which,

prior to the transactions involved here, also operated an auto-

mobile leasing division (“Waite Leasing’). GMAC is engaged

principally in the business of financing the acquisition by dealers

for resale of new products manufactured by GM and acquiring

from such dealers retail installment obligations covering sales

(including certain leasing transactions) of new products. Ar

the time of the transactions involved here, GMAC held numer-

ous chattel mortgage notes executed by Waite Pontiac in

connection with the purchase of automobiles for use in Waite

Leasing’s operation.

The respondents are shareholders of Bank Service Corporation

(“Bank Service”), an Indiana corporation. The amended

complaint’ alleges that on or about October 31, 1969, Bank

Service, as the buyer, entered into a written contract with Waite

Pontiac, as the seller, for the purchase of Waite Leasing. By

the terms of the contract, Bank Service assumed Waite Pontiac’s

existing chattel mortgage indebtedness to GMAC and agreed to

1. The certified record filed in this Court includes as Document

No. 1 Appellants’ Appendix filed October 10, 1972, in the Court

of Appeals for the Seventh Circuit. Record references herein are

to that Appendix.

ae ee

4

transfer to Waite Pontiac 7,000 shares of Bank Service stock

of an agreed value of one doilar ($1.00) per share. (R., p. 5A;

Ex. A, pp. 14A-18A.) The contract also contained a pro-

vision that the shareholders of Bank Service would agree to

indemnify Waite Pontiac against liability to GMAC on account

of the chattel mortgage indebtedness of Waite Pontiac which

Bank Service had assumed and agreed to pay, and the share-

holders, including respondents, who were its principal share-

holders, officers and directors, therefore executed as an adden-

dum to the contract a separate covenant agreeing to indemnify

Waite Pontiac against liability to GMAC. (R.. p. ISA.) GMAC

was not a party to the purchase contract.

The amended complaint further alleges that GMAC agreed

to permit the transfer of the assets of the leasing operation to

Bank Service, and to finance a new leasing operation to be con-

ducted by Bank Service. and/or its wholly owned subsidiary

General Auto Leasing & Rental Corporation (“GAL”). upon

condition that persons of substantial financial worth would

guarantee payment to GMAC of the existing obligations assumed

by Bank Service and of any future obligations of Bank Service

or such wholly owned subsidiary. (R.. p. 4A.)

In order to comply with the above condition, respondents, in

a transaction distinct from the sale described above. executed

and delivered to GMAC two separate written guarantees. In

the first, respondents guaranteed the payment by Bank Service

of all indebtedness owing or to be owed to GMAC (R. Ex. C.

pp. 22A-24A), while in the second, respondents guaranteed

payment by GAL of all obligations owed or to be owed by it

to GMAC (R. Ex. B. pp. 19A-21A). Waite Pontiac is not

alleged to have been a party to the credit transaction between

respondents and GMAC.

Waite Pontiac and GMAC are alleged to have violated

§ 10(b) of the Securities Exchange Act and Rule 10b-5 during

the negotiations between Bank Service, GMAC and Waite Pon-

tiac by having made untrue statements of material facts and

a A eS ve Ae = eae a

an

by having failed to state material facts with respect to the busi-

ness. the financial condition and the properties of Waite Pontiac

and Waite Leasing. thereby concealing from respondents and

Bank Service material adverse conditions of such business, finan-

cial position and properties, and also by having withheld informa-

tion concerning certain policies and practices of the management

of Waite Pontiac, GMAC and GM which should have been

revealed.

Bank Service and, or GAL allegedly conducted the purchased

leasing business for more than a year and a half at which time

they became insolvent by reason of alleged operating losses.

Thereafter. GMAC brought a state court action against respond-

ents on the guaranties, in which respondents counterclaimed for

damages and rescission of their guaranties, which remains pend-

ing. Respondents then commenced this federal court action

against petitioners. jurisdiction being asserted under £ 27 of

the Securities Exchange Act of 1934. 15 U. S.C. $ 78aa. The

respondents: amended complaint in this action seeks to recover

compensatory and punitive damages. and to have the guaranties

and all evidences of indebtedness relating thereto rescinded and

declared void.

The District Court for the Southern District of Indiana

sustained petitioner's motions to dismiss on the ground that

respondents, under their own allegations. were neither purchasers

nor sellers of securities and consequently lacked standing to

maintain this action under the rule originally enunciated in

Birnbaum v. Newport Steel Corp.. 193 F. 2d 461 (2d Cir.),

cert. denied, 343 U. S. 956 (1952). that only purchasers or

sellers of securities may maintain a private action under $ 10(b)

and Rule 10b-5.

The Court of Appeals for the Seventh Circuit did not disagree

with the District Court's conclusion that respondents were neither

purchasers nor sellers of securities in the context of the described

transactions. Nevertheless. it reversed the decision of the

District Court. The Court of Appeals held that the Birnhaum

purchaser-seller requirement is no part of the law of the Seventh

pronamit. eres =

6

Circuit and that respondents therefore were entitled to maintain

their § 10(b) and Rule 10b-5 action notwithstanding they were

neither purchasers nor sellers of securities. The rationale of

the Court of Appeals in reversing the judgment of the District

Court was that under the allegations of the complaint. the

transfer of the Bank Service stock to Waite Pontiac constituted a

sale of securities in violation of ¢ 10(b) and Rule 10b-5 as a

result of which Bank Service could have maintained an appro-

priate action under the statute and rule: that although respond-

ents were not the sellers of said stock. they were shareholders

of Bank Service and presumably executed the guaranties on

account of their interest as such shareholders: and that since

such execution is alleged to have been induced by the same

fraud or deceit which allegedly induced Bank Service to sell its

stock, they are “persons” upon whom the acts of the peti-

tioners Operated as fraud or deceit “in connection with the pur-

chase or sale of any security.” although they were neither

purchasers nor sellers either of the securities involved in con-

nection with the alleged rule violation or of any other securities.

REASONS FOR GRANTING THE WRIT

1. The Decision of the Court of Appeals for the Seventh Cir-

cuit Is in Conflict with the Decision of Every Other Court

of Appeals That Has Considered the Birnbaum Doctrine.

The decision of the Court of Appeals for the Seventh Circuit

in this case is in conflict with the decision of every other Court

of Appeals that has considered the purchaser-seller requirement

for standing to sue under § 10(b) of the Securities Exchange

Act and Rule 10b-5 of the Securities Exchange Commission.* 4

2. See Landy Vv. Federal Deposit Insurance C corporation, 486

F. 2d 139, 152-59 (3rd Cir. 1973), petition for certiorari filed,

42 U.S. L. W. 3336 (No. 73-819, November 23. 1973): Haberman

v. Murchison, 468 F. 2d 1305, 1311 (2d Cir. 1972): Mount

Clemens Industries, Inc. v. Bell, 464 F. 2d 339 (9th Cir. 1972):

Dudley v. Southeastern Factor and Finance Corp., 446 F. 2d 303

Se ea

ee Ee - -

The decision here represents the first instance in which a court

of appeals has rejected the view, initially set forth in Birnbaum

v. Newport Steel Corp., 193 F. 2d 461. 464 (2d Cir ). cert.

denied, 343 U. S. 956 (1952). that Rule 10b-5 “extended pro-

tection only to the defrauded purchaser or seller.” The Seventh

Circuit made its position abundantly clear with its conclusion

in this case that the purchaser-seller limitation “is not part of

the law of this circuit.” (App. I. p. Al3.)

Continued efforts in recent years both by litigants, and by

the Securities Exchange Commission as amicus curiae. to ob-

tain repudiation of the Birnbawn purchaser-seller limitation

have caused a number of the Courts of Appeals to review the

question. but prior to this case such efforts have been notably

unsuccessful. Only recently the Birnbaum rule was reaffirmed

by the Court of Appeals for the Third Circuit in Landy v. Fed-

eral Deposit Insurance Corporation, 486 F. 2d 139 (1973).

petition for certiorari filed, 42 U. S. L. W. 3336 (No. 73-819.

November 23. 1973). where the court explained as follows:

“Although various courts and commentators have sug-

gested elimination of the purchaser-seller requirement.

each of the circuit courts of appeals that has ruled on

this question recently has afirmed the basic Birnbaum

rule that standing under 19b-5 in a suit for damages fe-

quires purchaser-seller status." The reasons for retaining

(Sth Cir.). cert. denied, 404 U. S. 858 (1971): Herpich v. Wallace.

430 F. 2d 792 (Sth Cir. 1970): Sissons Vv. Wolfson, 428 F. 2d

455 (6th Cir. 1970). cert. denied, 400 U. S. 999 | 1971); Erling v.

Powell. 429 F. 2d 795 (8th Cir. 1970): City Nat. Bank v. Vander-

hoom, 422 F. 2d 221 (8th Cir.). cert. denied, 399 U. S. 905

(1970): Irequois Industries, Inc. Vv. Syracuse China Corp.. 417

F. 2d 963 (2d Cir. 1969). cert. denied, 399 U. S. 909 (1970).

3. Respondents in this case seek both damages and equitable

relief by way of rescission of the guaranties and have urged on the

basis of cases dispensing with the purchaser-seller requirement in

injunction cases (cf. Mutual Shares Corporation. Vv. Genesco, Inc..

384 F. 2d 540 (2d Cir. 1967)) that even though not entitled to

maintain an action for damages they should be entitled to the

equitable relief sought. The Court of Appeals in this case made no

such distinction. In Heyman v. Heyman, 356 F. Supp. 958. 964

8

the standing requirement are posited as essentially two

fold: first, the purpose of Congress in enacting section

10(b) was merely to extend to sellers of securities the

same protection that had been afforded to buyers under

the 1933 Securities Act: second, only Congress should

change an interpretation of an act unbroken since its

passage. See, e.g., Iroquois Industries, Inc. v. Syracuse

China Corporation, 417 F. 2d 963 (2d Cir. 1969):

Herpich v. Wallace. 430 F. 2d 792 (Sth Cir. 1970)... .

. Were we to extend the provisions of section 10(b)

beyond the buyer or seller relationship, we would be judi-

cially extending the terms of the statute and creating new

rights. The consequences of the view urged by plaintiffs

would establish a new and amorphous body of rights and

obligations heretofore unrecognized in federal jurisdiction.

Buyer or seller status is indispensable in establishing lia-

bility for damages under rule 10b-S.” 486 F. 2d 156-57,

158.

Perhaps what is most striking about the opinion of the Seventh

Circuit is that it seemingly ignores the basic point relied upon

in Landy as support for the Birnbaum rule, namely, that it was

Congress’ intent, in enacting $ 10(b). “merely to extend to

sellers of securities the same protection that had been afforded

to buyers under the 1933 Securities Act.” Indeed. this has

been the primary consideration underlying the purchaser-seller

limitation since the decision of Birnbaum itself. See 193 F. 2d

at 463. Yet apparently without concern for this essential con-

sideration, the Seventh Circuit has abandoned the purchaser-

seller limitation and, in doing so, has left an unfilled void in its

place. Thus, the Court of Appeals readily acknowledged that

it would not “try to formulate a succinct substitute for Birn-

baum, trusting that the appropriate limits to the rule will best

( S. DN. Y. . 1973), the court pointed out that the injunction cases

have sought to enjoin deceptive practices when resultant loss to

stockholders had not yet occurred, and that if Birnbaum could be

discarded whenever a complaint prayed equitable relief with respect

to a consummated transaction the exception would largely “envelop

the rule.”

Sy ert Le NE i

be defined through the process of case by case adjudication.”*

(App. I, p. Al2 n. 29.) In short, then, the Seventh Circuit

not only has seemingly rejected the heretofore recognized sig-

nificance of Congress’ intent in enacting $ 10(b) but has also

failed to offer any meaningful construction of the standing re-

quirement to replace the structure that has been developed on

the basis of that intent in Birnbaum and its numerous progeny.

Certainly, it is not difficult to imagine the unsettling effect which

the Seventh Circuit’s decision will have on litigation under

$ 10(b) and Rule 10b-5.

The Third Circuit’s opinion in Landy raises the equally im-

portant question whether the Seventh Circuit has exceeded the

scope of its function of statutory interpretation—as opposed to

statutory drafting—in abandoning the purchaser-seller limita-

tion which has long been recognized to be rooted in the intent

of Congress. This consideration has clearly been a significant

factor in previous decisions concerning the Birnbaum rule.

Thus. in /roquois Industries, Inc. v. Syracuse China Corp., 417

F. 2d 963 (2d Cir. 1969). cert. denied, 399 U. S. 909 (1970),

the Court of Appeals for the Second Circuit. although invited

by the appellant and the Securities Exchange Commission as

amicus curiae to overrule Birnbaum, affirmed its original deci-

sion there, stating that, in the light of the history set forth in

Birnbaum, the statute and rule were intended only to extend

protection to the “defrauded purchaser or seller.” The court

then added:

“The Birnbaum rule recognizes the policy of Congress

in enacting Section 10(b) and of the Commission in adopt-

ing Rule 10b-5. namely. the protection of defrauded pur-

chasers and sellers. \t is not the province of the courts to

4. Applying such a process to the present case yields only the

rather surprising conclusion that if a shareholder of a corporation

which purchases or sells a security as a result of alleged fraud or

deceit, engages, because of his interest as a shareholder and because

of the same fraud or deceit, in a transaction which involves neither

the sale nor the purchase of any security, he is entitled to a remedy

under the statute and rule to redress any injury alleged to have

been sustained.

eT HE On ~e

10

extend Section 10(b) to apply to transactions not intended

to be covered by Congress. We do well to heed the words

of Mr. Justice Black, writing for the Court in a case about

another section of the 1934 Act, Blau v. Lehman, 368

U. S. 403, 413, 82 S. Ct. 451, 457, 7 L. Ed. 2d 403

(1962):

“Congress can and might amend [the Act] if the

Commission would present to it the policy arguments

it has presented to us, but we think that Congress is

the proper agency to change an interpretation of the

Act unbroken since its passage, if the change is to

be made.’

“That the conduct averred in any given case may be

reprehensible does not mean that a federal remedy must

be furnished by judges. . . . If there is to be a federal

remedy, it is the Congress which must create it.” 417 F.

2d at 969 (emphasis added ).

See also Mount Clemens Industries, Inc. v. Bell, 464 F. 2d

339, 343 (9th Cir. 1972):

“Although this language was directed to Section 16(b) of

the Exchange Act. . . . we agree with our colleagues of the

Second Circuit that it applies with equal force to Section

10(b).”

2. The Decision of the Court of Appeals for the Seventh Cir-

cuit Cannot Be Rationalized Under Even the Most Liberal

Application That the Birnbaum Doctrine Has Heretofore

Been Given.

Substantially all of the Courts of Appeals have, to be sure,

recognized that the purchaser-seller limitation is to be read

“flexibly.” As stated in Herpich v. Wallace, 430 F. 2d 792,

806 (Sth Cir. 1970):

“We do not say that only those who are purchasers or

sellers in the ‘strict common law traditional sense’. . . may

maintain an action for damages under Rule 10b-5. .. .

In deciding whether a plaintiff has standing. we search

for what will best establish the congressional purpose . .

Thus we construe the ‘in connection with the purchase or

et ERE TS PRE eS ees, . SATIS

11

sale of any security’ clause found in both the section and

the rule broadly and flexibly to effectuate that purpose. . . .

The ‘purchaser’—‘seller’ standing requirement is to be

similarly construed . . . so that the broad design of the

section and the rule is not frustrated by the use of novel

or atypical transactions.”

Likewise, Landy indicates that while precise guidelines have

not been formulated as to when the flexible view of Rule 10b-5

will permit standing in the absence of technical purchaser or

seller status, the one criterion generally reiterated is whether

standing would efiectuate the broad purpose of the rule. See

486 F. 2d at 157. Presumably it was the lack of more precise

guidelines to the application of the purchaser-seller limitation

that caused the Court of Appeals for the Seventh Circuit to

state in this case:

“. . . Nor does the so-called rule really have integrity

when the words ‘purchaser’ and ‘seller’ are construed as

flexibly as has been necessary in order both to decide

10b-5 cases properly and also to continue to pay homage

to the Birnbaum rule.” (App. I, p. A9.)

Yet contrary to the apparent view of the Court of Appeals, it

is Clear that the courts applying the flexible interpretation of

Birnbaum have never lost sight of Congress’ basic purpose to

extend relief only to buyers or sellers of securities in the context

of § 10(b) and Rule 10b-5.

In SEC v. National Securities, Inc., 393 U. S. 453 (1969),

where this Court interpreted § 10(b) and Rule 10b-5 for the

first time, it was held that the exchange of shares by shareholders

of one company for shares of another company with which their

company was merging was a “purchase” of shares within the

terms of the statute and the rule. At one point. the Court

stated:

“This case presents none of the complications which may

arise in determining who, if anyone, may bring private

actions under § 10(b) and Rule 10b-5. Cf. J. J. Case Co.

v. Borak, 377 U. S. 426 (1964). This is a suit brought

by the Commission; the terms ‘purchase’ and ‘sale’ are

relevant only to the question of the statutory coverage.

Therefore there are no ‘standing’ problems lurking in the

case... .” 393 U.S. at 467 n. 9.

Still, confronted with the question “whether the respondents’

alleged conduct is the type of fraudulent behavior which was

meant to be forbidden by the statute and the rule,” the Court

explained:

“According to the amended complaint, Producers’ share-

holders were misled in various material respects prior to

their approval of a merger. The deception furthered a

scheme which resulted in their losing their status as share-

holders in Producers and becoming shareholders in a new

company. Moreover, by voting in favor of the merger,

each approving shareholder individually lost any right under

Arizona law to obtain an appraisal of his stock and pay-

ment for it in cash. Ariz. Rev. Stat. Ann. § 10-347

(1956). Whatever the terms ‘purchase’ and ‘sale’ may

mean in other contexts, here an alleged deception has

affected individual shareholders’ decisions in a way not at

all unlike that involved in a typical cash sale or share ex-

change. The broad antifraud purposes of the statute and

the rule would clearly be furthered by their application

to this type of situation. Therefore we conclude that

Producers’ shareholders ‘purchased’ shares in the new com-

pany by exchanging them for their old stock.” 393 U. S.

at 467 (emphasis added).

Thus, the rationale employed in National Securities was that

the shareholders of the old company were “purchasers” of

shares within the meaning of § 10(b) and Rule 10b-5 because

the alleged deception affected their investment decisions in a

way not unlike that involved in an investment decision to pur-

chase or sell securities. Similar reasoning was also applied in

Herpich v. Wallace, 430 F. 2d 792 (Sth Cir. 1970). where

the court said:

“In short, Congress meant to afford investors a reason-

able opportunity to make knowing, intelligent decisions

regarding their purchases and sales of securities in un-

—

. Apes

13

manipulated markets, . . . and the loss resulting in con-

nection with purchases or sales made without benefit of

such an opportunity is the type of injury section 10(b) and

Rule 10b-5 seek to prevent.” 430 F. 2d at 806. (Emphasis

added. )

In other words, decisions giving liberal application to the

Birnbaum doctrine have generally been rationalized on the

basis either that the transaction in which the injured party

participated had sufficient basic elements of a sale or purchase

of the securities involved in the alleged rule violation to bring

him within the broad purpose of the rule. or that the injured

party had sufficient relation to the transaction in which the

purchase or sale of the securities involved in the rule violation

occurred to make him a seller or purchaser of such securities

within such broad purpose.” There is, however, an obvious basic

difference between a flexible interpretation of “sale”, “purchase”.

“seller” or “purchaser” which is limited to situations in which the

injured party is linked directly to the securities involved in a

rule violation. and an interpretation of “any person” upon

whom an “act” or “practice” has operated “as a fraud or deceit”

“in connection with the purchase or sale of a security” which

dispenses altogether with the requirement that such person be

either a seller or purchaser—technically or under the flexible

view—of the security involved in the rule violation.

This distinction was clearly recognized by the Court of

Appeals for the Second Circuit in /nternational Controls Corp.

v. Vesco et al., _... F. 2d ..... (2d Cir. January 15, 1974.

Nos. 73-2202. 73-2255, 73-2568). slip opinion at p. 1399

(Mulligan J. dissenting in part). The majority held that an

in-kind dividend of a corporation to its shareholders of the stock

5. Thus, for example. in National Securities, the merger was

held to have sufficient basic elements of a sale to make the trans-

action a “sale” of securities in the context of the statute and rule.

while in James v. Gerber Products Co., 483 F. 2d 944 (6th Cir.

1973), a trust beneficiary was held to be a “seller” of the securities

involved in the rule violation because she was the person benefited

by the sale and therefore had the interest of a de facto seller.

EE erat Se SS ae Sat ~

Bivsericecccnnies: Bile meee.

14

of a wholly owned subsidiary which was induced by fraud was a

sale of such stock within the meaning of § 10(b) and Rule

10b-5, even though the corporation received no consideration

therefor. While the holding may have extended the flexible

concept of “sale” beyond prior decisions, the majority rejected

the suggestion of the dissenting Judge that it signalled the demise

of Birnbaum:

“Our dissenting brother's ‘fear’ that our decision today

signals the demise of the Birnbaum doctrine—limiting

standing to sue under § 10(b) to the ‘purchaser or seller’

of securities—is wholly unfounded. Having determined that

ICC’s dividend of its Fairfield General portfolio stock was

the kind of meaningful disposition of securities which

Congress sought to protect under § 10(b), it could not be

more clear that ICC was the ‘seller’ of those securities.

Compare Birnbaum v. Newport Steel Corp., supra (the

corporation lacked standing where its controlling share-

holder sold his shares) with Ruckle v. Roto American

Corp., supra (the corporation had standing where it had

agreed to sell its own newly-issued shares).” Slip Op. at

p. 1419 n. 16.

Essentially the same distinction between Birnbaum and

Ruckle v. Roto American Corp., 339 F. 2d 24 (2d Cir. 1964),

that was put forth in Yesco must be said to apply in this case,

only in reverse. For if a corporation lacks standing to sue under

the rule where its controlling shareholder sold his shares of the

corporation. it must follow that shareholders lack personal

standing where, as here, the corporation sold its own shares.

As the Court of Appeals conceded, the only purchase or sale of

a security involved in this case was the transfer of 7,000 shares

of stock from Bank Service to Waite Pontiac and respondents

could not be characterized as sellers of that stock under the most

flexible view of the Birnbaum doctrine. Consequently, the court

was compelled either to repudiate the Birnbaum doctrine or to

attempt somehow to extend that doctrine beyond any previous

application. In the latter regard, respondents contended both

that they were purchasers of securities. by reason that their

TR Ce hl AED OLN Di

i)

guaranty of the indebtedness of Bank Service to GMAC was in

effect an agrcemcit to purchase notes evidencing such indebted-

ness in the event of insolvency, and that they were sellers of

securities, by reason of the delivery of such guaranty to GMAC.

The guaranty transaction, however, was obviously not an in-

vestment transaction by respondents but an ordinary commercial

credit transaction not within any purpose of the statute and rule.

Cf. Lino v. City Investing Co., 487 F. 2d 689 (3d Cir. 1973),

and McClure v. First National Bank, 352 F. Supp. 454 (N. D.

Tex. 1973). Therefore. the Court of Appeals chose the only

alternative actually available if it was to rule for respondents

—it repudiated the Birnbaum doctrine completely. It is. then.

the continuing viability of that doctrine which is squarely

presented to this Court by the decision below.

3. This Court Has Not Heretofore Passed Upon the Correctness

of the Birnbaum Doctrine.

While conceding that no holding of this Court is inconsistent

with the view that only purchasers or sellers of securities are

protected by Rule 10b-5, the Court of Appeals for the Seventh

Circuit purported to find support for the rejection of the

purchaser-seller requirement in Superintendent of Ins. v. Bankers

Life & Casualty Co., 404 U. S. 6 (1971). The court’s argument

is twofold.

First, the Court of Appeals stated that Congress, the Supreme

Court, and the Commission have all used the term “investors”

to describe the class of persons protected by Rule 10b-5 and the

statutory authorization for the rule refers to the prohibition of

deceptive devices “ ‘for the protection of investors.’” It then

added: “And speaking for a unanimous court in Superintendent

of Insurance Vv. Bankers Life & Casualty Co., Justice Douglas

stated that the crux of the case was the fact that ‘Manhattan

suffered injury as a result of deceptive practices touching its

sale of securities as an investor.’ 404 U. S. 6, 12-13 (emphasis

rer ree FO ae

eo a eth Be ee The

Betacwirinissimorn. MEE EL AS. 2 20?

16

added.)” (App. 1, p. A9). By adding emphasis only to the

words “as an investor” the Court of Appeals minimized the

Significance of the preceding language “touching its sale of

securities.” (Emphasis added.) In fact, this Court in Bankers

Life also said:

“Manhattan was the seller of Treasury bonds and, it

seems to us, clearly protected by £10(b) .. . of the

Securities Exchange Act. which makes it unlawful to use

‘in connection with the purchase or sale’ of any security,

‘any manipulative device or contrivance’ in contravention

of the rules and regulations of the Securities and Exchange

Commission.

“There certainly was an ‘act’ or ‘practice’ within the

meaning of Rule 10b-5 which operated ‘as a fraud or deceit’

on Manhattan, the seller of the Government bonds.” 404

U. S. at 9. (Emphasis added. )

Hence, it appears wholly unreasonable to attach the significance

which the Court of Appeals attaches to this Court's usage of the

word “investor” in Bankers Life.

The Court of Appeals further stated that the “basic holding”

of Birnbaum was repudiated in Bankers Life, and that it was

convinced that the purchaser-seller limitation is nothing more

than an appendage to that holding without independent justifica-

tion. (App. I, p. Al3.) Four other Courts of Appeal have,

however, previously rejected the contention that Bankers Life

warrants repudiation of the purchaser-seller limitation by impli-

cation or otherwise. Thus, for instance, in Haberman v. Murch-

ison, 468 F. 2d 1305. (2d Cir. 1972), the court, after stating

that Section 10(b) and Rule 10b-5 afford protection only

to those who actually purchase or sell securities to their loss

in reliance upon the withholding or misrepresentation of material

information or other manipulative or deceptive devices, said:

“Nothing in the Supreme Court's opinion in Supt. of

Insurance of New York v. Bankers Life and Cas. Co., 404

U. S. 6, 92 S. Ct. 165, 30 L. Ed. 2d 128 (1971), is to the

contrary. Although the Court there reversed this court's

SOT La PE a Boab

17

holding that Section 10(b) extended only to fraudulent

or manipulative sales and not to the fraudulent appropria-

tion of the proceeds of a sale, it in no way suggested a

rejection of the rule that a plaintiff under Section 10(b)

must be a party to the sales transaction. The Court made

clear

‘that Manhattan [the injured party] was the seller of

Treasury bonds and, it seems to us, clearly protected

by § 10(b) ... The Act protects corporations as well

as individuals who are sellers of a security.” 404 U. S.

at 9, 10, 92 S. Ct. at 167-168. (Emphasis supplied. )”

468 F. 2d at 1311 n. 5 (first emphasis added).

See also Landy v. Federal Deposit Insurance Corporation, 486

F. 2d 139. 155 (3d Cir. 1973), petition for certiorari filed,

42 U. S. L. W. 3336 (No. 73-819, November 23, 1973):

James Vv. Gerber Products Co., 483 F. 2d 944, 948 (6th Cir.

1973); Mount Clemens Industries, Inc. v. Bell, 464 F. 2d 339.

344 (9th Cir. 1972). Indeed. it appears clear from this Court's

own opinion in Bankers Life that the question of the limitations

on standing to sue under § 10(b) and Rule 10b-5 was there

reserved for future consideration. See 404 U. S. at 13-14 n. 10.

Certainly. it cannot be said that the purchaser-seller limitation

was rejected in that decision.

4. The Decision of the Court of Appeals for the Seventh Cir-

cuit Involves an Important Question of Federal Law Re-

quiring Resolution by This Court.

The purchaser-seller requirement has long been recognized to

be an important limitation on the use by private parties of

$ 10(b) and Rule 10b-5 to seek redress for injury resulting from

fraud. The Court of Appeals in this case readily assumed that

“complete abandonment of Birnbaum will significantly increase

our workload.” but refused to accept this as a reason for reject-

ing what it believed “to be a correct interpretation of the statute

or the rule.” (App. I, p. 12.) Without question. the practical

impact of any particular interpretation of a statute is not a rele-

a

a Rl SE OR OES

18

vant consideration in the process of statutory interpretation. the

exclusive purpose of which is to determine the intent of Congress

in enacting the statute in question. Nevertheless. the practical

impact of the interpretation adopted by the Seventh Circuit—

that is, the extension of § 10(b) and Rule 10b-5 to apparently

large numbers of potential suitors who previously could not

invoke the statute or the rule—is certainly a highly relevant

consideration in assessing the importance of the decision below.

And this consideration is amplified here by the failure of the

Court of Appeals, in rejecting Birnbaum, to suggest any alterna-

tive standards which should govern standing under § 10(b) and

Rule 10b-5, thus giving emphasis to the Landy statement that

“The consequences of the view urged by plaintiffs would estab-

lish a new and amorphous body of rights and obligations hereto-

fore unrecognized in federal jurisdiction’ 486 F. 2d at 158.

In sum, an area of such federal significance should not be left

in its present unsettled state. particularly not when the position

of the Seventh Circuit conflicts with that of every other circuit

which has considered the question. The Court of Appeals was.

of course. well aware of the disuniformity in federal law which

would result from its decision, but it did not believe “that

Birnbaum should be followed simply to preserve national con-

sistency in the interpretation of federal securities legislation.”

(App. I, p. 13.) Under such circumstances, as the Court of

Appeals further recognized, “the only sure way to achieve con-

sistency throughout the federal judiciary on a question of this

character is for the Supreme Court to resolve such conflict

among the circuits as does exist.” (App. I. p. 13.)

19

CONCLUSION

For the reasons stated, it is respectfully submitted that the

petition for certiorari should be granted.

Respectfully submitted.

ALAN W. Boyp.

HENRY J. PRICE.

Davip B. HUGHES,

Attorneys for Petitioner General

Metors Acceptance Corporation.

James M. SECREST.

Attorney for Petitioner Dave Waite

Pontiac, Inc.

FRAZER F. HILDER,

LAWRENCE W. MIDDLETON.

JOHN J. HIGGINS,

BARNES. HICKAM, PANTZER & Boyp.

HuGcues & HUuGHEs.

HiLGepaG, JOHNSON. SECREST & MURPHY.

Of Counsel.

Al

APPENDIX I

IN THE UNITED STATES COURT OF APPEALS

For the Seventh Circuit

September Term, 1973 September Session, 1973

Appeal from the

United States Dis-

trict Court for the

WILLARD D. Eason, M. O. SaTROM

No. 72-1722

and JEAN M. SaTROM, |

Plaintiffs-Appellants. | Southern District of

vs. > Indiana.

GENERAL Motors ACCEPTANCE Cor- | No. IP 71 C 613

PORATION and DavVE WAITE! (Care J. HOLDER.

PonT1ac, INC., Judge.

Defendants-A ppellees. .

Argued October 19, 1973—-Decided December 28, 1973

BEFORE KILEY and STEVENS, Circuit Judges. and WyYZANSKI,

Senior District Judge.*

STEVENS, Circuit Judge. Plaintiffs are shareholders of a

corporation which purchased a car leasing business from one

of the defendants. In connection with the transaction, the

corporate purchaser issued 7,000 shares of its stock to the seller,

and the plaintiffs individually guaranteed certain liabilities as-

sumed by the purchaser. Plaintiffs accuse both defendants of

* Senior District Judge Charles Edward Wyzanski, Jr. of the

District of Massachusetts, is sitting by designation.

Sf RAT RE SE SEER

A2

fraud and seek relief under § 10(b) of the Securities Exchange

Act of 1934,' 48 Stat. 891, 15 USC § 78j(b), and Securities

and Exchange Commission Rule 10b-5.7 The question presented

is whether their claim is foreclosed by the so-called “Birnbaum

rule” which limits private relief for a violation of Rule 10b-5

to persons who were either purchasers or sellers of a security.

The appeal is from an order dismissing plaintiffs’ third

amended complaint and denying leave to file a fourth. The es-

sential facts are quite simple. Prior to October 31, 1969, one

of the defendants (Dave Waite Pontiac, Inc.) operated a

Pontiac dealership and also an automatic leasing division.

Purchases of cars for the leasing business were financed by

General Motors Acceptance Corporation, the second defend-

ant. Bank Service Corporation, a company in which the plain-

tiffs owned stock, entered into an agreement to purchase the

leasing business. As consideration for the business, Bank

Service issued 7,000 shares of its stock to Waite and assumed

1. Section 10(b) of the Act provides:

“It shall be unlawful for any person . . . [t]o use or employ,

in connection with the purchase or sale of any security regis-

tered on a national securities exchange or any security not so

registered, any manipulative or deceptive device or contrivance in

contravention of such rules and regulations as the Commission

may prescribe as necessary or appropriate in the public interest

or for the protection of investors.”

2. Rule 10b-5 provides:

“It shall be unlawful for any person, directly or indirectly, by

the use of any means or instrumentality of interstate commerce,

or of the mails, or of any facility of any national securities ex-

change,

“(a) To employ any device, scheme, or artifice to

defraud,

“(b) To make any untrue statement of a material fact

or to omit to state a material fact necessary in order to

make the statements made, in the light of the circum-

stances under which they were made, not misleading, or

“(c) To engage in any act, practice, or course of busi-

ness which operates or would operate as a fraud or deceit

upon any person, in connection with the purchase or sale

of any security.” 17 CFR § 240.10b-5.

Se -<4-- a

A3

the liabilities of the leasing business, including notes payable

to GMAC, and the individual plaintiffs delivered a guarantee

of those notes, as well as a guarantee of future liabilities. to

GMAC.

The leasing business failed; Bank Service became insolvent

and defaulted on the notes.* GMAC then brought suit in a

state court to recover on the guarantees. Plaintiffs countered

with this federal action, accusing both defendants of fraud and

seeking rescission of the guarantees.

Plaintiffs seek to avoid Birnbaum’s purchaser-seller limitation

on private relief under Rule 10b-5 in various ways. They con-

tend that their guarantees were securities which they sold to

GMAC; that the underlying notes are securities which they are

being forced to purchase; that they were indirect sellers of the

7,000 shares of corporate stock: and, in aij events. that the

Birnbaum limitation should be disavowed in this circuit. Since

the necessity of stretching the definitions of “purchasers.” “sell-

ers,” and “securities” is a result of the Birnbaum rule, we think

it appropriate to examine the viability of that rule first. For

purposes of decision, therefore. we assume that the only pur-

chase or sale of a security involved in the transaction was the

transfer of 7,000 shares of stock from Bank Service to Waite,

and we reject the suggestion that plaintiffs should be character-

ized as “sellers” of that stock. The question which is thus pre-

sented is whether. notwithstanding the fact that they were neither

purchasers nor sellers of a security. plaintiffs may obtain relief

under Rule 10b-5. In answering that question, we first note

that a violation of Rule 10b-5 has been alleged and then con-

sider whether any remedy is available to these plaintiffs.

I.

For present purposes it is conceded that material misstate-

ments and omissions attributable to both GMAC and Waite

3. A subsidiary which operated the business also allegedly be-

came “defunct.”

tala bs Cato

Bpavccnsinniot ila abla 9658 26

A4

have been adequately alleged. The 7,000 shares of Bank Service

stock were unquestionably “securities” within the meaning of

Rule 10b-5. It is also settled that the issuance and delivery of

such shares constituted a “sale,”* and further, that even though

the alleged fraud related to the value of the assets acquired,

rather than the value of the security delivered, the deception

was “in connection with” the sale of a security.* Finally, “the

fact that the transaction [was] not conducted through a securi-

ties exchange or an organized over-the-counter market is irrele-

vant to the coverage of § 10(b).” Superintendent of Insurance

v. Bankers Life & Casualty Co., 404 U. S. 6, 10. In short,

defendants do not challenge the conclusion that a violation of

Rule 10b-5 has been alleged Nor would they dispute a federal

court’s jurisdiction to entertain an appropriate claim by the

corporation, Bank Service.® The disputed question is whether

plaintiffs, as individual shareholders of Bank Service and guar-

antors of its indebtedness to GMAC, may assert a Rule 10b-5

claim.

II.

The question of plaintiffs’ right to relief has three aspects:

(a) whether they have “standing,” (b) whether they are pro-

tected by the rule. and (c) whether overriding considerations

of policy should defeat their claim.

4. See Dasho v. Susquehanna Corp., 461 F. 2d 11, 27 (7th

Cir. 1972).

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

201-203 (Sth Cir. 1960) cert, denied 365 U. S. 814. Not only did

the Supreme Court cite Hooper with approval in Superintendent of

Insurance Vv. Bankers Life and Casualty Co., 404 U. S. 6, 10-11,

but the same analysis is applicable to the transaction in the Bankers

Life case itself. The fraud related to the use of the proceeds of

the sale of Manhattan’s bonds, rather than the sale of those bonds

or even the price at which Manhattan stock was sold to Begole.

6. Presumably such a claim, at least for rescission, would have

no value since the 7,000 shares of Bank Service stock which might

be recovered are now worthless.

AS

A.

Neither the statute nor Rule 10b-5 expressly authorizes a

private remedy. Nevertheless. in a 1946 decision which is now

universally followed, Judge Kirkpatrick held that a civil action

could be maintained by a member of the class “for whose spe-

cial benefit the statute was enacted.”* The Birnbaum case, de-

cided six years later.” has been read as holding that only the

purchaser or the seller of a security may maintain such an ac-

tion; this purchaser-seller limitation has been frequently described

as a “standing requirement.”

This “standing requirement” may be interpreted in two quite

different ways. On the one hand, it may signify that only pur-

chasers or sellers of securities have legal rights that are pro-

tected by Rule 10b-5. In this sense. the analysis of the

plaintiffs status—that is to say. his relationship to defendant's

violation of Rule 10b-S—really determines whether the plain-

tiff is a person who has suffered a legal wrong.®

On the other hand. as the term “standing” is more properly

used, it assumes that the plaintiff is a member of the class pro-

tected by the rule at issue. and addresses the question whether

he has a sufficient interest in a real controversy with the de-

fendant to entitle him to invoke the jurisdiction of a federal

court. Thus. for example, although a taxpayer, in common

with the rest of the citizenry, may be protected by the rule he

invokes. he may lack standing to litigate an issue because of

7. Kardon v. National Gypsum Co., 69 F. Supp. 512. 514

(E. D. Pa. 1946).

8. Birnbaum v. Newport Steel Corp., 193 F. 2d 461 (2d Cir.

1952). cert. denied, 343 U. S. 956 (A. N. Hand. J.).

9. Cf., Judge Cardozo’s classic analysis in Palsgraf v. Long

Island Railroad, 162 N. E. 99, 100 (N. Y. 1928): “What the plain-

tiff [seeking to sue in tort] must show ‘a wrong’ to herself, i.e.. a

violation of her own right, and not merely a wrong to someone

else, in conduct ‘wrongful’ because unsocial. but not ‘a wrong’ to

anyone else.”

ee EE er CL BAI Et

A6é

the “case” or “controversy” limitation on the exercise of federal

judicial power. Frothingham v. Mellon, 262 U. S. 447. In

this sense, the requirement that the plaintiff must have “stand-

ing” raises a jurisdictional question under Article III of the

United States Constitution.’®

The Birnbaum rule has been interpreted as a standing re-

quirement in this constitutional and jurisdictional sense.''’ We

are satisfied that such an interpretation of Birnbaum is unwar-

ranted and we have no doubt that the plaintiffs’ interest in the

controversy before us is sufficient to satisfy the requirements

of Article III. Indeed, the parties with a vital stake in the out-

come of the dispute are the individual plaintiffs on the one hand

and GMAC on the other. One or the other will suffer a loss of

approximately $300,000—the balance allegedly due on the

loans made by GMAC to which plaintiffs’ guarantees apply.

This dispute may certainly be regarded as a “case” or “contro-

versy” between these parties within the meaning of Article III.

In the Birnbaum case itself Judge Hand made no reference

to the Constitution and did not mention the word ‘ ‘standing.”

10. Professor Wright summarizes the scope of the doctrine as

follows:

“The law of standing is almost exclusively concerned with

such public law questions as determinations of constitutionality

and review of administrative or other governmental action. In

theory, of course, it is not so limited. The person suing for

breach of contract or for a tort must satisfy the court that he

has standing to bring such a suit, but in practice such suits

are brought only by persons harmed by the supposed wrong,

and his standing to sue is self-evident. It is only where the

question is of a public nature that the interested bystander is

likely to attempt suit.” C. A. WRIGHT, FEDERAt Courts.§ 13,

p. 39 (1970 ed.).

11. See Herpich v. Wallace, 430 F. 2d 792, 805 (Sth Cir.

1970); Mount Clemens Industries, Inc. v. Bell, 464 F. 2d 339, 343

(9th Cir. 1972). In the latter case the court stated that the pur-

chaser-seller limitation is “required as a matter of constitutional

necessity.” See, also. Manor Drug Stores v. Blue Chip Stamps.

F. 2d . (9th Cir. Oct. 15, 1973), slip opinion at p. 15

(Hufstedler, ‘ " dissenting).

A7

The decision in that case turned on the court's evaluation of the

kind of conduct which was forbidden by Rule 10b-5. The court

concluded that the rule was “directed solely at that type of

manipulative or fraudulent practice usually associated with the

sale or purchase of securities . . .” 193 F. 2d at 464. Since

the rule at that time was thought to relate only to public sales

of securities. the prohibition of that type of activity was quite

reasonably undersood as intended to afford “protection only to

the defrauded purchaser or seller.” bid. As conceived by its

author. the purchaser-seller limitation was thus a description of

the court’s understanding of the class of persons protected by

Rule 10b-5.

Instead of stating the issue in terms of standing, we think

it is more useful to ask whether the plaintiffs were members of

the class for whose special benefit Rule 10b-5 was adopted.

This is the inquiry which is suggested in Judge Kirkpatrick’s

opinion which originally articulated the basis for finding an

implied private remedy under Rule 10b-5."

12. Thus, at page 513 of 69 F. Supp. he stated:

“It is also true that there is no provision in Sec. 10 or else-

where expressly allowing civil suits by persons injured as a

result of violation of Sec. 10 or of the Rule. However, “The

violation of a legislative enactment by doing a prohibited act,

or by failing to do a required act, makes the actor liable for an

invasion of an interest of another if; (a) the intent of the

enactment is exclusively or in part to protect an interest of the

other as an individual; and (b) the interest invaded is one

which the enactment is intended to protect. * * *’ Restate-

ments, Torts, Vol. 2, Sec. 286. This rule is more than merely

a canon of statutory interpretation. The disregard of the com-

mand of a statute is a wrongful act and a tort. As was said in

Texas & Pacific R. Co. v. Rigsby, 241 U. S. 33, 39, 36 S. Ct.

482, 484, 60 L. Ed. 874, “This is but an application of the

maxim, Ubi jus ibi remedium.’”

And on the following page:

“The other point presented by the defendants is that, under

the general rule of law, civil liability for violation of a statute

accrues only to a member of a class (investors) for whose

special benefit the statute was enacted—an argument applied

to both Sec. 10 and to Rule X-10B-5. Sec. 10 prohibits

La RANTM AY /'5.10 pintliadee ledusciesrcaks 9

OCU kaa yD ae

AA Ae

Dietitians wi.

A8

B.

Judge Hand’s formulation of the “Birnbaum rule” in 1952

was an identification of the persons to whom Rule 10b-5 “ex-

tended protection.” Protection against the type of fraudulent

practice usually associated with the sale or purchase of securi-

ties appropriately extended “only to the defrauded purchaser

or seller.” In the last two decades, however, the rule has been

interpreted to encompass additional types of misconduct and

to extend protection to a variety of persons not included within

the traditional definition of either purchaser or seller. Thus.

issuers,’* trust beneficiaries,‘ merging corporations,’® minority

shareholders in short form mergers,’® parties to incomplete

transactions,’’ offerees,’* and others'® have been treated as

though they were sellers and thereby accorded the protection

of the rule. The course of judicial decision since 1952, when

Birnbaum was decided, has actually recognized that the class

of protected persons is broader than merely purchasers and

sellers.

deceptive devices ‘in contravention of such rules and regula-

tions as the Commission may prescribe as necessary or appro-

priate in the public interest or for the protection of investors.’

I cannot agree, however, that ‘investors’ is limited to persons

who are about to invest in a security or that two men who have

acquired ownership of the stock of a corporation are not in-

vestors merely because they own half of the total issue.”

13. Hooper v. Mountain States Security Corp., supra.

14. James v. Gerber Products Co., 483 F. 2d 944 (6th Cir.

1973).

15. Dasho v. Susquehanna Corp., 380 F. 2d 262, 267 (7th Cir.

1967), (Fairchild, J., concurring), cert. denied Bard v. Dasho, 389

U. S. 977; see also Dasho v. Susquehanna Corp., 461 F. 2d 11.

supra.

16. Vine v. Beneficial Finance Co., 374 F. 2d 627 (2d Cir.

1967), cert. denied 389 U. S. 970.

17. A.J. Brod & Co. v. Perlow, 375 F. 2d 393 (2d Cir. 1967).

18. Manor Drug Stores v. Blue Clip Stamps, supra.

19. See generally A. R. Bromberg, SECURITIES Law: FrRaup

Sec. RuLE 10b-5, § 8.8 (1971).

A9

The language of Rule 10b-5 itself describes any act or

practice which operates as a fraud or deceit “upon any person

in connection with the purchase or sale of a security.” The

Supreme Court has repeatedly stated that this language should

be given a broad and flexible construction.“” Construing the

words “any person” to include a purchaser or a seller but no

one else is not consistent with that admonition. Nor does the

so-called rule really have integrity when the words “purchaser”

and “seller” are construed as flexibly as has been necessary in

order both to decide 10b-5 cases properly and also to continue

to pay homage to the Birnbaum rule. Moreover, a formal pur-

chaser-seller limitation is not consistent with the overriding

requirement that, in construing the 1934 Act, “form should be

disregarded for substance and the emphasis should be on eco-

nomic reality.” Tcherepnin v. Knight, 389 U. S. 332, 336.

Congress, the Supreme Court, and the Commission have all

used the term “investors” to describe the class of persons pro-

tected by Rule 10b-5. Thus, the statutory authorization for

the rule refers to the prohibition of deceptive devices “for the

protection of investors.”*' And speaking for a unanimous court

in Superintendent of Insurance Vv. Bankers Life & Casualty Co.,

Justice Douglas stated that the crux of the case was the fact

that “Manhattan suffered injury as a result of deceptive prac-

tices touching its sale of securities as an investor.” 404 U. S.

6, 12-13 (emphasis added ).** .

In its brief as amicus curiae in that case, the Securities and

Exchange Commission also stressed the statutory purpose. im-

plemented by Rule 10b-5, to protect investors from all forms

20. See, e.g., Affiliated Ute Citizens v. United States, 406 VU. S.

128, 151.

21. See § 10(b) quoted in footnote |, supra.

22. Earlier in the opinion Justice Douglas stated that Manhattan

“was injured as an investor through a deceptive device... .” 404

U.S. at 10.

EME MDT antes

(LBP sae +

sues

A10

of securities fraud.** Instead of attaching significance to the

fact that Manhattan was the seller of the government securities,

the Commission stated: “Manhattan not only suffered an injury

as a result of the fraudulent dealings in its government securi-

ties, it suffered that injury in its capacity as an investor.”**

Although no Supreme Court holding is inconsistent with the

view that only purchasers or sellers of securities are protected

by Rule 10b-5, we thing the Court’s opinions fairly imply that

the rule was intended to protect a broader class of persons.

The emphasis on the injured party’s status as an investor indi-

cates that the protection of the rule extends to persons who,

in their capacity as investors, suffer significant injury as a

direct consequence of fraud in connection with a securities

transaction, even though their participation in the transaction

did not involve either the purchase or the sale of a security.

The plaintiffs in this case were certainly “investors” in the

transaction which is allegedly tainted by fraud. Their interest

as stockholders of Bank Service Corporation was apparently

sufficient to induce them to execute substantial personal guar-

antees. As individual guarantors they were direct parties to

the transaction in dispute. If, as plaintiffs have alleged, the

transaction was consummated in violation of Rule 10b-5, we

believe the plaintiffs, as investors and as principals in the

transaction, suffered a legal injury which may be redressed by

a federal court.

C.

In addition to suggesting that the Birnbaum rule is constitu-

tionally compelled, it has been argued that the purchaser-seller

23. “While Congress had no purpose to regulate trans-

actions which comprise no more than internal corporate mis-

management, it sought to protect securities investors, including

corporations such as Manhattan, from all forms of securities

fraud.” Brief for the Securities and Exchange Commission at

p. 23.

24. Id. at 29.

NMRA A a BRE OS BRS ae SOF BM

All

limitation should be retained to forestall an unmanageable

flood of federal litigation,*” and to preserve national consistency

in the interpretation of federal securities legislation.” We find

neither of these arguments persuasive.

The volume of 10b-5 litigation has already expanded dra-

matically and will no doubt continue to do so whether or not

the purchaser-seller limitation is rejected.** The extent to which

a refusal to adhere to Birnbaum will affect that volume is really

a matter of speculation.** The fact that the purchaser-seller

limitation is unacceptable does not mean that there will be no

25. See, e.g., J udge Hufstedler’s dissent in Manor Drug Stores V.

Blue Chip Stamps, .... F. 2d. .... (9th Cir. Oct. 15, 1973), slip

opinion at p. 15.

26. See Mount Clemens Industries, Inc. v. Bell, supra, 464 F.

2d at 342.

27. As Judge Wisdom has noted:

“In recent years, the rule has been applied in such a variety of

situations that one can scarcely find an issue of the advance

sheets of the Federal Supplement and Federal Reporter that

does not contain an opinion on § 10(b). This extraordinary ex-

pansion of subject-matter coverage by § 10(b) and Rule 10b-S,

coupled with the possibility of extraordinarily great liability.

has moved courts to limit the class of persons who may re-

cover to purchasers or sellers of securities.” Rekant v. Desser,

425 F. 2d 872, 877 (Sth Cir. 1970).

28. It is not unlikely that the principal cause of concern about

the increase in this type of litigation is an assumption that it will

always be much easier to allege and prove a 10b-5 case than a com-

mon law fraud case. That assumption may not be warranted because

it is not necessarily true that the strict standards of disclosure which

appropriately apply to transactions in which there is a dramatic

disparity in the parties’ access to material information will auto-

matically and totally apply to negotiated transactions in which the

parties typically rely on contract warranties and pre-closing in-

spections or audits as a basis for the investment decision. A flexible

statute which emphasizes the relevance of the context in which a

transaction takes place should neither limit its protection to an

arbitrarily defined class of purchasers and sellers, nor arbitrarily

assume that every purchaser and every seller is entitled to precisely

the same disclosure. See Comment, The Prospects for Rule X-1]0B-5;

An Emerging Remedy for Defrauded Investors, 59 Yae L. J. 1120,

1143 (1950).

iia

SS Pe 8 Rete ASU LT aes

Al2

limit of any kind on the availability of private relief.*’ For in

each case the plaintiff will have to demonstrate membership in

the “special class” protected by Rule 10b-5 and injury as a direct

consequence of the alleged violation. The number of parties

who may invoke Rule 10b-5 without the purchaser-seller limi-

tation may not differ materially from the number who would

recover by persuading a court to interpret the purchaser-seller

concept flexibly.

Assuming, however, that a complete abandonment of Birn-

baum will significantly increase our workload, we may not for

that reason reject what we believe to be a correct interpretation

of the statute or the rule. Indeed, the volume of future litiga-

tion that was more clearly predictable as a consequence of the

Supreme Court's holding in the Bankers Life case was not even

mentioned in the Court's opinion as a possible objection to its

broadened interpretation of Rule 10b-5 as encompassing the

misuse of proceeds of sale. The fear that the volume of 10b-5

litigation may actually impair the effective operation of organ-

ized securities markets. see Herpich v. Wallace, supra, 430 F.

2d at 804. is not. in our opinion, well founded; but if we are

wrong, the Securities and Exchange Commission has both the

power and the expertise to adopt appropriate amendments to

29. Section 4 of the Clayton Act expressly authorizes “any per-

son injured in his business or property by reason of” an antitrust

violation to sue for damages. Although that broad language opened

“nearly limitless possibilities” for damage recovery, a case by case

evaluation of what may be described either as the “standing” issue

or the concept of injury has resulted in a significant limitation on the

potential scope of recovery. See generally In re Multidistrict Vehicle

Air Pollution M. D. L. No. 31, 481 F. 2d 122 (9th Cir. 1973),

and the many cases cited therein. We question whether the rejec-

tion of the purchaser-seller limitation in Rule 10b-5 litigation will

have any more disastrous consequence than the rejection of any one

of the “talismanic rubrics” identified in that opinion. Either a “tar-

get area” or a “direct injury” analysis would seem preferable to a

somewhat tattered purchaser-seller rubric. In any event, we de-

liberately avoid the temptation to try to formulate a succinct sub-

stitute for Birnbaum, trusting that the appropriate limits to the

rule will best be defined through the process of case by case

adjudication.

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the rule. As the Commission has repeatedly stated, it is now of

the view that the purchaser-seller limitation is an artificial re-

striction inconsistent with the intent of the underlying statute.

That view merits our respect.

Nor do we believe that Birnbaum should be followed simply

to preserve national consistency in the interpretation of federal

securities legislation. We are inclined to think that the extent

of the consistency in applying Birnbaum is overstated*” and is

less important than an independent appraisal of an important

issue arising in an area of the Jaw which, despite the age of the

statute. is still in an embryonic stage of development. See Dasho

Vv. Susquehanna Corp., supra, 461 F. 2d 11, 23 at n. 26. In all

events. the only sure way to achieve consistency throughout the

federal judiciary on a question of this character is for the Su-

preme Court to resolve such conflict among the circuits as does

exist.

As Judge Sprecher demonstrated in Jannes v. Microwave

Communications, Inc., 461 F. 2d 525. 528-530 (7th Cir. 1972).

the basic holding of Birnbaum was repudiated by a unanimous

Supreme Court in the Bankers Life case. We are convinced

that the purchaser-seller limitation is nothing more than an ap-

pendage to that holding without independent justification. We

hold that it is not part of the law of this circuit.**

The judgment is reversed and the case is remanded for fur-

ther proceedings.

30. Bromberg has noted that “the buyer condition has been

stretched by broad interpretation to include almost any shareholder

affected by a corporate transaction.” Bromberg, Securities Law, Vol.

2. § 8.8. p. 222. We also note that our decision in Dasho v. Susque-

hanna Corp., 380 F. 2d 262, supra, is frequently cited for the

proposition that Birnbaum is the law of this circuit. In Dasho, how-

ever, Judge Fairchild merely explained why the Birnbaum formula-

tion would not defeat plaintiff's claim. since merging corporations are

both sellers and purchasers of securities. Jd. at 269-270. cited with

approval in Securities and Exchange Commission v. National Securi-

ties. Inc. 393 U. S. 453. 467-468.

31. This opinion has been circulated to all judges in regular

active service; no judge has requested that the case be reheard

en banc.

ee ee eee

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UNITED STATES COURT OF APPEALS

For the Seventh Circuit

Chicago, Illinois 60604

December 28, 1973

Before

Hon. Rocer J. KILey, Circuit Judge

Hon. JOHN PAUL STEVENS, Circuit Judge

Hon. CHARLES EDWARD WyZANSKI, JR., Senior District Judge*

WILLARD D. Eason, M. O. SATROM )

and JEAN M. SATROM,

Plaintiffs- Appellants,

Appeal from the United

No. 72-1722 Vs. _ States District Court

for the Southern

GENERAL Motors ACCEPTANCE Cor- District of Indiana.

PORATION and Dave WaAITE Pon-

TIAC, INC..,

Defendants-A ppellees. |

JUDGMENT.

This cause came on to be heard on the transcript of the

record from the United States District Court for the Southern

District of Indiana, and was argued by counsel.

On consideration whereof, it is ordered and adjudged by

this court that the judgment of the said District Court in this

cause appealed from be, and the same is hereby, REVERSED.

with costs, and the cause be and the same is hereby RE-

MANDED to the said District Court. in accordance with the

opinion of this Court filed this day.

* Senior District Judge Charles Edward Wyzanski, Ir.. of the Dis-

trict of Massachusetts, is sitting by designation.

Al5S

UNITED STATES CourT OF APPEALS

For the Seventh Circuit

Chicago, Illinois 60604

January 23, 1974

Before

Hon. RoGer J. KILEY, SR., Circuit Judge

Hon. JOHN Paut STEVENS, Circuit Judge

Hon. CHARLES E. WyZANSKI, SR., District Judge

WittaRD D. Eason, M. O. SATROM }

and JEAN M. SaTROM, Appeal trom the United

Plaintifjs-A ppellants, States District Court

for the Southern

\. District of Indiana.

Indianapolis _ Divi-

sion.

No. 72-1722 vs.

GENERAL Motors ACCEPTANCE Cor-

PORATION and Dave WalTtE Pon-

Trac. INc.. (IP 71 C 613)

Dejendants-A ppellees. |

On consideration of the petition for rehearing and sugges-

tion that it be reheard en banc filed in the above-entitled cause.

no Judge in active service having requested a vote thereon. nor

any Judge having voted to grant the suggestion, and all of the

members of the panel having voted to deny a rehearing.

IT IS ORDERED that the petition for a rehearing in the above-

entitled cause be and the same is hereby DENIED.

GER®. foe ste > ee ee ee ee) ee we ee

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APPENDIX II

UNITED StTaTEs District Court

Southern District of Indiana

Indianapolis Division

WILLARD E. Eason, M. O. SATROM >

and JEAN M. SATROM

vs. . No. IP 71-C-613

GENERAL MOTORS ACCEPTANCE |

Corp., DAVE WAITE PonrTIAC, INC.

Entry for June 20, 1972

HONORABLE CALE J. HOLDER, Judge

This cause came before the Court upon the defendant Gen-

eral Motors Acceptance Corporation’s motion to dismiss the

third amended complaint and each paragraph thereof and the

Court being duly advised in the premises now SUSTAINS the

motion to dismiss and the action is dismissed as to G. M. A. C.

The plaintiffs have no standing to maintain the action against

G. M. A. C. under Section 10(b) of Securities Exchange Act

of Rule 10(b)5 promulgated thereunder. (Brinbaum v. New-

port Steel Corporation, 2 Circuit, 193 F. 2d 461; and Jachi-

miec, etc. V. Schenley Industries, Inc., 7 Circuit (Feb. 26,

1965) Cause No. 15027.

(C. R. No. 1, p. 25-A.)

Reh ae SE

Al7

UNITED StTaTEs District COURT

Southern District of Indiana

Indianapolis Division

WILLARD D. EAson, et al.

VS.

No. IP 71-C-613

GENERAL MOTORS ACCEPTANCE

CORPORATION, and Dave WAITE |

PonTIACc, INC. |

Entry for June 20, 1972

HONORABLE CALE J. HOLDER, Judge

This cause came before the Court on the plaintiffs’ motion

for leave to file fourth amended complaint and for an extension

of time to file a notice of appeal. The Court. after considering

said motion and being duly advised in the premises, now

denies the same.

This cause also came before the Court on the plaintiffs’

motion for default. The Court. after considering said motion

and being duly advised in the premises. now denies the same.

This cause also came before the Court on the motion of

Defendant Waite to dismiss plaintiffs’ third amended complaint

as to Dave Waite Pontiac, Inc. The Court. after considering

said motion and being duly advised in the premises, now SUS-

TAINS the same, and the action is dismissed without prejudice

with costs assessed against plaintiffs.

This cause also came before the Court on the objections

of Defendant General Motors Acceptance Corporation to filing

of fourth amended complaint. The Court, after considering

said objections and being duly advised in the premises, now

sustains the same. and the action is dismissed without prejudice

with costs assessed against plaintiffs.

(C. R. No. 1, p. 29-A.)