Amicus Curiae Brief — Blue Chip Stamps v. Manor Drug Stores

Supreme Court brief1975

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INDEX

Question presented

Interest of the Securities and Exchange Com-

NI pci anraeer tiesto ariecnenageencisbnieaeionetaeeteetannnee

Statement _.._... Se ina tat ici ese ececaslonieneraatsnapecatnees

Sumrhary*of argument

Arguments

The victim of deceptive activities in con-

nection with the purchase or sale of se-

curities should be able to recover his de-

monstrable damages whether or not he

has purchased or sold.securities _..... __.

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

“any person” against deceptive de-

vices material to an investment deci-

sion __

B. There is an implied civil remedy on

hehalf of all persons injured by vio-

lations of Rule 10b-5, including those

who have neither purchased nor sold

securities

C. This Court should not adopt the

Birnbaum rule as a method to limit

the class of potential plaintiffs ___

ACER AAR DLL RAPT SA. CET

Page

CITATIONS

Cases: Page |

A. T. Brod & Co. v. Perlow, 375 F.2d

6 occ. 10, 15, 32

Affiliated U te Citizens \ v. . United States,

406 U. S. 128 7, 10, 18, 25, 26

Association of Data Processing Organi-

zations, Inc. v. Camp, 397 U.S. 150... 19

Berko v. Securities and Exchange Com-

mission, 316 F.2d 137 .- ae 16

Birnbaum v. Newport Steel Corp., 193

‘F.2d 461, certiorari denied, 343 U.S.

956 - _4, 5, 6, 7, 8, 11

Britt v. Cyril Bath Co., 417 F. 2d 433 __ 21

City National Bank v. Vanderboom, 422

F.2d 221, certiorari denied, 399 U.S.

WO 9

Commerce Reporting Co. v. Puretec, Inc.,

ce. . es | pea ionennocene 10

Conley v. Gibson, 355 U.S. 41 2

Crane Co. v. Westinghouse Air Brake Co.,

419 F.2d 787, certiorari denied, 400

he, eee 32

Drachman v. Harvey, 453 F.2d 722, re-

versed on rehéaring en bane, 453 F.2d

736 . Z _ 31-32

Eason v. General “Motors ~ Acceptance

Corp., 490 F.2d 654, certiorari denied,

416 US. 960 _........ ; 9, 20, 24, 30

Ellis v. Carter, 291 F. 2d 270, “dismissal

affirmed, 328 F.2d 573 . 10

Fischman v. Raytheon M fg. Co., 188 F. 2d

783 . sca: _ 18, 20

Flast v. Cohen, 392 U. S. 83 | ER ane 19

Ill

Cases—Continued Page

Fratt v. Robinson, 203 F.2d 627 __...... 18, 20

Goodman v. H. Hentz & Co., 265 F. Supp.

ice ee 10

Greater Iowa Corp. v. McLendon, 378 F.

2d 783 nnn 12

Greenstein v. Paul, 400 F.2d 580 31

Hanly v. Securities and Exchange Com-

mission, 415 F.2d 589 ae

Hardin v. Kentucky Utilities Co., 390

5 ee Ene ee ee 19

Hooper v. Mountain States Securities

Corp., 282 F.2d 195, certiorari denied,

Be psec ey tees 9, 18, 20

Hughes v. Securities and Exchange Com-

mission, 174 F.2d 969 __.____....__.__. 16

International Controls Corp. v. Vesco,

490 F.2d 1334, certiorari denied, 417

U.S. 932 - iniacenesaen ae eee

Iroquois Industries, Ine. v. Syracuse

China Corp., 417 F.2d 963 _.---- 9, 31

J. I. Case Co. v. Borak, 377 U.S. 426.2, 6, 7, 18,

21, 22, 23, 31

James v. Gerber Products Co., 483 F.2d

944. 9, 32

Kahan * v. Rosenstiel, 424 F. 2d 161, ‘certio-

rari denied sub nom. Glen Alden Corp.

v. Kahan, 398 U.S. 950 21

Kardon v. National Gypsum Co., 69 F.

PUG Teta 19

Kerbs v. Fall River Industries, Inc., 502

F.2d 731 - 9

Kuehnert v. Texstar Corp., 412 F. 2d 700. 16

Lanasa Fruit S.S. & I. Co. v. Universal

Insurance Co., 302 U.S. 556 12

Cases—Continued Page

Landy v. Federal Deposit Insurance

Corp., 486 F.2d 189, certiorari denied,

OO TE Binns et 9

M. L. Lee & Co. v. American Cardboard ~

& Packaging Corp., 36 F.R.D. 27 10

McClure v. Borne Chemical Co., 292 F.2d

824; certiorari denied, 368 U. S. 939... 11

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

= | Se ae Cae nee Ente 2, 6, 22

Mount Clemens Industries, Inc. v. Bell,

464 F.2d 339 — 5

Mutual Shares Corp. v. “Genesco, ‘Inc., 384

F.2d 540 _. . 21, 32

N. Sims Organ & Co., Ine. Vv. - Securities

and Exchange Commission, 293 F.2d

; eee 16

Opper v. Hancock Securities Corp., 367

F.2d 157, affirming, 250 F. Supp. 668. 10

Petroleum Exploration, Inc. v. Public

Service Commission, 304 U.S. 209 __. 24

Rekant v. Desser, 425 F.2d 872 _......_. 10-11

Ruckle v. Roto American Corp., 339 F.2d

so =: 32

Sargent v. _ Genesco, Ine., 492 F. 2d "150__ 9

Securities and Exchange Commission v.

Capital Gains Research Bureau, _

Ge Ue 6 . 13,18

Securities and Exchange Commission — v.

National Securities, Inc., 393 U.S. 453 - 23

Securities and Exchange ‘Commission v.

Texas Gulf Sulphur Co., 401 F.2d 833,

certiorari denied sub nom. Coates v.

Securities and Exchange Commission,

394 U.S. 976 . 11, 17, 28

Cases- -Continued Page

Sciwenbaum v. Firstbrook, 268 F. Supp.

385, affirmed, 405 F.2d 200, reversed

in part on other grounds, 405 F.2d 215,

certiorari denied sub nom. Mafiley v.

Schoenbaum, 395 U.S. 906... 12

Shapiro v. Merrill Lynch, Pierce, Fenner

& Smith, Inc., 495 F.2d 228 28

Sierra Club v. Morton, 405 U.S. 727 __----. 19

Simmons v. Wolfson, 428 F.2d 455, certio-

rari denied, 400 U.S. 999 . -.. ---. 9,12

Slavin v. Germantown Fire Ins. Co., 174

F.2d 799 —~ es aed eee 18

Smallwood v. Pearl Brewing Corp., 489

Stockwell v. Reynolds & Co., 252 F. Supp.

215 _........- 10

Superintendent of Insurance v. Bankers

Life & Casualty Co., 430 F.2d 355, re-

versed, 404 U.S. 6... ------ 6-7, 8, 10, 13, 15,

18, 19, 21, 31

Tcherepnin v. Knight, 389 U.S. 332 18, 24

Travis v. Anthes Imperial Ltd., 473 F.2d

OI aoc ectintesce intense eee 32

Tully v. Mott Supermarkets, Inc., 337

F. Supp. 834 _...____-__----_---_+-—--- 9

United States v. Blue Chip Stamp Co.,

272 F. Supp. 432 _.. 3

United States v. Students Challenging

Regulatory Agency Procedures, 412

Vine v. Beneficial Finance Co., 374 F.2d

627, certiorari denied, 389 U.S. 970... 21, 32

Wyandotte Transportation Co. v. United

States, 889 U.S. 191 -........-.-.---------— 6, 19, 21

Cases—Continued

Young v. Seaboard * Comp, . 360 F. ~ Supp.

490 eee: 9

Statutes and rules:

Securities Act of 1938, 48 Stat. 74, as

amended, 15 U.S.C. 77a, et seq.:

Section 17(a), 15 U.S.C. 77q(a) . 12, 29

Securities Exchange Act, 48 Stat. 881, as

amended, 15 U.S.C. 78a, et seq.:

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

Page

Section 14(a), 15 U.S.C. 78n(a) __ 22

Section 27, 15 U.S.C. 78aa 19

Rules under Securities Exchange Act of

1934:

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

Rule 10b-5(c), 17 C.F.R. 240.10b-5

Rule 14a-9(a), 17 CFR. 240. 14a-9

() a eRe ne ee 22

Miscellaneous:

2 Bromberg, Securities Law: Fraud—

SEC Rule 10b-5, Sec. 7.6(1), p. 190.21 _

(1973) 11

Comment, Inroads o on 1 the Necessity for a a

Consummated Purchase or Sale under

Rule 10b-5, 1969 Duke LJ. 349

TOGO) ce 23

Comment, The Decline of the Purchaser-

Seller Requirement of Rule 10b-5, 14

Vill. L. Rev. 499 (1969) 23

VII

Miscellaneous—Continued

Comment, The Purchaser-Seller Rule: An

Archaic Tool for Determining Stand-

ing under Rule 10b-5, 56 Geo. L.J. 1177 .

|.) ) Renna een eee er)

78 Cong. Rec. 7696 eee 14

H. Rep. No. 1383, 73d Cong., 2d Sess. _.. 11, 13

H. Conf. Rep. No. 1838, 73d Cong., 2d

Sess. . 14,15

Hearings before the House. Committee o on

Interstate and Foreign Commerce on

H.R. 7852 and 8720, 73d Cong., 2d

Sess: _ 14,15

Hearings before ‘the Senate Committee o on

Banking and Currency on S. Res. 84

(72d Cong.) and S. Res. 56 and 97

(73d Cong.), Part 15, 73d Cong. 1st

Sess. 15

Investors Management Co., -Ine., -Securi-

ties Exchange Act Release No. 9267

(July 29,1971) 17

Jacobs, Birnbaum in Flux: Signi ficant

106-5 Developments, 2 Sec. Reg. L.J.

305 (1975) 23

Leech, Transactions in Corporate Control,

104 U. Pa. L. Rev. 725 (1956) . 23

Lowenfels, The Demise of the Birnbaum

Doctrine: A New Era for Rule 10b-5,

54 Va. L. Rev. 268 (1968) . “ 23

Merrill Lynch, Pierce, Fenner & Smith, .

Inc., Securities Exchange Act Release

No. 8459 (November 25, 1968) _. 17

Note, Civil Liability Under Rule X-10b-5, |

42 Va. L. Rev. 587 (1956) . 24

VIII

Miscellaneous—Continued

Note, Fiduciary Suits Under Rule 10b-5,

1968 Duke L.J. 791 0

Note, Limiting the Plaintiff Class: Rule

10b-5 and the Federal Securities Code,

72 Mich. L. Rev. 1898 (1974)

Note, Rule 10b-5: Elements of a Private

Right of Action, 43 N.Y.U. L. Rev.

541 (1968)

Note, Standing to Sue in 10b-5 ‘Action:

Eason v. GMAC and Its Impact on the

Birnbaum Doctrine, 49 Notre Dame

Lawyer 1131 (1974) -

Note, The Purchaser-Seller Limitation t to

SEC Rule 10b-5, 53 Cornell L. Rev. 684

Gs _: eA Rear ey ne econ

2 Restatement of Torts, Sec. 286

Ruder, Current Developments in the Fed-

eral Law of Corporate Fiduciary Rela-

tions—Standing to Sue Under Rule

10b-5, 26 Bus. Law 1289 (1971) -

S. 3420, 73d Cong., 2d Sess.

S. Rep. No. 1455, 73d Cong., 2d ‘Sess. -

27 Vand. L. Rev. 572 (1974) -

Page

. 23-24

18, 14

In the Supreme Court of the United States

OCTOBER TERM, 1974

No. 74-124

BLUE CHIP STAMPS, ET AL., PETITIONERS

Vv.

MANOR DRUG STORES, ETC.

ON WRIT OF CERTIORARI TO THE UNITED STATES

COURT OF APPEALS FOR THE NINTH CIRCUIT

BRIEF FOR THE SECURITIES AND EXCHANGE

COMMISSION AS AMICUS CURIAE

QUESTION PRESENTED

The Commission will discuss the first question pre-

sented: Whether a party who neither purchased nor

sold securities has standing to seek damages for in-

juries caused it by a violation of the antifraud provi-

sions of Section 10(b) of the Securities Exchange Act

of 1934 and Rule 10b-5 thereunder.

(1)

INTEREST OF THE SECURITIES AND

EXCHANGE COMMISSION

The Commission is primarily responsible for the ad-

ministration and enforcement of the federal securities

laws, including the Securities Exchange Act of 1934.

Private actions by the victims of securities frauds,

however, are a “necessary supplement” to the Com-

mission’s enforcement activities. Mills v. Electric

Auto-Lite Co., 396 U.S. 375, 382; J. I. Case Co. v.

Borak, 377 U.S. 426, 482. The Commission opposes

restrictive constructions of the securities laws and of

the Commission’s rules that would weaken the protec-

tions they afford investors. Accordingly, the Commis-

sion as amicus curiae in private actions has argued

consistently that the right to recover damages for vio-

lations of the broad antifraud provisions of Rule 10b-

5, authorized by Section 10(b) of the Securities Ex-

change Act, should not be limited to actual purchasers

and sellers of securities but should extend to all in-

vestors and potential investors injured by violations

of the Rule.

STATEMENT

In December 1963 the United States filed a civil

antitrust action against Blue Chip Stamp Co. and nine

of its twelve stockholders.’ The complaint charged

that the defendants had conspired to restrain and had

1 This statement of facts is taken from the opinion of the

court of appeals and from the complaint filed by Manor Drug

Stores. Because the district court granted petitioners’ mo-

tion to dismiss the complaint, its factual allegations must be

accepted as correct. Conley v. Gibson, 355 U.S. 41.

monopolized the trading stamp business in California.

In addition to Blue Chip Stamp Co., the defendants —

were major California retailers who used Blue Chip

stamps and who collectively owned 90 percent of Blue

Chip Stamp Co. stock. The suit was settled in 1967

by a consent judgment. See United States v. Blue

Chip Stamp Co., 272 F. Supp. 432 (C.D. Calif.).

The judgment provided. that Blue Chip Stamp Co.

would be merged. into a new corporation, Blue Chip

Stamps. Securities of the new corporation were to be

offered, at “bargain” prices, to retail firms—including

Manor Drug Stores, the plaintiff in this action—that

had used Blue Chip stamps but had not owned stock

in Blue Chip Stamp Co. Each of these retail firms

was entitled to purchase securities in proportion to the

amount of stamps it had used. The complaint of re-

spondent Manor Drug Stores alleges that the securi-

ties were offered at a bargain in order to allow the

users to share in the undistributed profits of Blue

Chip Stamp Co. (App. 10-11).

The complaint charges that the defendants ree

petitioners) devised a scheme to dissuade the offerees,

by means of misleading statements, from purchasing

the securities. The apparent motivation for the

scheme was that any securities not purchased in the

“bargain” offer could be sold later on the open mar-

ket by petitioners at a greater price, thereby increas-

ing the assets of Blue Chip Stamps and the value of

each share owned by the other petitioners. Alterna-

tively, the shares not sold in the offering could be

retained by Blue Chip _— and the shareholders of

Blue. Chip Stamps could “retain” the undistributed

yoenes that would have been distributed by the “bar-

gain” sale.’

In order to YEE the offerees from purchasing

the securities, petitioners unduly emphasized in the

prospectus (App. 55-90) certain “Items of Special

Interest” that might adversely affect the value of the

securities; the prospectus also contained inflated es-

timates of anticipated expenses. Because of these

misleading representations certain offerees did not

purchase the securities and, therefore, did not re-

ceive the intended “bargain.” *

The district court dismissed the complaint on ‘the

basis of the “Birnbaum rule,” attributed to Brin-

baum v. Newport Steel Corp., 193 F.2d 461 (C.A. 2),

certiorari denied, 343 U.S. 956, which states that a

person who is neither a purchaser nor a seller of

securities may not bring an action under Section 10

(b) of the Securities Exchange Act of 1934 or Rule

10b-5 thereunder. _

? As petitioners noted (Br. 7, n. 6), the plan of reorgani-

zation did not call specifically for public sale of the unsold

shares. The plan, however, forbade petitioners from owning

more than 43 percent of Blue Chip Stamps and, if some of the

users decided not to purchase the shares offered, petitioners

would have to sell either the unpurchased shares or their own

shares in order to reduce their holdings to this proportion. In

' either event the asset value per share would be’ greater for

petitioners if the users failed to purchase their allotments.

+ Although the offering price of the new securities was $101,

the market value was _— to be $315 at that time (App.

11).

Respondents appealed, but before the appeal was

decided another panel of the Ninth Circuit, in Mount

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

adopted the Birnbaum rule. A divided panel in the

instant case accepted Birnbaum and Mount Clemens

as controlling, but reversed on the ground that those

cases did ndt involve a situation where the plaintiffs

had a right to buy securities “at a fixed price and in

-_ a fixed amount” (App. 141). The court held that the |

offering of securities in this case, in compliance with

the antitrust decreé, “served the same function as”

a contract for the’ purchase or sale of securities and ©

therefore supported a damages remedy for the non-

buying plaintiff class (App. 141, 155).

SUMMARY OF ARGUMENT

‘Section 10(b) of the Securities Exchange Act of |

1934, and Rule 10b-5, promulgated by the Securities

and Exchange Commission pursuant to Section 10

(b), provide that it is unlawful to use deceptive de-

vices or make misleading statements “in connection

with the purchase or sale of any security.” In Birn-

baum v. Newport Steel Corp., 193 F.2d 461 (C.A.

2), certiorari denied, 343 U.S. 956, the Second Cir-

cuit held that under the Act and Rule only individuals

who had purchased or sold securities could bring

actions to seek redress for a violation.

The proscriptions under Section 10(b) and Rule

10b-5 “are broad and, *- * * are obviously meant to

be inclusive.” Affiliated Ute Citizens v. United States,

406 U.S. 128, 151. Accordingly, a violation of Sec-

tion 10(b) and Rule 10b-5 repeatedly has been held

not to depend upon proof of an actual purchase or

sale of a security, and includes deceptive activity

that affects an investment decision not to buy or sell

a security no less than a decision to do the contrary.

Even the dissenting opinion in the court below does

not question that a violation of Rule 10b-5 has been

alleged in this case. |

The Birnbaum rule has nevertheless survived as an

essentially arbitrary principle of “standing”—that

a victim of a violation may bring an action for dam-

ages only if he is the purchaser or seller of securities

—although the courts applying the rule disagree as

to its precise scope and as to exceptions that may be

available. The Birnbaum limitation is inconsistent

with this Court’s repeated recognition that persons

within the class a statute is designed to protect, and

who have been injured by a violation of that statute,

have standing to seek relief for injuries they have

suffered. See, e.g., Wyandotte Transportation Co. v.

United States, 389 U.S. 191. This principle has been

applied generally under the Securities Exchange Act,

see’ J. I. Case Co. v. Borak, 377 U.S. 426, and Mills v.

Electric Auto-Lite Co., 396 U.S. 375, and specifically

under Rule 10b-5, Superintendent of Insurance v.

Bankers Life & Casualty Co., 404 U.S. 6, and Affi-

liated Ute Citizens v. United States, 406 U.S. 128.

Consistent with this principle, courts of appeals

that have applied the Birnbaum doctrine to damage

actions have nevertheless permitted private suits for

equitable relief with respect to violations of Rule 10b-

5. But as this Court recognized in Borak, supra, and

Mills, supra, with respect to similar antifraud- rules

relating to proxy solicitation, the remedial objectives

of the Securities Exchange Act require that a pri-

vate action for damages also be recognized.

To the extent the Birnbaum rule serves any pur-

pose, it acts as a device to limit the class of po-

tential plaintiffs, and thus, as petitioners point out,

may ameliorate the possibility of strike suits and

“calamitous” damage judgments. But the arbitrary

denial of standing to individuals who are not pur-

chasers or sellers of securities but have suffered

demonstrable loss because of a violation of the Act

is contrary to the purposes of the securities laws and

unjustified. The/public policy of preventing unwar-

ranted damage-awards could be achieved through

requirements (in appropriate cases) of stricter stand-

ards of proof or the limitation of vicarious liability.

ARGUMENT

THE VICTIM OF DECEPTIVE ACTIVITIES IN CON-

NECTION WITH THE PURCHASE OR SALE OF

SECURITIES SHOULD BE ABLE TO RECOVER HIS

DEMONSTRABLE DAMAGES WHETHER OR NOT

HE HAS PURCHASED OR SOLD SECURITIES

In Birnbaum v. Newport Steel Corp., 193 F.2d 461

’ (C.A. 2), certiorari denied, 343 U.S. 956, the Second

Circuit discussed the understanding it then had of

the purpose of Section 10(b) and Rule 10b-5. It

stated that the Rule is directed “only at ‘a fraud

perpetrated upon the purchaser or seller’ of securi-

ties,” id. at 463, and that, accordingly, the Rule

“extended protection only to the defrauded purchaser

or seller.” * Jd. at 464. This narrow reading of Rule

* The plaintiff in Birnbaum was a shareholder in a corpora-

tion contemplating an advantageous merger with another

firm. The controlling shareholder in the corporation in which

plaintiff held securities elected to sell his shares, at a sub-

stantial control premium, to a third corporation. As a result

of this sale of control the possibilities for merger were fore-

gone, and plaintiff did not reap the advantages that merger

would have brought him. He sued the controlling share-

holder and the acquéring corporation; the court of appeals

affirmed a dismissal of the action, stating that the Rule was

not intended to protect the stockholders of a corporation

against a breach of fiduciary duties by corporate insiders.

Id. at 464. If no more were involved in Birnbaum, the case

would not be troublesome. This Court has subsequently

agreed that the statute does not regulate transactions that

constitute no more than internal corporate mismanagement.

Superintendent of Insurance V. Bankers Life & Casualty Co.,

~ 404 U.S. 6, 12.

10b-5—principally based on the court’s narrow read-

ing of Section 10(b)—has not been followed.

The “Birnbaum rule” has become a principle of

“standing,” rather than an interpretation directed to

any limitation on the scope of the Act’s and Rule’s

prohibitions—that is, despite allegations of a clear

violation of Section 10(b) and Rule 10b-5 that have

resulted in injury, if the injured person did not

purchase or sell the securities he may not bring an

action to recover his damages.°

* Most courts of appeals have accepted the Birnbaum rule,

although the courts disagree about the scope of the doctrine

and the exceptions available to avoid its application. See,

e.g., Iroquois Industries, Inc. v. Suracuse China Corp., 417 F.2d

963 (C.A. 2), certiorari denied, 395 U.S. 909; Lundy v. Fed-

eral Deposit Insurance Corp., 486 F.2d 139 (C.A. 3), cer-

tiorari denied, 416 U.S. 960; Sargent v. Genesco, Inc., 492 F.2d

750 (C.A. 5); Smallwood v. Pearl Brewing Corp., 489 F.2d

579 (C.A. 5); City National Bank v. Vanderboom, 422 F.2d

221 (C.A. 8), certiorari denied, 399 U.S. 905; Simmons v.

Wolfson, 428 F.2d 455 (C.A. 6), certiorari denied, 400 U.S.

999;cf. Kerbs v. Fall River Industries, Inc., 502 F.2d 731, 738-

740 (C.A. 10) ; International Controls Corp. v. Vesco, 490 F.2d

1334 (C.A. 2), certiorari denied, 417 U.S. 932; Hooper v.

Mountain States Securities Corp., 282 F.2d 195 (C.A. 5),

certiorari denied, 365 U.S. 814; James Vv. Gerber Products Co.,

483 F.2d 944 (C.A. 6).

The Seventh Circuit has rejected Birnbaum. See Eason V.

General Motors Acceptance Corp., 490 F.2d 654, certiorari

denied, 416 U.S. 960. Several district courts recently have

disavowed the Birnbaum rule as inconsistent with the pre-

vailing interpretation of Rule 10b-5. See Young v. Seaboard

Corp., 360 F. Supp. 490 (D. Utah); Tully v. Mott Super-

markets, Inc., 337 F. Supp. 884 (D.N.J.). (Landy v. Federal

Deposit Insurance Corp., supra, 486 F.2d at 156, n. 10, ap-

parently limits Tully to requests for injunctive relief.) And

several district courts have held that there may be a private

A. Section 10(b) and Rule 10b-5 Protect “Any Person”

Against Deceptive Devices Material To An Investment

Decision

Section 10(b) of the Securities Exchange Act of

1934, 15 U.S.C. 78j(b), provides that it is unlawful

for any person to use, “in connection with the pur-

chase or sale of any security * * * any manipulative n

or deceptive device or contrivance” in contravention of

the Commission’s rules. In Affiliated Ute Citizens v. \

United States, 406 U.S. 128, 151, this Court stated

that Rule 10b-5(c) prohibits “any act, practice or

dourse of business which operates or would operate

as a fraud or deceit upon any person * * *,” and held

that the proscriptions under Section 10(b) and Rule

10b-5 “are broad and, by repeated use of the word

‘any,’ are obviously meant to be inclusive.” Similarly,

Superintendent of Insurance, supra, 404 U.S. at 11, n.

7, held that Section “10(b) and Rule 10b-5 prohibit

all fraudulent schemes in connection with the pur-

chase or sale of securities, * * *.”° As the court be-

low recognized prior to the instant case: ‘

action by an investor who, in violation of the rule, has been

misled not to sell his securities. See, e.g., Commerce Report-

ing Co. Vv. Puretec, Inc., 290 F. Supp. 715, 718-719 (S.D. ‘

N.Y.) ; Opper v. Hancock Securities Corp., 367 F.2d 157 (CA.

2), affirming 250 F. Supp. 668 (S.D.N.Y.); Goodman Vv. H.

Hentz & Co., 265 F. Supp. 440, 443-445 (N.D. IIl.); Stockwell

v. Reynolds & Co., 252 F. Supp. 215, 213-219 (S.D.N.Y.);

M. L. Lee & Co. Vv. American Cardboard & Packaging Corp.,

36 F.R.D. 27, 30-31 (E.D. Pa.).

¢ Emphasis in original. This Court was quoting from A. T.

Brod & Co. V. Perlow, 375 F.2d 393, 397 (C.A. 2).

1 Ellis v. Carter, 291 F.2d 270, 274 (C.A. 9), dismissal

affirmed, 328 F.2d 573. Accord, Rekant v. Desser, 425 F.2d

Sees ree ee eer Lo eee ees

It would have been difficult to frame the auth-

ority to prescribe regulations in broader terms.

* * * We see no keason to go beyond the plain

meaning of the word “any” indicating that the

use of manipulative or deceptive devices or con-

trivances of whatever kind may be forbidden

* * *

Even the court of appeals that decided Birnbawm has

subsequently stated that the broad language of Rule

10b-5 “demonstrates that the SEC sought by the Rule

* * * fully to implement the Congressional purpose

and objectives underlying Section 10(b).”* And, as

‘one commentator wrote, the Section and Rule con-

tain what is “plainly and—one must aggume—in-

tentionally the loosest linkage, in any of the federal

antifraud provisions, between a proscribed act and

a security transaction.” °

Petitioners assert (Pet. Br. 31) that the language

of Rule 10b-5 ‘and Section 10(b), by “limiting” their

coverage to matters “in connection with the purchase

872, 880 n.15 (C.A. 5); see also McClure v. Saree Chemical

Co., 292 F.2d 824, 834 (C.A. 3), certiorari denied, 368 U.S.

939.

® Securities and Exchange Commission V. Texas Gulf Sul-

phur Co., 401 F.2d 833, 860 (C.A. 2) (en banc), certiorari

denied sub nom. Coates v. Securities and Exchange Commis-

sion, 394 U.S. 976.

The House Committee appraised the function of the Se-

curities Exchange Act as an undertaking to advance the law

by a “constant extension of the legal conception of a fiduciary

relationship—a guarantee of ‘straight shooting’ * * *.” H.

Rep. No. 13838, 73d Cong., 2d Sess. 5.

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

7.6(1), p. 190.21 (1973).

or sale of any security,” “does not include an offer to

purchase or sell” (petitioners’ emphasis). They con-

clude: “Had Congress intended section 10(b) to reach

offers, it knew how to accomplish that purpose.” But

Section 17(a) of the Securities Act, upon which the

language of Rule 10b-5 is based, expressly and unam-

biguously proscribes fraud “in the offer” as well as

fraud “in the * * * sale of any securities * * *.” As_

the petitioners themselves recognize (Pet. Br. 18-19),

Rule 10b-5 was adopted to extend to “all purchasers

of securities” the same “prohibitions on fraud” that

Section 17(a) imposed upon sellers." Although Sec-

tion 17(a) of the Securities Act relates only to

tioners suggest, the plaintiff’s only error in the district court

was in failing to allege a cause of action predicated upon

Section 17(a) of the Securities Act as well as one under Rule

10b-5.

The complaint must be read in the light most favorable

to the plaintiff, recognizing that any ambiguities or omissions

in the pleadings should be resolved in favor of the plaintiff,

since any such deficiencies in the complaint can be cured by

amendment, see Lanasa Fruit S. S. & I. Co. v. Universal In-

surance Co., 302 U.S. 556, 559. For the same reasons that a

cause of action is recognized under Rule 10b-5, it must be

recognized under Section 17(a). This would cure the de- ‘

ficiency that the petitioners perceive—although some courts, .

disregarding even the unambiguous expression of congres-

sional purpose, have applied the Birnbaum doctrine to ac-

tions brought under Section 17(a) as well as under Rule

10b-5. See, e.g., Schoenbaum Vv. Firstbrook, 268 F. Supp. 385,

396 (S.D. N.Y.), affirmed, 405 F.2d 200 (C.A. 2), reversed in

part on other grounds, 405 F.2d 215 (en banc), certiorari

denied sub nom. Manley v. Schoenbaum, 395 U.S. 906; Greater

Iowa Corp. Vv. McLendon, 378 F.2d 783, 790-791 (C.A. 8);

Simmons V. Wolfson, supra, 428 F.2d 455.

fraudulent activity “in” the offer or sale of securities,

the broader statutory language “in connection with”

used in Section 10(b) and Rule 10b-5 (which re-

lates to all deceptive activities “touching” securities

transactions, Superintendent of Insurance, supra, 404

U.S. at 12) made it unnecessary to include the word

“offer” in those provisions. Cf. Securities and Ex-

change Commission v. Capital Gains Research Bureau,

Inc., 375 U.S. 180, 197-199.

There can be no doubt under the Act, Rule, and

controlling decisions of this Court, that, if the allega-

tions of respondent’s complaint are true, prohibited

deceptive statements have been made. This conclu-

sion is supported by the legislative history of the

statute. The Securities Exchange Act of 1934 was

enacted in response to “the speculative orgy of 1928

and 1929”™ and a presidental call for securities

“legislation [that] has teeth in it.”"* Congress,

recognized that “[s]peculation, manipulation, * * *

investors’ ignorance, and disregard of trust relation-

ships by those whom the law should regard as fiduci-

aries” were “all a single seamless web,” * and that an

act designed to purge all avenues of abuse would re-

quire broad remedial provisions. Thus, the Act was

intended to cover “a wide field.” ™

Congress understood, however, that it could not, by

specifying or cataloguing particular forms of unlaw-

1S. Rep. No. 1455, 73d Cong., 2d Sess. 81.

2 H. Rep. No. 1383, 73d Cong., 2d Sess. 2.

13 H. Rep. No. 1383, 73d Cong., 2d Sess. 6.

pty Ibid.

ful conduct, itself effectively prohibit all forms of

practices that “for some purposes may be turned to

illegitimate and fraudulent means.” ** Accordingly, it

vested “broad discretionary powers in the [Securities

and Exchange Commission].” * See generally Super-

intendent of Insurance, supra.

Section 10(b) creates such discretionary power by

authorizing the Commission by rule and regulation to

proscribe manipulative or deceptive practices in con-

nection with the purchase or sale of any security. As

one of the draftmen described an earlier version (then

Section 9(c) ) before the House Committee, the section

provided, in effect:

“Thou shalt not devise any other cunning de-

vices.” * * * [S]ubsection (c) is a catch-all

clause to prevent manipulative devices. * * * The

Commission should have the authority to deal

with new manipulative devices.”

The Senate bill, from which most of Section 10(b)

was taken verbatim,"* went further; it gave the Com-

mission broad rulemaking authority with respect to

deceptive as well as manipulative practices. Although

15 Td. at 7.

16 [bid.; see also 78 Cong. Rec. 7696 (remarks of Rep. Ray-

burn). The Senate Committee viewed the Securities Act of

1933 and the Securities Exchange Act of 1934 as vesting “in

the Securities and Exchange Commission jurisdiction over the

source of and traffic in securities.” S. Rep. No. 1455, 73d

Cong., 2d Sess. 393.

11 Hearings Before the House Committee on Interstate and

Foreign Commerce on H.R. 7852 and 8720, 73d Cong., 2d

Sess. 115.

18 H, Conf. Rep. No. 1838, 73d Cong., 2d Sess. 32-33.

representatives of the securities industry had com-

plained that these provisions would give the Commis-

sion power to prohibit virtually anything,” the Con-

ference Committee broadened the language of the sec-

tion still further.

The Senate bill would have authorized rulemaking

with respect to practices “detrimental to the interests

of the investor,” but the Committee expanded the au-

thority to cover rulemaking “‘necessary or appropriate

in the public interest” as well as “for the protection

of investors.” * After considering these alternatives,

Congress agreed upon the present language, which

gives the Commission broad rulemaking power to pro-

hibit “any manipulative or deceptive device or contri-

vance,” and omitted language that would have con-

fined the section solely to securities traded or listed

on a national securities exchange.”

. 1° Hearings on H.R. 7852 and 8720, supra, n. 17, at 178,

208-209, 251, 258, 297, 305, 486; Hearings Before the Senate

Committee on Banking and Currency on S. Res. 84 (72d

Cong.) and S. Res. 56 and 97 (73d Cong.), Part 15, 73d Cong.,

1st Sess. 6624-6625, 6634, 6899, 6910, 6936-6938, 6988.

20 H. Conf. Rep. No. 1838, supra, at 32-33. Cf. A.T. Brod &

Co. Vv. Perlow, supra, 375 F.2d at 396:

These rules and regulations [under Section 10(b)] were

to be promulgated by the Commission “in the public in-

terest or for the protection of investors.” * * * Rule

10b-5 * * * was designed to protect both investors and

‘the public interest.’ [Emp*asis in original.]

21 See S. 3420, Section 10(b), 73d Cong., 2d Sess. (April 17,

1934). In enacting Section 10(b), Congress intended to en-

sure fairness in securities transactions generally, whether

conducted in the organized securities markets or face-to-face.

Superintendent of Insurance, supra, 404 U.S. at. 10.

In order to fulfill these Congressional objectives, the

courts have repeatedly rejected restrictive readings of

Rule 10b-5. For example, proof of a substantive

violation of Section 10(b) and Rule 10b-5 does not

depend upon proof of an actual purchase or sale of a

security. In Securities and Exchange Commission v.

Texas Gulf Sulphur Co., 401 F.2d 833, 854-855 (C. A.

2), certiorari denied sub nom. Coates v. Securities

and Exchange Commission, 394 U.S. 976, the court

held that deceptive public statements, negligently

made, that might generally affect securities transac-

tions, violate Rule 10b-5. Nor must the Commission,

in its own actions, demonstrate that any persons have

suffered injury because of a purchase or sale; it need

show only that the forbidden deceptive practices nate.

been committed. Hughes v. Securities and Exchange —

Commission, 174 F.2d 969, 974 (C.A.D.C.). See also

Berko v. Securities and Exchange Commission, 316

F.2d 137, 143 (C.A. 2); N. Sims Organ & Co., Ine.

v. Securities and Exchange Commission, 293 F.2d 78,

80, n. 3 (C.A. 2). Cf. Kuehnert v. Teustar’Corp.,

412 F.2d 700, 704 (C.A. 5), in which the court stated

that it was not convinced that there was any differ-

ence in substance between a successful fraud and an

attempt, since the statutory phrase “ ‘any manipula-

tive or deceptive device’ * * * seem[ed] broad enough

to encompass conduct irrespective of its outcome.”

The Court of Appeals for the Second Circuit has

aptly noted that material facts that must be fully dis-

closed if the standard of Rule 10b-5 is to be met in-

clude those “which may affect the desire of investors

to buy, sell, or hold the company’s securities.” Securi-

ties and Exchange Commission v. Texas Gulf Sulphur

Co., supra, 401 F.2d at 849. Consistent with this view

is Hanly v. Securities and Exchange Commission, 415

F.2d 589, 594-595 (C.A. 2), which applied Rule 10b-5

to misleading statements and omissions that had in-

duced a broker’s customer to hold his stock rather

than to sell it in the face of a declining market. In

administrative proceedings the Commission has’ re-

peatedly taken the position that'a person violates the

Rule by misleading an investor not to sell.”

Because—if the assertions in respondent’s com-

plaint are correct—there has been a violation by peti-

tioners of the Act and Rule, the question open for de-

cision is whether that violation can be redressed by a

private plaintiff.

B. There Is an Implied Civil Remedy on Behalf of All

Persons Injured by Violations of Rule 10b-5, Includ-

ing Those Who Have Neither Purchased Nor Sold

Securities

The limitation on standing imposed by the Birn-

baum rule is inconsistent with the decisions of this

and other courts. that have implied causes of action

for violations of the securities acts’ prohibitions in

order to provide redress to persons for whose protec-

tion those prohibitions were adopted.

Although Section 10(b) and Rule 10b-5 do not ex-

pressly provide a civil remedy to the victims of pro-

scribed behavior, this Court has recognized an implied

22 See, e.g., Investors Management Co., Inc., Securities Ex-

change Act Release No. 9267 (July 29, 1971), pp. 9-10; Merrill

Lynch, Pierce, Fenner & Smith, Inc., Securities Exchange

Act Release No. 8459 (November 25, 1968), p. 5.

PSS

18 .

right of action under their provisions. Superintendent

of Insurance v. Bankers Life & Casualty Co., supra,

404 U.S. at 13 n.9; Affiliated Ute Citizens v. United

States, supra, 406 U.S. at 151. These two decisions -

reflect this Court’s repeated admonition that the fed-

eral securities laws, “enacted for the purpose of avoid-

ing frauds,” must be construed “not technically and

respectively, but hearst to effectuate [their] re-

"medial purposes.” Securities and Exchange Com-

mission v. Capital Gains Research Bureau, Inc., 375

err: S. 180, 195 (Investment Advisers Act). In Palere-

pnin v. Knight, 389 U.S. 332, 336, this principle was

applied to the Securities Exchange Act generally; and

in Superintendent, supra, 404 U.S. at 12, and Affilr-

ated Ute Citizens, supra, 406 U.S. at 151, this Court

recognized that damages could be sought for viola-

tions of Section 10(b) and Rule 10b-5. :

A private right of action under Rule 10b-5 reflects |

this Court’s recognition that “[p]rivate enforcement

* * * provides a necessary supplement to Commission

action.” J.J. Case Co. v. Borak, supra, 377 U.S. at

432.’ Accordingly, this Court in Borak directed “the

federal courts ‘to adjust their remedies so as to grant

the. necessary relief’ where federally secured rights

are invaded.” Id. at 433. It continued: *

22 The Courts of Appeals have long recognized an implied

right of action under Rulé 10b-5. See, e.g., Fischman Vv. »

Raytheon Mfg. Co., 188 F.2d 783 (C.A. 2); Fratt v. Robinson,

203 F.2d 627 (C.A. 9); Hooper Vv. Mountain States Securities

Corp., 282 F.2d 195; cf. Slavin v. Germantown. Fire inourence

Co., 174 F.2d 799, 805-806 ie 8) (dictum). —

And it is also well settled that where legal rights

have been invaded, and a federal statute provides

for a general right to sue for such invasion,

federal courts may use any available remedy to

make good the wrong done.

It then held that Section 27 of the Securities Ex-

change Act provided such a “general right to sue” be-

cause it “grants the District Courts jurisdiction ‘of all

suits in equity and actions at law brought to enforce

any liability or duty created by this title.’” Ibid.

' Borak and this Court’s more recent cases apply to

the Securities Exchange Act the principle, applied in

other areas of the law, that the touchstone for deter-

mining whether particular persons may maintain a

civil action to redress a violation of a statutory pro-

hibition or obligation is whether their interest “fell

within the class that the statute was intended to pro-

tect” and whether “the harm that had occurred was

of the type that the statute was intended to forestall.”

Wyandotte Transportation Co. v. United States, 389

US.: 191, 202". .

This was the principle recognized and applied in

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

(E.D. Pa.), the first judicial decision holding that

there is an implied right of action under Rule 10b-5.

There the plaintiff’s standing to seek relief was upheld

because the plaintiff was within the class of persons

2 See also United States v. Students Challenging Regula-

tory Agency Procedures, 412 U.S. 669, 686; Sierra Club Vv.

Morton, 405 U.S 727, 733; Association of Data Processing

Organizations, ‘nc. v. Camp, 397 U.S. 150, 152-153. Cf. Flast

v. Cohen, 392 U.S. 83; Hardin v. Kentucky Utilities Co., 390

US. 1.

“for. whose special benefit the statute was enacted.” *

More recently, the Court of Appeals for the Seventh

Circuit in Eason v. General Motors Acceptance Corp.,

490 F.2d 654, certiorari denied, 416 U.S. 960, cor-

rectly perceived that the opinions of this Court “fairly

imply that the rule [10b-5] was intended to protect

a broader class of persons” than only purchasers and

sellers’ of securities. 490 F.2d at 659. Because the

plaintiffs in that case “were members of the class for

whose special benefit Rule 10b-5 was adopted,” id.

at 658, they were held to have standing to seek dam-

ages for their alleged injuries, although they were

neither purchasers nor sellers of securities.

A primary purpose of Rule 10b-5 is to protect all

persons, not merely persons who may have purchased

or sold securities, against making investment decisions

on the basis of misleading or inaccurate informa-

tion. In prohibiting misleading or deceptive prac-

tices that operate as a fraud upon “any person,” it

prohibits such practices where their tendency is im-

properly to discourage action no less than when their

23 Kardon based its decision on 2 Restatement of Torts, Sec.

286, which provided:

The violation of a legislative enactment by doing a pro-

hibited 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 * * * [emphasis added].

See also Fratt v. Robinson, supra, 203 F.2d at 631; Fischman

v. Raytheon Mfg. Co., supra, 188 F.2d at 787, n. 4; Hooper v.

Mountain States Securities Corp., supra, 282 F.2d at 201.

tendency is to encourage unwarranted action. Indeed,

in Superintendent of Insurance, supra, 404 U.S. at

12, the Court observed that among those Congress

sought to protect from the impact of fraud were per-

sons who were the creditors of corporations that

may have been misled into buying or selling securi-

ties. A fortiori, persons making investment deci-

sions, including the decision not to purchase or sell,

are within the scope of the Act, and should (under

the Borak- and Wyandotte principle) be able to re-

cover damages.

Consistently with the principles supporting a pri-

vate éduse of action, the courts generally have recog-

nized) that a person who has neither purchased nor

gold securities nevertheless is entitled to the protec-

tion of Rule 10b-5, and therefore can obtain equitable

relief with respect to an.alleged Rule 10b-5 violation.

Kahan v. Rosenstiel, 424 F. 2d 161 (C.A. 3), cer-

tiorari denied sub nom. Glen Alden Corp. v. Kahan,

398 U.S. 950; Mutual Shares Corp. v. Genesco, Inc.,

384 F. 2d 540, 546-547 (C.A. 2); Britt v. Cyril

Bath Co., 417 F. 2d 483 (C.A. 6). In light of these

decisions, some of which have been rendered by the

same courts that adhere to the Birnbaum rule, it is

26 Situations where individuals are injured by the invest-

ment decisions. of others include that involved in Vine V.

Beneficial Finance Co., 374 F.2d 627 (C.A. 2),. certiorari.

denied, 389 U.S. 970, in which so many of plaintiff’s fel-

low shareholders accepted a tender offer (which was mis-

leading, in violation of Rule 10b-5) that the acquiring corpo-

ration was able to effect a merger, causing plaintiff injury.

The Vine court permitted recovery, and reconciled its hold-

ing with the Birnbaum doctrine by deeming the merger to

be a “forced sale” of the plaintiff's securities.

significant that in Borak this Court expressly re-

jected a contention that the private right of action

for violation of the antifraud provisions of proxy

Rule 14a-9(a)* should be “limited to prospective re-

lief,” and held that the remedial objectives of the

Securities Exchange Act required that a private right

of action for damages also be recognized.”

The Court observed in Borak that to limit “victims

of deceptive proxy statements” to prospective relief

under the federal statute would relegate them to state

court monetary remedies, and if these proved inade-

quate, “the whole purpose of the section [14 (a) ] might

be frustrated.” 3877 U.S. at 434-4385. Moreover,

building upon these principles, Mills v. Electric Auto-

Lite Co., 396 U.S. 375, rejected an interpretation that

would have “[insulated] from private redress an en-

tire category of proxy violations * * *,” holding that

“sych a result would subvert the congressional pur-

pose of ensuring full and fair disclosure to sharehold-

ers.” 396 U.S. at 382. |

The same reasoning applies to the scope of Rule

10b-5 and the remedies available under it. “[T]here

2* The language of Rule 14a-9(a) is substantially similar to

the language of Rule 10b-5(b).

28 Based upon the “purpose of §14(a) * * * to prevent

management or others from obtaining authorization for cor-

. porate action by means of deceptive or inadequate disclosure

in proxy solicitation,” 377 U.S. at 431, and the language of

Section 14(a), which, like Section 10(b), authorizes the

adoption of rules “in the public interest or for the protection

of investors,” 377 U.S. at 432 (emphasis by the Court), the

Court recognized “the availability of judicial relief where

necessary to achieve that result.” 377 U.S. at 432.

is no reason to emasculate the securities‘laws by for-

bidding remedies which might prove to be essential.

Cf. J. I. Case Co. v. Borak, 377 U.S. 426 (1964).”

Securities and Exchange Commission v. National Se-

curities, Inc., 393 U.S. 453, 463. If the rule is to be |

fraud relating to securities transactions, the right of

the victims of such fraud to maintain a private suit

based upon their negative actions must encompass

damages as well as injunctive relief.” As the Court

2° Commentators have concluded that the Birnbaum decision

was not dictated by the express language of Section 10(b)

or Rule 10b-5. They also note that Birnbaum has encouraged

mechanical application of a purchaser-seller requirement,

producing results contrary to the purposes for which that

legislation was enacted—to protect the public from the

effects of fraudulent representations about securities. See,

e.g., Note, Limiting the Plaintiff Class: Rule 10b-5 and the

Federal Securities Code, 72 Mich. L. Rev. 1398, 1412 (1974);

Note, Standing to Sue in 10b-5 Actions: Eason v. GMAC and

Its Impact on the Birnbaum Doctrine, 49 Notre Dame Lawyer

1131, 1146-1147 (1974); Comment, Inroads on the Necessity

for a Consummated Purchase or Sale under Rule 10b-5, 1969

Duke L.J. 349 (1969) ; Comment, The Purchaser-Seller Rule:

An Archaic Tool for Determining Standing under Rule 10b-5,

56 Geo. L.J. 1177, 1178 (1968); Note, The Purchaser-Seller

Limitation to SEC Rule 10b-5, 53 Cornell L. Rev. 684, 698

(1968); Lowenfels, The Demise of the Birnbaum Doctrine:

A New Era for Rule 10b-5, 54 Va. L. Rev. 268, 275-276

(1968) ; see also, Jacobs, Birnbaum in Flux: Significant 10b-5

Developments, 2 Sec. Reg. LJ. 305 (1975); 27 Vand. L.

Rev. 572 (1974); Leech, Transactions in Corporate Control,

104 U. Pa. L. Rev. 725, 774 (1956) ; Comment, The Decline of

the Purchaser-Seller Requirement of Rule 10b-5, 14 Vill. L.

Rev. 499, 501-502 (1969); Note, Fiduciary Suits Under Rule

_ 10b-5, 1968 Duke L.J. 791, 807-808; Note, Rule 10b-5: Ele-

ments of a Private Right of Action, 43 N.Y.U. L. Rev. 541,

of Appeals for the Seventh Circuit observed in Eason,

supra, 490 F.2d at 659, the purchaser-seller limita-

tion

is not consistent with the overriding requirement

that, in const~uing the 1934 Act, “form should be

disregarded is; substance and the emphasis

should be oz economic reality.” Tcherepnix v.

Knight, 389 U.S. 332, 336.

C. This Court Should Not Adopt the Birnbaum Rule as a

Method to Limit the Class of Potential Plaintiffs

Petitioners express concern (Pet. Br. 34) that

the decision of the court of appeals wold allow

anyone who had not purchased securities which were

offered to him to bring an action simply by claiming

* that he would have purchased the securities, if the

offeror had disclosed additional facts from which he

might have inferred that the securities were worth

more than the offering price. We agree with pe-

titioners that the effect, if any, of a deceptive prac-

545 (1968); Note, Civil Liability Under Rule X-10b-5, 42

Va. L. Rev. 587, 570-571 (1956); Ruder, Current Develop-

ments In The Federal Law of Corporate Fiduciary Relations

—Standing to Sue Under Rule 10b-5, 26 Bus. Law. 1289

(1971).

rules of standing; it is necessary only for a determined plain-

tiff to plead words consistent with applicable standing re-

quirements, even though he knows that he cannot succeed on

the merits. Opportunities for vexatious litigation will abound

wkcther or not the Birnbaum rule is adopted. As this Court

has recognized in a different context, “the expense and annoy-

ance of litigation is ‘part of the social burden of living under

government’.” Petroleum Exploration, Inc. v. Public Service

Commission, 304 U.S. 209, 222.

tice on someone who has neither purchased nor sold

securities may be more difficult to demonstrate than

is the effect on a purchaser or seller. In either case

the plaintiff must demonstrate some relationship be-

tween the alleged deceptive practice and his injury.

If, as here, that injury resulted from his own “non-

action,” he also must demonstrate that his failure to

act was caused by the defendant’s activities. But

this additional problem of proof can be ameliorated

by devices more consistent with the purposes of the

securities laws. ae

In Affiliated Ute Citizens, supra, Indians sought

relief under Rule 10b-5 against bankers who sought

their shares in the course of encouraging a market

for shares among non-Indians. This Court held that

if there was a direct relationship between the In-

dians and the bankers, and the bankers omitted to

state facts that a reasonable investor might have con-

sidered important in the making of his investment

decision, a causal connection between the wrong-

ful omission and the plaintiffs’ injuries would be

presumed. This presumption might apply in many

eases involving potential investors. In other cases,

however, it might be unreasonable for the courts to

make such a presumption and, indeed, where only a

tenuous relationship exists, it might be appropriate

(in order to prevent abuses) to impose upon the

plaintiffs a heavier burden of proof than would nor-

mally be applicable. It might be necessary, for ex-

ample, for a plaintiff who has neither purchased nor

sold securities to offer corroborative evidence which,

independent of his own testimony, tends to show that

the plaintiff’s investment decision was directly af-

fected by the deceptive device (or that the violation

caused him injury in some other way) and that he

was within the class of persons for whose benefit the

rule was adopted.”

Thus, contrary to petitioners’ argument, a daolaton

by this Court not to adopt the Birnbaum rule would

not require submitting to the finders of fact every

suit in which someone claimed that “but for” a public

statement by the defendant the plaintiff would have

acquired or would have sold securities. In fact, there

would be few situations where plaintiffs could dem-

onstrate a nexus between a wrongful act and an

alleged injury sufficient to permit submission of the

case to the jury, if that plaintiff were not the owner

of securities or a person to whom an offer to buy or

sell had been directed.

31 In the instant case, the dinest relationship that is alleged

to have existed between the plaintiff and the defendants seems

sufficient to warrant the presumption permitted by Affiliated

Ute Citizens. In any event, respondent’s reliance upon the

defendants’ alleged deceptive practices is corroborated by

the consent judgment in the antitrust action and by respond-

ent’s receipt of the misleading prospectus. It is reasonable

to believe that respondent was actively considering a purchase

of Blue Chip Stamps’ securities, and that the representations

in the prospectus were material to this decision. That should

be sufficient objective indicia, particularly if a plaintiff can

show, as respondent alleged here, that there was a plausible

reason why the issuer of the shares would be motivated to

make representations that would deter the plaintiff from

acting.

aT)

Moreover, even where a proper nexus has been

established, the fact that liability may be imposed

upon individual wrongdoers does not require that a

damage remedy must necessarily be recognized to the

same extent against the corporations for which they

work, if broad vicarious liability would conflict with

the objectives of the federal securities laws. Although

there are strong public policies that militate in favor

of imposing liability upon a corporation for the acts

of its officers and authorized agents, a court may

well be concerned that the wrongful acts of officers

in violations of Rule 10b-5 not expose the shareholders

of a publicly-owned corporation to undue liability.

Of course no reason exists, either in equity or in the

objectives of the federal securities laws, to permit

a corporation to retain profits or any other forms

of benefits it may have derived from the wrongful

acts of its officers or agents.** But where the cor-

poration has not benefited, the courts may find it

equitable, and consistent with the basis upon which

32 Since the Birnbaum rule may, in some situations, protect

corporations from liability even to the extent of profits that

can be traced to violations of the law, its rejection may impose

additional costs on some companies. Judge Hufstedler’s analy-

sis in dissent below seems implicitly to assume that there is or

may be widespread non-compliance with Rule 10b-5. If this

is so, any increased costs that would result from allowing

suit ,are the costs of compliance with the Rule, and long

: ‘since sshould have been paid. The securities laws as a whole

reflect a congressional-judgment that the benefits to be de-

rived from full disclosure of material facts outweigh the

economic costs that disclosure entails.

a right of action has been implied under Rule 10b-

5, to limit an award of damages against it."

Nor ‘is the arbitrary rule of “standing” advanced

by petitioners essential to protect the “common

method of distributing new securities * * *” (Pet.

Br. 28). The case at bar is not the “typical se-

curities transaction” described by petitioners (Pet.

Br. 28-30) ; typically the issuer and underwriter seek

to sell the securities as promptly as possible, and

rarely if ever would make them appear unattractive

through inadvertence or otherwise.

The Birnbaum rule does not produce a conflict be-

tween the registration requirements of the Securities

Act and the antifraud provisions of the Securities

Exchange Act, as petitioners suggest (Pet. Br. 36-

42). To be sure, compliance with the registration

requirements of the Securities Act assumes that

proper emphasis be given to risk factors byspersons

who seek to sell securities to the public. In this con-

text there may be a tendency to overstate risks, be-

cause it is doubtful that any court would find it ap-

propriate to impgse liability upon an offerer who

tends somewhat to understate the merits of the se-

curities he is honestly trying to sell, so long as no

truly material falsehood or omission is involved.*

33 Cf. Shapiro Vv. Merrill Lynch, Pierce, Fenner & Smith,

Inc., 495 F.2d 228, 241 (C.A. 2).

* The concept of materiality (see, e.g., Securities and Ex-

change Commission V. Texas Gulf Sulphur Co., 401 F.2d 833,

849 (C.A. 2) (en banc), iorari denied, 394 U.S. 976) elim-

inates the possibility that the most minute mistake will lead

to liability. Thus, offerers are not required to be “micro-

But where, as is alleged here, the sale of stock was

contrary to the petitioners’ self-interest, any over-

statement of the risks should not be viewed char-

itably. Fraud in the offer of securities is a violation

of Section 17(a) of the Securities Act, as well as a

violation of Rule 10b-5 under the Securities Exchange

Act, and, as we have seen (pp. 8-17, supra), the Birn-

baum rule adds nothing to a registrant’s substantive

legal duty. It relates only to a plaintiff’s ability to

recover for injuries.”

Petitioners also argue (Pet. Br. 34-35) that the

availability of the class-action procedure, a device

designed to permit vindication of just claims that

might be too small to pursue individually, and this

Court’s recognition that a causal relationship between

wrongful acts and resultant injury may be inferred

from the materiality of undisclosed facts, are reasons

to deny standing. But this really is a complaint that

remedies for violation of the Rule will work too well.

Throughout their brief (particularly at pp. 32-33)

petitioners also stress that respondent was not an

metrically accurate,” as Judge Hufstedler seems to fear (App.

151, n. 8.).

35 Thus, the alleged conflict is irrelevant to the question of

standing, since petitioners’ argument goes to the merits of

plaintiff’s claim that Rule 10b-5 has been violated, rather than

to the threshhold question of who may bring suit to test those

merits. If the petitioners can show that their discouraging

statements concerning Blue Chips Stamps’ prospects were

justified, consistent with the conservative philosophy of the

Securities Act registration requirements, they may prevail

on the merits. But the possibility that they may have a good

defense is no reason to deny a plaintiff its day in court.

“investor.” ** We submit that this is irrelevant. The

essence of respondent’s complaint is that petitioners

fraudulently induced the offerees to refrain from

investing; it would be most anomalous if the defend-

ants’ success in preventing an investment—the very

fraud that gives rise to the claim for relief—should

be viewed as a reason why the alleged victims should

not even be heard on the merits of their claim.

Finally, petitioners suggest that it would be un-

fair to those who have invested in particular se-

curities were a court to permit “those who have

never invested in, or made a legal commitment to the

offered securities,” to “seek the profit they allegedly

could have made had they accepted the offer, en-

tered into the transaction and put their funds at risk”

and then be “paid out of the pocket of the company

with which those who ht risked their funds.”

(Pet. Br. 32-33). But this\\analysis, whatever its

merits, does not support the Bgrnbawm rule.

Comparable situations exist even where the Birn-

baum rule permits suit. For example, a similar no-

risk-therefore-no-suit argument can be made where

a person has been fraudulently induced to sell (thus

ending his “risk”) while other non-selling investors’

continued to risk their capital. The Birnbaum rule

would not preclude these sellers, in effect, from hav-

ing a call on stock without having been subjected to

36 On this basis petitioners (Pet. Br. 20) purport to dis-

tinguish Eason v. General Motors Acceptance Corp., supra,

which expressly rejected the purchaser-seller requirement.

See pp. 9 n.5, 24, supra.

the risk borne by those who had not been deceived |

into selling.” At the same time the Birnbaum rule

bars suit by an investor who has put Kis funds at

risk but who is fraudulently dissuaded from selling

shares he already owns. |

The Birnbaum purchaser-seller requirement simply

is not a-doctrine placing “reasonable limits on the

broad exposure to damage liability that has developed

under the section and rule” (Pet. Br. 23). The

“limits” imposed by the Birnbaum rule are artificial

and arbitrary; it denies standing—without regard to

defendants’ culpability or plaintiffs’ ability to prove

their claims—to a class of persons for whose pro-

tection the statute was enacted.

The Birnbaum rule itself has provoked substantial

litigation concerning its scope and exceptions. At

least in recent years courts that have concluded from |

the pleadings that a plaintiff might have a meritorious

claim have been willing to devise interpretations and

exceptions to the Birnbaum rule that emphasize the

artificial nature of that rule. Compare Iroquois In-

dustries, Inc. v. Syracuse China Corp., 417 F.2d 963

(C.A. 2); Greenstein v. Paul, 400 F.2d 580 (C.A.

2); Superintendent of Insurance v. Bankers Life &

Casualty Co., 480 F.2d 355 (C.A. 2). 2versed, 404

U.S. 6, and Drachman v. Harvey, 453 F.2d 722

** Any inequity in both these situations can be adjusted

through judicious allocations of damages appropriate to the

particular case. Cf. J. I. Case-Co..v. Borak, supra, 377 U.S.

at 433-435. ‘

(C.A. 2), reversed on rehearing en banc, 453 F.2d

736, with International Controls Corp. v. Vesco, 490

F.2d 1834 _(C.A. 2), certiorari denied, 417 U.S. 932;

James v. Gerber Products Co., 483 F.2d 944 (C.A.

6); Travis v. Anthes Imperial Ltd., 473 F.2d 515

(C.A. 8); Crane Co. v. Westinghouse Air Brake Co.,

419 F.2d 787 (C.A. 2), certiorari denied, 400 U.S.

822; Vine v. Beneficial Finance Co., 374 F.2d 627

(C.A, 2), certiorari denied, 389 U.S. 970; A. 7.

Brod & Cogv. Perlow, 375 F.2d 393 (C.A. 2); Mutual

Shares Corp. v. Genesco, Inc., 384 F.2d 540 (C.A.

2), and Ruckle v. Roto American Corp., 339 F.2d 24

(C.A. 2).

The existing exceptions to the Birnbaum rule al-

low oeipiiridenle who neither’ purchased nor sold

securities fo bring suit, and so already permit the

vexatious litigation petitioners fear. Others may

sue in the hope of creating additional exceptions to

the rule. Litigation over these exceptions can be

protracted and costly, as the instant case demon-

strates. Indeed, the combined social costs of strike

_ suits falling within the current exceptions and the

costs of litigation determining the existence. and

scope of these exceptions may exceed whatever costs

might be incurred from allowing standing to all per-

sons within the class protected by Rule 10b-5 who

allege they have been injured by a defendant’s viola-

tion of it. —

We submit that the equitable limitation on vicar-

ious liability for damages we have suggested above,

together with appropriate burden-of-proof require-

a /

ern ene

ments, will sufficiently protect all of the legitimate

interests of petitioners and other offerors of securities.

This Court should not go further and adopt a rule of

standing that places an arbitrary obstacle to recovery

in the path of innocent victims and serves primarily

to protect violators of the rule.

CONCLUSION

For the foregoing reasons, the judgment of the

court of appeals should be affirmed on the ground that

no “purchaser-seller limitation” is applicable to a

' private cause of action pursuant to Section 10(b)

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

aw *

——

Respectfully submitted.

ROBERT H. Bork,

Solicitor General.

FRANK H. EASTERBROOK,

Assistant to the Solicitor General.

LAWRENCE E. NERHEIM, ‘

General Counsel,

DAVID FERBER,

. Solicitor,

RICHARD E. NATHAN,

Assistant General Counsel,

Davin K. GINN,

. Attorney,

Securities and Exchange Commission.

, FEBRUARY 1975.

& 3G. 6. GOVERNMENT printine orrice, 1975 se0802 113

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