Opposition Brief — Titan Group, Inc. v. Faggen

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JUL 18 1975

Ix THE MICHAEL RODAK, JR. GL

Supreme Court of the United States

OCTOBER TERM, 1975

No. 74-1630

TITAN GROUP, INC.,

Petitioner,

against

HAROLD FAGGEN,

Respondent.

BRIEF IN OPPOSITION TO PETITION FOR A WRIT OF

CERTIORARI TO THE UNITED STATES COURT OF

APPEALS FOR THE SECOND CIRCUIT

Burton S. Cooper

Attorney for Respondent

235 East 42nd Street

New York, New York 10017

(212) 687-8800

Of Counsel:

SHEIB, SHATZKIN & CoopeER

Epwarp LABATON

JorEL C. FEFFER

TABLE OF CONTENTS

Reasons for Denial of Certiorari .................. 3

Point I—This Court should not review a dismissal

of petitioner’s private damage claim of Rule

10b-5 fraud where the Courts below properly

examined the transaction in light of the surround-

Se CUNO aa ok ocak one feb ee ak assay S

Pornt I1—The acceleration of the debentures by vir-

tue of the default in the payment of interest was

RE erase ec reereseh obese trceconsi avert eed 10

LUMEN T .. eecewueweehs onrensrce nest eae cenes 10

TABLE OF Cases

Affiliated Ute Citizens vy. United States, 406 U.S. 128

CSE RE SRA c Raa a Chae ERS ne eRe Ee Are 6,7,8

Arber v. Essex Wire Corp., 490 F.2d 414 (6th Cir.),

cert. denied 419 U.S. 830 (1974) ...............

Chris Craft Industries, Inc. v. Piper Aircraft

Corp., 480 F.2d 341 (2d Cir.), cert. denied 414

ees OA AR os ws Veda Ode ha ee eee baes 8

City National Bank vy. Vanderboom, 422 F.2d 221

~“)

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

Clement A, Evans & Co. vy. McAlpine, 434 F.2d 100

(5th Cir. 1970), cert. denied, 402 U.S. 988 (1971) 7

Competitive Associates, Inc. v. Laventhol, Krekstein,

Horwath & Horwath, CCH Fed. See. L. Rep.

TOG000 (38 Caz: Bey G TPTO) eos cbc ask cscs 8,9

PW iat i ee

— 2 SPREE aN IY EA

Ate

ii TABLE OF CONTENTS

PAGE

Financial Indus. Fumd, Inc. vy. McDonnell Douglas

Corp., 474 F.2d 514 (10th Cir.), cert. deniel, 414

US. 874 (1978) ...22 2220 cecccccccecesccesenes 7

Kohler v. Kohler Co., 208 F.Supp. 808 (E.D. Wisc.

1962), aff’d, 319 F.2d 634 (7th Cir. 1963) ....... 7

Kohner v. Wechsler, CCH Fed. See. L. Rep. ¥ 93,537

(S.D.N.Y. June 10, 1972), aff'd as modified 477

er Oe ED bcd ustecsescsridesinnae 7

Landy v. Federal Deposit Insurance Corp., 48€ F.2d

139 (3d Cir. 1973), cert. denied, 416 U.S. 960

CN Fc elicited) Selec eS deee dee needed enese'e o

Lewis v. Dansker, 357 F.Supp. 636 (S.D.N.Y. 1973) ..

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

Gemsed, Bae UD. Gil (IDE). oon c ccc ccc asians 7

Metro-Goldwyn-Mayer v. Ross, 509 F.2d 980 (24 Cir.

Ea Sa tna aR Re er Or near 8,9

Ply-Gem Industries, Inc. v. Green, CCH Fed. See. L.

Rep. { 94,026 (S.D.N.Y. June 15, 1973), aff'd and

rem., 503 F.2d 1362 (2d Cir. 1974) ............ 7

Robinson yv. Cupples Container Co., 513 F.2d 1274

eT EE hs wb deh koe dink 66* e000) 200 7,8

Vohs v. Dickson, 495 F.2d 607 (5th Cir. 1974) ...... 7

Statute Crrep

Securities Exchange Act of 1934, Rule 10b-5. .2,3, 4, 6, 8, 10

SEP EEL PELLET IE I LIBRO ILE ELE LE LEE LES EERE RIE BS IROL LEILA GA

a PO SELES NOE ARO MDIR LEB L LLG GILL ELA ES. «IPM Rite ‘ “ 24 ik PAPODGE

IN THE

Supreme Court of the United States

OCTOBER TERM, 1975

No. 74-1630

TITAN GROUP, INC.,

Petitioner,

against

HAROLD FAGGEN,

Respondent.

+

BRIEF IN OPPOSITION TO PETITION FOR A WRIT OF

CERTIORARI TO THE UNITED STATES COURT OF

APPEALS FOR THE SECOND CIRCUIT

This action was commenced three and one-half years

after the execution of m-ticulously drafted contracts con-

taining Respondent’s detailed financial representations and

warranties, pursuant to which contracts Petitioner acquired

from Respondent four highly profitable actuarial consult-

ing companies (the “Faggen Companies”). In its proxy

statement filed with the Securities and Exchange Commis-

sion and disseminated to its shareholders six months after

the closing, Petitioner acknowledged that the transaction

was conducted at arm’s-length and that the financial and

other affairs of the Faggen Companies had been thoroughly

investigated (Def. Ex. D, R. 1542).* In exchange for the

* As used herein ‘‘R’’ refers to the appendix before the Court

of Appeals; ‘‘Pet.’’ refers to the Petition for a Writ of Certiorari;

and ‘‘Pet. A’’ refers to the appendices to such Petition.

=D THROUGH

POOR COPY

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SAUTE FERS RIT? 17)

2

Faggen Companies, Petitioner delivered to Respondent

convertible subordinated debentures in the principal amount

of $5,500,000 with interest at 4% per annum and with

amortization of principal to occur between the sixth and

tenth years.

Before having made any payment on account of principal,

and after the Petitioner had withdrawn more than $2,000,000

in cash and marketable securities from the Faggen Com-

panies, Petitioner defaulted in its interest payment and

simultaneously commenced this action to rescind the trans-

action, alleging that there were fraudulent misrepresenta-

tions and omissions in violation of Rule 10b-5 under the

Securities Exchange Act of 1934 (17 C.F.R. 240.10b-5).

These alleged misrepresentations and omissions did not

relate to the contract documents themselves but to a

memorandum delivered two months prior thereto. The

Respondent counterclaimed on the debentures which, by

their terms, were accelerated by virtue of the default.

The United States District Court for the Southern Dis-

trict of New York, Harold R. Tyler, J., in dismissing the

complaint after trial and awarding judgment to Respondent

on his counterclaim, held that Respondent had made no

misrepresentation and did not omit to state any material

fact. The Court of Appeals for the Second Circuit (Water-

man, Oakes and Gurfein, JJ.) unanimously affirmed. Re-

hearing and rehearing en bane were denied. Petitioner

now seeks review of these determinations claiming that the

factual findings were erroneous because the courts failed to

apply the proper standards of reliance and materiality to

the aforesaid memorandum. The facts relating to this case

are fully detailed in the opinions below.

Notwithstanding the Trial Court’s express factual find-

ings to the contrary and the affirmance by the Court of Ap-

pealg of those findings, Petitioner in disregard of those

findings continues to assert that Respondent omitted to dis-

close a loss of clients, by virtue of which Petitioner pur-

ee ee Oe ee ee ee ot am oe ore . PO MS LO A AO OLS AGG EE IGA LS ae oe

Se

3

chased a “shrinking business” (Pet. 4, 5),* and that Re- ;

spondent omitted to disclose the assumptions upon which }

the adjusted earnings were based (Pet. 5,7). As to both '

contentions which relate only to issues of fact and not to

questions of law, the Courts below found for Respondent

(Pet. A 5a-7a, lida, 19a, 20a, 31a-34a).

Reasons for Denial of Certiorari

AS DEEL aE ES PRR CURE A

1—This Court should not review factual] findings, af-

firmed by the Court of Appeals, that Respondent made no

false statement and did not omit to state any material fact

necessary to make the statements made not misleading.

2—This Court should not accede to Petitioner’s request

to rewrite Rule 10b-5(2) so as to bar the presently required

* Petitioner does more than disregard the findings. It actually

distorts the record. Thus, it states: ‘‘ Undisputed evidence showed

a $386,922 shrinkage (40%) of the $1 million gross actuarial busi-

ness of the Faggen Companies between 1966 and 1973’’ (Pet. 6).

The undisputed evidence is directly to the contrary. The President

of Petitioner’s actuarial division testified that in 1969 the company

acquired a single client whose volume exceeded $250,000 and that

the gross actuarial business of the Faggen Companies did not shrink

(R. 811, 819-20). This testimony was summarized in one question

and answer:

The Court: And if I also understand your testimony,

though it is true in this period of time, those years, you lost

about forty clients, it did not have any great impact upon the

gross or the volume, to use your word, partly because you picked

up one new client which practically absorbed or virtually came

close to absorbing the loss of billings or volume which went out

with the forty?

The Witness: Yes.

(R. 819-20)

Petitioner’s so-called ‘‘ undisputed evidence’’ consists of a list of

clients lost in the eight years from 1966 to 1973, inclusive, three

years before and five years after acquisition, but fails to include any

new clients gained in the same period. Yet the person who on Peti-

tioner’s behalf prepared that list, testified that ‘‘like any other busi-

ness, there were clients gained [and] clients lost’’ by the Faggen

Companies during ‘those years (R. 793).

TEL Ne cl RT bale! A MER IOR ICME AREARS 0 EO GK PD. he TT

4

inquiry into the particular circumstances of a transac-

tion in determining the materiality of the alleged omis-

sions, for to do so would reverse an unbroken line of cases

requiring a plaintiff to establish causation in fact as a

necessary element in a Rule 10b-5 claim.

3—This Court should not review a judgment for the

principal amount of debentures properly accelerated by

Petitioner’s default.

POINT I

This Court should not review a dismissal of peti-

tioner’s private damage claim of Rule 10b-5 fraud

where the Courts below properly examined the trans-

action in light of the surrounding circumstances.

The Trial Court found, and the Court of Appeals af-

firmed, that Petitioner failed to prove, as Rule 10b-5(2)

requires, that Respondent had made a misleading state-

ment or omitted “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.’’

As to each of Petitioner’s factual contentions in its

Petition, the trial Court found and the Court of Appeals

affirmed that there had been no shrinking business, that

the memorandum of adjusted earnings was reasonable and

that Petitioner was aware of the assumptions underlying

the adjustments (Pet. A 4a-6a).

Notwithstanding these express factual findings against

it, and the plain language of Rule 10b-5, Petitioner argues

that Judge Tyler should have ignored the circumstances of

the transaction® and instead should have found, and the

* Petitioner contends that the Court may not consider the ‘‘cir-

cumstances’’ of the transaction in determining the materiality of an

(footnote continued on following page)

PO tect

ASAE NON AR ME mB 1 a

5

Court of Appeals should have affirmed, that there was a

shrinking business, that the adjusted earnings were not

reasonable and that the basis for the adjustments was not

disclosed—that somehow the courts below would have made

such findings if, instead of judging the Petitioner in the

light of the circumstances surrounding this transaction,

they had substituted for the Petitioner a hypothetical

‘‘reasonable investor’’.

In egregious unconcern for the record, but as a make

weight for its argument that a different factual finding

would have resulted if the hypothetical ‘‘reasonable in-

vestor’’ had been substituted for Petitioner, Petitioner

now, for the first time, accuses Judge Tyler of making

his findings on the basis of his ‘‘prejudicial opinions of

small conglomerates, circa 1965, and their particular nego-

tiating agents’’ (Pet. 18). Petitioner makes not a single

record reference in support of this startling accusation. It

never made any such accusation before the Court of Ap-

peals and in making such accusation before this Court it

implies that the Court of Appeals was likewise so moved

since that Court found that there was abundant record

evidence to support Judge Tyler’s findings.

Notwithstanding the indefensible charge against the

courts below, the substitution of the ‘‘reasonable investor”

for the Petitioner would not have changed the facts that

there was no shrinking business, the adjusted earnings

were reasonable and Respondent disclosed the assump-

tions upon which the adjusted earnings were based.

Finally, it is frivolous for Petitioner to suggest that

the substitution of a “reasonable investor” for the actual

(footnote continued from preceding page)

omission; that the Court of Appeals supplanted ‘‘objective mate-

riality’’ with ‘‘cireumstances’’ (Pet. 18) that it was improper for

the trial court to attempt to reconstruct the ‘‘cireumstances’’ of

the omission (Pet. 19); and that the Court of Appeuls substituted

the ‘‘uncertain doctrine of ‘circumstances’ ’’ for an ‘‘objective rule

of law’’. (Pet. 5)

6

investor would eliminate the potential for a trial Court’s

prejudice. Disregarding for the moment the plain lan-

guage of Rule 10b-5, the substitution by the Court of its

own “reasonable investor’’ judgment in all cases, regardless

of the circumstances, would open wide the doors to the very

potential which Petitioner ostensibly seeks to avoid. Kule

10b-5 requires a factual determination in light of the cir-

cumstances surrounding the transaction and that means

making a determination based upon the parties to the

transaction as well as the transaction itself. Affiliated Ute

Citizens v. United States, 406 U.S. 128 (1972), did not re-

write Rule 10b-5 to eliminate the requirement of an exami-

nation into such circumstances, it simply permitted resort

to a fictional “reasonable investor” where proof of reliance

with respect to a particular investor was difficult. To sug-

gest that what Affiliated Ute intended was to substitute the

“reasonable investor’’ in all cases regardless of the circum-

stances is to suggest that the “circumstances” language of

Rule 10b-5 is meaningless.

Implicit in Petitioner’s contention that the Court below

erred in considering the materiality of the alleged omis-

sions applicable to the Petitioner, rather than to some

hypothetical “reasonable investor”, is the suggestion that,

in determining who that “reasonable investor” was, the

Courts should have ignored the sophistication or knowl-

edge of the parties.

The materiality requirement of a Rule 10b-5 fraud case

requires the court to examine the circumstances and to

reject the notion that the transaction, or the parties, be

examined in a vacuum. Consequently, where the parties

are sophisticated, have business experience and expertise,

are acquainted with the affairs of the corporation whose

securities they purchase, and have access to the informa-

tion alleged to be misrepresented, the Courts have con-

sistently inquired into the materiality to the particular

investor of the alleged misrepresentations and omissions,

—s-

7

and have generally denied relief in the absence of strong

affirmative proof by the plaintiff that the particular mis-

statement or omission complained of was material to such

plaintiff. Such cases include: List v. Fashion Park, Inc.,

340 F.2d 457 (2d Cir.) cert. denied, 382 U.S. 811 (165);

Kohner v. Wechsler, CCH Fed. See. L. Rep. {93,537

(S.D.N.Y. June 10, 1972), aff’d as modified, 477 F.2d 666

(2d Cir. 1973); Ply-Gem Indus., Inc. v. Green, CCH

Fed. See. L. Rep. § 94,026 (S.D.N.Y. June 15, 1973), aff'd

and rem., 503 F.2d 1362 (2d Cir. 1974); Kohler v. Kohler

Co., 208 F.Supp. 808 (E.D. Wise. 1962), aff’d, 319 F.2d

634 (7th Cir. 1963); City National Bank v. Vanderboom,

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

(1970); Clement A. Evans & Co. v. McAlpine, 434 F.2d

100 (5th Cir. 1970), cert. denied, 402 U.S. 988 (1971);

Robinson v. Cupples Container Co., 513 F.2d 1274 (9th

Cir. 1975); Financial Indus. Fund, Inc. vy. McDonnell

Douglas Corp., 474 F.2d 514 (10th Cir.), cert. denied,

414 U.S. 874 (1973); Landy v. Federal Deposit Insurance

Corp., 486 F.2d 139 (3d Cir. 1973), cert. denied, 416 U.S.

960 (1974); and Arber v. Essex Wire Corp., 490 F.2d 414

(6th Cir.), cert. denied, 419 U.S. 830 (1974); Vohs v. Dick-

son, 495 F.2d 607 (5th Cir. 1974).

What is material to an unsophisticated investor (as in

Affiliated Ute) may not be to a conglomerate corporation.

See Arber v. Essex Wire Corporation, supra, and Robinson

v. Cupples Container Co., supra. In contradiction of the

authorities cited in the paragraph above, Petitioner argues

that materiality cannot vary with the circumstances of the

particular transaction or the parties thereto—that a state-

ment or omission from a document is or is not material,

regardless of the sophistication of the parties or the

events which preceded the delivery of the document in

question or the conversations that related thereto or the

investigation that followed the document or the contractual

mneed

NR NE NEN EN RR ee A FN, SBE AAPA SERRE AN ET

representations that ultimately were made. Materiality,

Petitioner claims, is a matter of law (Pet. 5).

While materiality may be a rule of law, what is material

is a question of fact (see, e.g., Robinson vy, Cupples, Con-

tainer Co., supra; Lewis v. Dansker, 357 F.Supp. 636, 642

(S.D.N.Y. 1973). Omissions are never material as a matter

of law until their materiality has been factually determined.

As the Court below observed (Pet. A 7a-8a), causation

in fact is a fundamental element in a Rule 10b-5 private

action. Causation is established by materiality and, in

appropriate cases, reliance.

Contrary to Petitioner’s contention (Pet. 10), there is

nothing novel in Judge Waterman’s statement (Pet. A 7a)

that Affiliated Ute did not abolish reliance as a prerequisite

to recovery and that only where proof of reliance was dif-

ficult as a practical matter did Affiliated Ute authorize

proof of materiality in lieu thereof. See Chris Craft In-

dustries, Inc. v. Piper Aircraft Corp., 480 F.2d 341, 374

(2d Cir. 1973), cert. denied, 414 U.S. 910 (1973).

The Court of Appeals rejected Petitioner's contention

that Affiliated Ute eliminated reliance as an element in all

Rule 10b-5 actions involving omissions of material fact

(Pet. A 7a). Having lost that argument, Petitioner now

asserts, contrary to Rule 10b-5 and the aforementioned au-

thorities, that, because it should have been judged as a

“reasonable investor”, instead of what it was, it was not

even required to prove materiality in the circumstances of

its case (Pet. 5, 18, 20, 21).

Petitioner asserts that Judge Waterman’s opinion is

inconsistent with two recent opinions in the Second Cir-

cuit—Competitive Associates, Inc. v. Laventhol, Krekstein,

Horwath &€ Horwath, CCH Fed. Sec. L. Rep. 7 95,090 (2d

Cir. May 8, 1975) and Metro-Goldwyn-Mayer v. Ross, 509

F.2d 930 (2d Cir. 1975). These opinions were brought to

+ Leet ihe ERED R A, FEMI: lente)

me o ge a Ne Serta a)

ee ee ee eee ne On none Pee eee ees tt |

the attention of the panel which decided this case, both

before the opinion was rendered and thereafter in the peti-

tion for rehearing or rehearing en banc.

The Competitive Associates and Metro-Goldwyn-Mayer

opinions are clearly consistent with, and indeed support,

the Court’s decision in this case. Competitive Associates

reversed a decision granting summary judgment because

the District Court “(was premature in denying [plaintiff] ‘

an opportunity to prove its claims” (CCH p. 97,866) and re-

manded the case for trial, holding that the plaintiff was

required to prove causation in fact and to “allege that it

would not have acted as it did had it known of the informa-

tion withheld by defendants’? (CCH p. 97,865). The

Court did not hold that plaintiff would recover even if it ;

failed to prove the allegation—if it could not establish

causation in fact. Yet, that is what Petitioner seeks here,

for in this case Petitioner failed to prove the allegations in

its complaint.

Contrary to Petitioner's assertion, Metro-Goldwyn-

Mayer v. Ross, supra, was not a legally identical situation

to the case at bar; there the District Court found an omitted

fact to be material (509 F.2d at 933), but nevertheless re-

jected plaintiff’s claim for rescission. In the instant case,

the District Court found no material omission. In Metro-

Goldwyn-Mayer, the Court of Appeals reversed on the

strength of the materiality of the omission combined with

a breach of a contractual representation in the exchange

agreement. Here, the Court of Appeals affirmed—be- “+

cause there was neither a material omission nor breach ‘

of any contractual representation.

Finally, Petitioner’s argument that the Court of Appeals

excluded ‘‘all disclosure accounting prinziples from this

case” (Pet. 19) is a distortion of the Court’s opinion.

The Court held that the summary of adjusted earnings

was neither false nor misleading. The Court found that i

the summary was not a financial report to which ac-

BESTS

PR BT LI EOL EE IT APO

PAYER ION ORSON RII HEN RAIN : eSNG SHER

PTE Brn, A Rae ae RY QP ROEA. “4 RR EEN Ee RO ee Ron ae oy Sy OR

Re CH DINO FTE ee

10

counting principles and rules apply, but an accurate por-

trayal of exactly what it purported to be—“an approxima-

tion of what the Faggen Companies would earn through the

elimination of certain expenses if the companies were

publicly, rather than privately, owned’’ (Pet. A 6a). No-

where does Petitioner mention, as the courts below obser-

ved, that there was neither a claim nor proof that there

was any false or misleading statement in the historical

financials incorporated into the definitive contracts which

were represented by Respondent to be accurate and that

on the trial each of the Petitioner’s financial experts, as

well as the lawyer who negotiated the deal on Petitioner’s

behalf, conceded that these financials were accurate in all

respects (R. 254, 564, 654, 705).

POINT Il

The acceleration of the debentures by virtue of the

default in the payment of interest was proper.

In rejecting Petitioner’s claim, Judge Tvler in a separ-

ate opinion (Pet. A 36a, et seq.) affirmed by the Court

of Appeals (Pet. A 9a-10a) found that there was neither

hidden interest nor a penalty in the debentures and that

the debentures were therefore enforceable in accordance

with their terms. There is no compelling reason to review

that essentially factual determination.

Conclusion

The District Court found and the Court of Appeals

affirmed that the Respondent was not guilty of any fraudu-

lent misrepresentation or omission in connection with the

transaction. The Petitioner would rewrite Rule 10h-5 and

would reverse a host of authorities which require that a

transaction be judged in light of all surrounding circum-

a Le

By

ll

stances. Petitioner would eliminate causation in fact as a

prerequisite to recovery. The courts below properly ap-

plied the requirements of Rule 10b-5 in making their fac-

tual determinations. There is no conflict among the Cir-

cuits on the issues raised. There is no reason for this Court

to grant this Petition. The writ should be denied.

Respectfully Submitted,

Burton 8. Cooper

Attorney for Respondent

Of Counsel:

Sueis, SHatzkin & Coorer

Epwarp LABATON

JoreL C, Ferrer

a ee Ciel as

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