MARBURY MANAGEMENT, INC., аnd Harry Bader, Plaintiffs-Appellants-Appellees, v. Alfred KOHN, Defendant-Appellant, and Wood, Walker & Co., Defendant-Appellee.
Nos. 129, 130, Dockets 79-7364, 7380.
United States Court of Appeals, Second Circuit.
Argued Oct. 29, 1979. Decided April 21, 1980.
629 F.2d 705
Before MESKILL and KEARSE, Circuit Judges, and DOOLING, District Judge.
Nor in a consent decree context do we see anything wrong with requiring the parties to face up to the issue of fees in their settlement negotiations. Cf. Regalado v. Johnson, 79 F.R.D. 447 (N.D.Ill.1978) (expressing concern over the propriety of injecting the issue of fees into settlement negotiations). Failure to confront the fees issue merely muddies the waters, as the present case well demonstrates. We of course do not suggest that an attorney in the course of settlement negotiations need, or in every case properly may, hold out, against his client‘s best interests, for a specific fees award to be included in the consent decree. If agreement as to fees is not easily accomplished, the parties may provide for submission of the entire question of fees to the court; further, they may, of course, decide to waive fees altogether. But there is nothing whatever to be encouraged in the path followed here—leaving the matter of fees unmentioned in the settlement and then raising it unilaterally several months later under circumstances that cast a shadow upon the settlement itself. Where Congress has spoken on the subject of fees, there can be no virtue in pretending the issue does not exist.
As plaintiff‘s fees claim was filed out of time, it should not have been entertained, and we hold the district court was without jurisdiction to make any award.
The fees award entered by the district court is vacated.
Jay H. Fischer, New York City (Fischer & Klein, New York City, of counsel), for defendant-appellant Kohn.
Charles A. Crocco, Jr., New York City (Lunney & Crocco, New York City, of counsel), for appellee Wood, Walker & Co.
Marbury Management, Inc., (“Marbury“) and Harry Bader sued Alfred Kohn and Wood, Walker & Co., the brokerage house that employed Kohn, for losses incurred on securities purchased through Wood, Walker allegedly on the faith of Kohn‘s representations that he was a “lawfully licensed registered representative,” authorized to transact buy and sell orders on behalf of Wood, Walker.1 After a non-jury trial before thе Honorable Lee P. Gagliardi, District Judge, the court found that Kohn was employed by Wood, Walker as a trainee and that his repeated statements that he was a stock broker and his use of a business card stating that he was a “portfolio management specialist” were undeniably false; the court found further that Kohn made the statements with intent to deceive, manipulate or defraud in making them, and that his misstatements were material. The court found that Kohn‘s misrepresentations about his employment status caused Marbury and Bader to purchase securities from Kohn between summer 1967 and April 1969. The district court also found that the predictive statements Kohn made about various various securities were not fraudulently made, and that there was no evidence that they were made without a firm basis.
Judge Gagliardi reasoned: a trainee at a brokerage firm can accept buy or sell orders by phone only under the supervision of a broker and cannot recommend the purchase of a security outside the brokerage office; moreover, the qualifications and expertise of a security salesman are particularly significant criteria in evaluating any information as inherently speculative as future earnings predictions; and a reasonable investor would consider the total mix of information that he received significantly alterеd if he learned that the investment advice was being furnished to him by a trainee in the field rather than by a specialist. Judge Gagliardi concluded that the important circumstance was that the terms “broker” and “specialist” themselves connote a level of competence to the reasonable investor. Thus, he held Kohn liable to plaintiffs under
Judge Gagliardi dismissed the plaintiffs’ claims against Wood, Walker on the ground of plaintiffs’ failure to prove that Wood, Walker participated in the fraudulent manipulation or intended to deceive plaintiffs; treating plaintiffs as basing their claims against Wood, Walker solely on the theory that the firm aided and abetted Kohn‘s fraud, the court found that the evidence supported neither a finding of conscious wrongful participation by the firm nor a legally equivalent recklessness but at best a finding of negligence in supervision.
Judge Gagliardi‘s findings of fact are not clearly erroneous. The cross-appeals of defendant-appellant Kohn from the judgment against him and of plaintiffs-appellants from the judgment exonerating Wood, Walker from liability raise questions of law that are hardly novel but are not free from difficulty in application. It is concluded that the judgment against appellant Kohn must be affirmed and that in favor of Wood, Walker reversed.
Here the claim and finding are that Kohn‘s statements by their nature induced both the purchase and the retention of the securities, the expertise implicit in Kohn‘s supposed status overcoming plaintiffs’ misgivings prompted by the market behavior of the securities.2 Plaintiffs’ recovery of their whole loss measured by the decline in value of the securities to the date when they learned the truth certainly does not fit the familiar rubric, for example, of
As Judge Weinfeld observed in Miller v. Schweickart, 413 F.Supp. 1062, 1067 (S.D.N.Y.1970):
Proximate cause, of course, is a concept borrowed from the law of torts, and generally requires that one‘s wrongful conduct play a “substantial” or “essential” part in bringing about the damage sustained by another.
The generalization is that only the loss that might reasonably be expected to result from action or inaction in reliance on a fraudulent misrepresentation is legally, that is, proximately, caused by the misrepresentation. Restatement (Second) of Torts § 548A (1977). See Levine v. Seilon, 439 F.2d 328, 333-34 (2d Cir. 1971). Oleck v. Fischer, Fed.Sec.L.Rep. (CCH) ¶ 96,898, at 95,702-03 (S.D.N.Y.1979), aff‘d 623 F.2d 791 (2d Cir. 1980), in effect requires that the damage complained of be one of the foreseeable consequences of the misrepresentation. The case for Marbury and Bader is that, since the misrepresentation was such as to induce both their purchases and their holding of the securities, their holding and its duration determined the extent of their losses. As in Schlick v. Penn-Dixie Cement Corp., 507 F.2d 374, 380-81 (2d Cir. 1974), cert. denied, 421 U.S. 976, 95 S.Ct. 1976, 44 L.Ed.2d 467 (1975), the claim is that the misrepresentation was the agency both of transaction causation and of loss causation.
Liability for representations having the effects of Kohn‘s representation was famil-
cannot in such case shelter themselves under the statement that they did not make the representations, i. e., commit the fraud with the motive or for the purpose of inducing the plaintiff to sell his stock. They intended to deceive the plaintiff and they were induced thereto by other causes, yet the natural, proximate and direct result of such deception they knew or had reasonable ground for believing would be this sale, although its accomplishment was not the particular purpose of their fraud. In such case their liability would seem to be plain.
Id. at 588, 38 N.E. at 719. So in David v. Belmont, 291 Mass. 450, 197 N.E. 83 (1935), plaintiff had retained stock of a certain company and bought additional shares of the same stock in reliance on certain representations made by defendant which were false. The court said:
Presumably [plaintiff] continued to hold the stock after the purchase in reliance on the representations. The fraud was thereforе continuing in its effect until such time as the plaintiff discovered the falsity of the representations. A loss which he suffered would manifestly be the difference in the then value of the stock and the price which he paid for it.
Id. at 454, 197 N.E. at 85. Similarly in Cartwright v. Hughes, 226 Ala. 464, 147 So. 399 (1933), the plaintiff bought stock of the defendants’ bank on their representation that it was “a good investment,” that the bank was solvent, and that its assets were “good clean assets.” The bank ceased to function and its stock became worthless. The issue in the appellate court was the appropriate measure of damages. Agreeing that the ordinary rule measures damages by the difference between value at the time of the fraud and what the value would have been had the representations been true (the so-called “warranty” measure of damages), the court said:
The question of time is not often involved, but in such a transaction as this in 4 Sutherland on Damages, § 1172, at p. 4409, it is said that “the value of the stock sold is not uniformly fixed as of the time of the sale, especially if the purchase was made as an investment. The fraud in such a case has been considered operative until the purchaser learned of it; that is regarded as the time when his cause of action arose.”
The proposition that fraudulent representations may induce the retention of securities as an investment and entail liability for the damages flowing frоm retention was given a more general form in Continental Insurance Co. v. Mercadante, 222 A.D. 181, 225 N.Y.S. 488 (1st Dept. 1927). The court there said:
Where the damage is caused by inducing plaintiff‘s inaction, it is necessarily more difficult to allege or prove causation than in those cases where active conduct is induced. Indeed, in all fraud cases, the element of proximate cause is more impalpable than in negligence cases because we are dealing with the plaintiff‘s state of mind. The defendants cannot, therefore, require the same exact proof of causation.
Id. at 186, 225 N.Y.S. at 494. See to the same effect Hotaling v. A.B. Leach & Co., 247 N.Y. 84, 93, 159 N.E. 870, 873 (1928) (“As long as the fraud continued to operate and to induce the continued holding of the bond, all loss flowing naturally from that fraud may be regarded as its proximate
Although the theory of plaintiffs’ case relates their damages to the inaction of retaining the securities on the faith of their belief in Kohn‘s assertion of his status, the claim is nevertheless one within Section 10(b) and Rule 10b-5 because the representation relied upon was made in connection with the purchase of securities, and both Marbury and Bader sue as purchasers of securities. Cf. Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 731, 755, 95 S.Ct. 1917, 1924, 1934, 44 L.Ed.2d 539 (1975) (private damage action under Rule 10b-5 is confined to actual purchasers or sellers of securities). The case is not one in which nothing has been shown except an inducement to hold as in Parsons v. Hornblower & Weeks-Hemphill, Noyes, 447 F.Supp. 482, 487 (M.D.N.C.1977), aff‘d, 571 F.2d 203 (4th Cir. 1978), if that case is a correct reading of Blue Chip. Nor is this case similar to Hayden v. Walston & Co., 528 F.2d 901 (9th Cir. 1975): there the plaintiffs had purchased securities through a salesman who was not a duly licensed registered representative, but did not show that the salesman‘s nondisclosure of his status rendered his other statements misleading within the meaning of Rule 10b-5, and there was, evidently, no claim or proof that he held himself out to be a duly registered representative. The second ground of suit rejected in the Hayden case, that a private right of action could be predicated on the violation of the National Association of Securities Dealers rules, has not been relied upon in this case, and was not a ground of decision in the district court.
It follows from what has been said that the judgment against defendant-appellant Kohn must be affirmed.3
2. Marbury and Bader have appealed from the judgment in favor of Wood, Walker. Judge Gagliardi considered the case against Wood, Walker as one in which plaintiffs sought recovery against Wood, Walker only “as an aider and abettor of Kohn‘s securities law violations.” Judge Gagliardi found that the evidence did not show that Wood, Walker intended to deceive plaintiffs, or knew of Kohn‘s violations, or provided substantial assistance to Kohn in violating the securities law, but at most showed only negligence on Wood, Walker‘s part. Applying the standard of Rolf v. Blyth, Eastman Dillon & Co., 570 F.2d 38, 44-48 (2d Cir.), cert. denied, 439 U.S. 1039, 99 S.Ct. 642, 58 L.Ed.2d 698 (1978), the district court held that plaintiffs
(a) Marbury and Bader have in this court again argued that Wood, Walker is liable because the evidence shows that it did aid and abet Kohn‘s commission of the fraud. If Kohn and Wood, Walker are regarded as distinct actors liable for each other‘s acts only to the extent of their conscious and intentional complicity in them, and the “aiding and abetting” theory requires that approach, Judge Gagliardi‘s conclusion is unassailable on the evidence. The circumstances on which plaintiffs rely to show that Wood, Walker should be held liable as an “aider and abettor” may suggest inadequate supervision and lax control but they do not show that the firm was guilty of “knowing or intentional misconduct” or of equivalently reckless misconduct. See generally Ernst & Ernst v. Hochfelder, 425 U.S. 185, 197, 200-201, 96 S.Ct. 1375, 1382, 1384, 47 L.Ed.2d 668 (1976); Edwards & Hanly v. Wells Fargo Securities Clearance Corp., 602 F.2d 475, 483-85 (2d Cir. 1979), cert. denied, 444 U.S. 1045, 100 S.Ct. 734, 62 L.Ed.2d 731 (1980); Rolf v. Blyth, Eastman Dillon & Co., supra, 570 F.2d at 44-48.
(b) A threshold question on this aspect of plaintiffs’ appeal relates to plaintiffs’ right to argue that the court should have considered the respondeat superior and controlling person contentions. The district judge took the view, 470 F.Supp. at 515 n.11, that plaintiffs had not alleged that Wood, Walker was liable either as a controlling person or as a principal under the respondeat superior doctrine, and that, in consequence, the court did not need to consider Wood, Walker‘s liabilities on either of those theories. In the opinion, id. at 515, the court said that plaintiffs’ position, as expressed at the trial and in their post-trial memorandum of law, indicated that they sought recovery against Wood, Walker as an aider and abettor of Kohn‘s violations.
While plaintiffs have not denominated their argument in this court and in the district court a respondeat superior argument, and the complaint did not contain the traditional allegation that Kohn made the representations relied upon in the course of his employment with Wood, Walker, the evidence upon which plaintiffs rely in this court, as in the district court, and the allegations of fact made in the complaint are alike completely descriptive of the transactions and of the roles of the actors in them, and they are the evidence and allegаtions relevant to a determination of the respondeat superior issue, and inevitably, of the Section 20(a) issue. Plaintiffs’ counsel argued the respondeat superior issue orally at the trial, and the bare failure to reiterate it in the closing brief in the district court cannot be considered an abandonment of the point.
The way in which the case was tried, and the shift in the emphasis of argument on the motion to dismiss arising from the introduction of Ernst & Ernst into the discussion may explain Judge Gagliardi‘s taking the position that he had to consider only the aider and abettor analysis, but the record evidence tending to support the plaintiffs’ claim on the other two grounds was before the court, and, on the whole of that evidence, the three theories of liability—aider and abettor, controlling person, and respondeat superior—equally presented themselves for resolution. There was evidence of Kohn‘s hiring, his compensation, his authority to accept orders over the telephone at the firm‘s Bronx office, the execution by Wood, Walker of the orders Kohn obtained from plaintiffs, the fact that Wood, Walker received the brokerage commission on all the transactions, the extent to which and the circumstances in which
It was then error not to pass on the respondeat superior and Section 20(a) issues which lurked in the record, unless resort to respondeat superior is precluded by Section 20(a) and the district court‘s rejection of the claim that Wood, Walker aided and abetted Kohn‘s violations implies a finding that Wood, Walker has a “good faith” defеnse under Section 20(a). That section provides in relevant part:
Every person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder shall also be liable jointly and severally with and to the same extent as such controlled person to any person to whom such controlled person is liable, unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action.
This court has avoided explicit “resolution of the rather thorny controlling person-respondeat superior issue,” Rolf v. Blyth, Eastman Dillon & Co., supra, 570 F.2d at 48 n.19. SEC v. Management Dynamics, Inc., 515 F.2d 801, 812-13 (2d Cir. 1975), reasoned, in the light of the legislative history, that the “controlling person” provision of Section 20(a) was not intended to supplant the application of agency principles in securities cases, and that it was enacted to expand rather than to restrict the scope of liability under the securities laws;5 the court, however, intimated no view as to cases involving minor employees, claims for damages, or respondeat superior which might be broader than the apparent authority involved in Management Dynamics, which dealt with actions of a principal executive officer using corporate facilities to create a misleading appearance of activity in the stock in question. A little later in
The cases in this court are not, however, to that effect. Moerman v. Zipco, Inc., 422 F.2d 871 (1970), affirming on the district court opinion, 302 F.Supp. 439 (E.D.N.Y.1969), approved the imposition of liability on a corporation and its controlling directors under Section 20(a); but nothing in the district court opinion considered normal agency principles, or treated Section 20(a) as supplanting the doctrine of respondeat superior. The en banc decision in Lanza v. Drexel & Co., 479 F.2d 1277, 1299 (2d Cir. 1973), declined to impose Rule 10b-5 liability, through Section 20(a), on an outside director of BarChris Corporation for fraud perpetrated by other officials of the corporation in inducing the plaintiffs to exchange stock in their thriving сompany for shares of BarChris stock that soon became worthless. The Lanza case did not present any occasion for considering respondeat superior; only if the court had held that the director was in guilty complicity with the officials of the corporation who had perpetrated the fraud would the court have had to decide whether the investment banking firm of which the defendant director was an employee was liable on a respondeat superior or Section 20(a) theory for its employee‘s delinquency. 479 F.2d at 1319-20 (opinion of Judge Hays, dissenting in part). The district court in Gordon v. Burr, 366 F.Supp. 156, 167-168 (S.D.N.Y.1973), adopted the view that Section 20(a) and not respondeat superior is the appropriate standard for determining secondary liability of a brokerage firm under the ‘34 Act, but this court, reversing the district court‘s imposition of Section 20(a) liability on a brokerage house by reason of the fraud of one of its stock salesmen, did not comment on the rationale of the decision in the court below; it said only that if the brokerage house was liable it must be “derivatively—as a ‘controlling person’ of [the salesman] within the meaning of § 20(a) of the 1934 Act.” Gordon v. Burr, 506 F.2d 1080, 1085 (2d Cir. 1974). The court cited SEC v. Lum‘s Inc., 365 F.Supp. 1046, 1064-65 (S.D.N.Y.1973), which rejected the respondeat superior approach, with evident approval, but the part of the Lum‘s opinion cited deals principally with the standard of culpability required for Section 20(a) liability, and that was thе point on which this court cited it. Moreover this court has in Management Dynamics, supra, 515 F.2d at 813, stated that Gordon v. Burr does not dictate a result contrary to the application of agency principles to hold brokerage firms liable for acts of their employee; Geon Industries, supra, 531 F.2d at 54, states that this court has, in Management Dynamics, held the Lum‘s view—that a brokerage house could be liable for its employee‘s securities frauds only as a controlling person under Section 20(a)—to be erroneous. In Edwards & Hanly v. Wells Fargo Securities Clearance Corp., 458 F.Supp. 1110 (S.D.N.Y.1978), the court held that a defendant was liable for its president‘s Rule 10b-5 frauds both on the respondeat superior and on the Section 20(a) theories, but the judgment was reversed because the evidence was insufficient to support a finding that the individual wrongdoer had aided and abetted the fraud
Cases in other circuits are not in agreement about the relation of respondeat superior to Section 20(a) liability. The Eighth Circuit, in Myzel v. Fields, 386 F.2d 718, 737-739 (8th Cir. 1967), imposed Section 20(a) liability in a Rule 10b-5 case in which, on the evidence, the liability of the allegedly controlling persons was governed “neither by principles of agency nor conspiracy,” but the court assumed that common law principles of agency would apply to impose liability on a principal for an agent‘s deceit committed in the business he was appointed to carry out.
The Sixth Circuit, in Armstrong, Jones & Co. v. SEC, 421 F.2d 359, 362 (6th Cir.), cert. denied, 398 U.S. 958 (1970), held, adopting the position of the Securities Exchange Commission, that sanctions may be imposed on a broker-dealer for the wilful violations of its agents under the doctrine of respondeat superior; the court did not refer to Section 20(a). In Holloway v. Howerdd, 536 F.2d 690, 694-95 (6th Cir. 1976), the Sixth Circuit, following what it took to be the lead of the Second, Fourth, Fifth and Seventh Circuits, went farther in holding that the controlling person provisions,
The Fourth Circuit, in Johns Hopkins University v. Hutton, 422 F.2d 1124 (4th Cir. 1970), cert. denied, 416 U.S. 916, 94 S.Ct. 1623, 40 L.Ed.2d 118 (1974), a case brought under
The Fifth Circuit in Lewis v. Walston & Co., 487 F.2d 617 (5th Cir. 1973), applied agency principles in imposing liability on a brokerage firm in a suit under Section 12(1) of the ‘33 Act for an employee‘s sale of unregistered stock to plaintiffs, notwithstanding that the brokerage house never received a commission or other benefit from the transactions, did not deal in unregistered securities in the course of its own business, and did not perform any of its usual brokerage functions in the completion of the sales transactions. Later, in a case in which liability under Rule 10b-5 could have been imposed only under Section 20(a) if the evidence had warranted it, the Fifth Circuit, under the mistaken impression that Gordon v. Burr, supra, had committed this circuit to the view that Section 20(a) was “the exclusive way to hold someone secondarily liable” in Rule 10b-5 cases, stated that such an approach might be unnecessarily restrictive to the securities acts but that it did not need to resolve that question in the case before it. Woodward v. Metro Bank of Dallas, 522 F.2d 84, 94 n.22 (5th Cir. 1975). The Seventh Circuit in a “churning” case, Fey v. Walston & Co., 493 F.2d 1036, 1052-53 (7th Cir. 1974), held a brokerage house liable for the conduct of
The earliest of the cases usually cited for the proposition that Section 20(a) of the ‘34 Act supplanted the doctrine of respondeat superior in securities cases, Kamen & Co. v. Paul H. Aschkar & Co., 382 F.2d 689, 697 (9th Cir. 1967), does not elaborate the point, and Hecht v. Harris, Upham & Co., 430 F.2d 1202, 1210 (9th Cir. 1970), which imposed liability in a churning case, did so under Section 20(a) on the basis that the brokerage house had failed to maintain adequate internal controls, and that its failure of diligence constituted failure to act in good faith; the court did not refer to the doctrine of respondeat superior. Later, in Zweig v. Hearst Corp., 521 F.2d 1129, 1132-33 (9th Cir.), cert. denied, 423 U.S. 1025, 96 S.Ct. 469, 46 L.Ed.2d 399 (1975), the court interpreted its earlier decision in Kamen as holding that Section 20(a) is to be applied to determine an employing corporation‘s liability and as rejecting the contention that “the more stringent doctrine of respondeat superior remained effective to establish vicarious liability.” The court did not explain the basis for its conclusion. Most recently, in Christoffel v. E. F. Hutton & Co., 588 F.2d 665, 667 (9th Cir. 1978), the court, in a single sentence, and, again, without discussion, stated that it was “the established law of [the 9th] Circuit that section 20(a) supplants vicarious liability of an employer for the acts of an employee applying the respondeat superior doctrine.”
The Third Circuit, in Rochez Brothers, Inc. v. Rhoades, 527 F.2d 880, 884-886 (3rd Cir. 1975), concluded in what is, it may be, elaborate dictum, that, in the light of the legislative history and of earlier cases, “the principles of agency, i. e., respondeat superior, are inappropriate to impose secondary liability in a securities violation case.” Id. at 884. The court put its conclusion essentially on the ground that the defense furnished by the closing language of Section 20(a)—
unless the controlling person acted in good faith and did not directly or indirectly induce the act or acts constituting the violation or cause of action—
established a standard of conscious culpability that was inconsistent with the imposition of an essentially secondary liability on respondeat superior grounds.6 Rochez Brothers was followed in Thomas v. Duralite Co., 524 F.2d 577, 586 (3rd Cir. 1975). In both cases liability was not in fact imposed under Section 20(a) because, in Rochez Brothers, the active wrongdoer, and not the corporation of which he was an officer, was the controlling person, and because, in Duralite, the active wrongdoers were not acting for the corporation in the transaction in the corporation‘s shares.7
Different considerations control the application of respondeat superior principles. Here the concern is simply with scope or course of employment and whether the acts of the employee Kohn can fairly be considered to be within the scope of his employment. See Restatement (Second) of Agency §§ 228, 229, 257, 258, 261, 262, 265. The evidence of record in the present case presents substantial issues of credibility and interpretation, but it indicates, if taken at face value, that Kohn at all times acted as an employee of Wood, Walker, and accounted to Wood, Walker for the transactions. The evidence contains no indication that he profited by any of the transactions other than by reason of his compensation from Wood, Walker as one of its employees. Whatever the specific limitations on his authority as between him and his employer, the evidence, again, indicates, although with some uncertainty, that it was his function as a trainee to be an intermediary in the making of transactions in securities, but that there were certain limitations on the manner in which he was to carry on his activities. Kohn‘s deviant conduct, while it may have induced the purchase of securities that would not otherwise have been purchased, did not appear, on the record made at the trial, to mark any deviation from Kohn‘s services to his employer. Arguably, what he did was done in Wood, Walker‘s service, though it was done badly and contrary to the practices of the industry and the standing instructions of the firm. The record on the respondeat superior issue more than sufficed to require the trier of the fact to dispose of the issue on the merits.
Where respondeat superior principles are applied, the special good faith defense afforded by the last clause of Section 20(a) is unаvailable. Quite apart from the fact that that conclusion was clearly adumbrated in SEC v. Management Dynamics, supra, 515 F.2d at 812-13, and has become settled law in other circuits, there is no warrant for believing that Section 20(a) was intended to narrow the remedies of the customers of brokerage houses or to create a novel defense in cases otherwise governed by traditional agency principles. On the contrary
The judgment against defendant Kohn is affirmed and the judgment in favor of Wood, Walker & Co. is reversed, and a new trial of the claims of Marbury Management and Harry Bader against Wood, Walker & Co. is granted.
MESKILL, Circuit Judge, dissenting:
In straining to reach a sympathetic result, the majority overlooks a fundamental
I share my colleagues’ condemnation of Kohn‘s misconduct and express no view as to whether recourse may lie in an appropriate court under a theory more feasible than the one advanced by plaintiffs. In approving Kohn‘s present sanction, however, the majority is more righteous than right, for its decision abandons the traditional understanding of causation in the context of the sale of securities induced through misrepresentation, disregards governing precedent and extends the reach of Section 10(b) beyond that of its common law antecedent to provide for recovery in cases in which federal policies are offended by such expansion. Accordingly, I respectfully dissent.
The essential facts are undisputed and bear but brief recapitulation. While a trainee at the brokerage firm of Wood, Walker & Co., Kohn deceitfully held himself out to be a registered representative and “portfolio management specialist.” Trading upon those non-existent credentials,1 he persuaded Marbury Management and its principal shareholder, Bader, to purchase several highly speculative stocks. Contrary to a New York Stock Exchange rule requiring that purchase orders placed by novices be reviewed and approved by licensed brokers, Wood, Walker processed these orders without the necessary clearance. Despite Kohn‘s sincere belief in the bright prospects of each of these investments, their market value plummeted. The precise timing of their decline and the reasons therefor are not apparent from the record; it suffices for present purposes to note that Kohn‘s exaggeration of his expertise played no role in the economic collapse of the various stocks he had touted.
Under these circumstances, no recovery may be had against either Kohn or Wood, Walker under Section 10(b) since it is patent that the essential element of causation was not and could not be established as a matter of law. While it is true that Kohn‘s misrepresentations may have been a precondition of the ensuing injury in that the investments might not have been made had he revealed his lack of qualifications, those misstatements nevertheless do not constitute the legal cause of the subsequent pecuniary loss and consequently will not suffice to establish an actionable fraud.2
From time immemorial proof of proximate cause—the legal link between the misconduct alleged and the injury averred—
if false statements are made in connection with the sale of corporate stock, losses due to a subsequent decline of the market, or insolvency of the corporation, brought about by business conditions or other factors in no way related to the representations, will not afford any basis for recovery. It is only where the fact misstated was of a nature calculated to bring about such a result that damages for it сan be recovered.
Prosser, Law of Torts § 110 at 732 (4th ed.) (footnotes omitted).
The rationale for this exacting standard of causation is quite simply that one should be held liable only for the foreseeable consequences of one‘s action. Where the purchase of stock is induced through a misrepresentation, one is chargeable only for the consequences flowing from that statement; one does not thereby become an insurer of the investment, responsible for an indefinite period of time for any and all manner of unforeseen difficulties which may eventually beset the stock. This Court has previously remarked upon the necessity of thus restricting “the potentially limitless thrust of Rule 10b-5 to those situations in which there exists a causation in fact between the act and injury.” Titan Group, Inc. v. Faggen, 513 F.2d 234, 239 (2d Cir.), cert. denied, 423 U.S. 840, 96 S.Ct. 70, 46 L.Ed.2d 59 (1975). See also Globus v. Law Research Service, Inc., supra, 418 F.2d at 1292, cert. denied, 397 U.S. 913, 90 S.Ct. 913, 25 L.Ed.2d 93 (1970) (“causation must be proved else defendants could be held liable to all the world“); List v. Fashion Park, Inc., 340 F.2d 457, 463 (2d Cir.), cert. denied, 382 U.S. 811, 86 S.Ct. 23, 15 L.Ed.2d 60 (1965) (Rule 10b-5 does not “establish a scheme of investors’ insurance“). The Restatement (2d) of Torts takes a similar
there is no liability when the value of the stock goes down after the sale, not in any way because of the misrepresented financial condition, but as a result of some subsequent event that has no connection with or relation to its financial condition. There is, for example, no liability when the shares go down because of the sudden death of the corporation‘s leading officers. Although the misrepresentation has in fact caused the loss, since it has induced the purchase without which the loss would not have occurred, it is not a legal cause of the loss for which the maker is responsible.
Restatement (2d) of Torts § 548A at 107 (1977).5
Although the term causation is not itself used in
Mere factual causation however is not enough. Causation in cases under the securities acts is governed by the principle, set forth above, that the loss complained of must proceed directly and proximately from the violation claimed and not be attributable to some supervening cause. Piper v. Chris-Craft Industries, Inc., 430 U.S. 1, 51, 97 S.Ct. 926, 954, 51 L.Ed.2d 124 (1977) (Blackmun, J., concurring). While this rule is easily stated, its application to cases brought under the federal statutes has frequently been problematic since in such cases both the violation and the resulting loss must each be linked with the requirement of a securities transaction, whether it be a
[] That is to say, the basic distinction between reliance and legal cause bears emphasizing, because the two concepts are so frequently blurred: A buyer can have relied on a seller‘s misstatement of a material fact in deciding to buy; but, if the general market drops precipitately the next day on news of a political assassination or an invasion in some part of the world, the buyer‘s loss is caused not by the misstatement (except in the “but for” or post hoc propter hoc sense) but by the disastrous political news. Tentative Draft # 2, § 215A at 5 (1973). (Commentary on § 220 of the Proposed Official Draft (1978)).
That is, the violation must have precipitated the securities decision (be it a purchase or sale or a shareholder‘s vote), a requirement denominated as “transaction causation,” and the victim‘s injury must also be proven to have derived from that same securities decision, a requirement somewhat ambiguously termed “loss causation,” Schlick v. Penn-Dixie Cement Corp., 507 F.2d 374, 380-81 (2d Cir. 1974), cert. denied, 421 U.S. 976, 95 S.Ct. 1976, 44 L.Ed.2d 467 (1975). Attempts to prove the existence of each link in this somewhat elongated chain of causation have engendered considerable controversy. With respect to “transaction causation,” it was frequently contended, particularly in nondisclosure cases, that plaintiff‘s course of action was in fact unaffected by the material omissions, and that this first link had not, therefore, been established. Such contentions have been rejected in several cases, see Mills v. Electric Auto-Lite Co., 396 U.S. 375, 385, 90 S.Ct. 616, 622, 24 L.Ed.2d 593 (1970), and Affiliated Ute Citizens v. United States, supra, 406 U.S. at 153-54, 92 S.Ct. at 1472; see also Shapiro v. Merrill Lynch, Pierce, Fenner & Smith, Inc., supra, 495 F.2d at 238-40, which holds that in nondisclosure suits, transaction causation will be presumed when the matters withheld are material. See Piper v. Chris-Craft Industries, Inc., supra, 430 U.S. at 50-51, 97 S.Ct. at 953-954 (1977) (Blackmun, J., concurring). Similarly spirited defenses have also been raised with respect to the second link, as defendants have claimed that the injury was not occasioned by a securities transaction, or that the connection between those events was too attenuated to satisfy the loss causation requirement. See Superintendent of Insurance v. Bankers Life & Casualty Co., 404 U.S. 6, 92 S.Ct. 165, 30 L.Ed.2d 128 (1971); Vine v. Beneficial Finance Co., 374 F.2d 627 (2d Cir.), cert. denied, 389 U.S. 970, 88 S.Ct. 463, 19 L.Ed.2d 460 (1967); Hoover v. Allen, 241 F.Supp. 213, 230 (S.D.N.Y.1965). See also Chris-Craft Industries, Inc. v. Piper Aircraft Corp., 480 F.2d 341, 401 (2d Cir. 1973) (Mansfield, J., concurring and dissenting).
In my view, these cases do not undercut the requirement that a single, direct causal chain run uninterrupted from the alleged violation through a securities transaction to a demonstrable injury. In resolving the technical problems of establishing transaction or loss causation, the courts have refused to create insuperable barriers to the demonstration of their existence, and in appropriate situations have allowed the element of causation to be demonstrated through resort to related notions such as reliance or materiality. Nevertheless, in facilitating the proof of causation, the courts have never renounced the element itself, and have never departed from the rudimentary principle that causation will not be found to exist where there is lacking a
On the contrary, the courts have consistently denied recovery of damages in situations, such as the present case, where the effect of the misrepresentation is merely to place a victim in a vulnerable position which subsequently leads to his injury due to a supervening event. For example, in Oleck v. Fischer, CCH [1979 Transfer Binder] Fed.Sec.L.Rep. ¶ 96,898 (S.D.N.Y.1979), aff‘d, No. 79-7513 (2d Cir. June 4, 1980), plaintiffs after reading defendant‘s prospectus sold it their business in exchange for promissory notes payable over time. The prospectus projected a favorable image of defendant‘s financial condition, due in part to a misrepresentation of the collectibility of a substantial debt owed defendant by a third party. That obligation was in fact defaulted upon, defendant underwent a financial collapse, and plaintiffs never received payment on their notes. The district court denied relief against the defendant or its independent accountant, however, since it held that the misrepresentation was not the operative cause for defendant‘s demise and plaintiffs’ consequent losses, which were in fact due to defendant‘s catastrophic losses in certain coal mining ventures which could not have been offset even if the debt had been fully discharged. Consequently, recovery was denied, inter alia, on the grounds that causation had not been established.
Again, in Miller v. Schweickart, 413 F.Supp. 1062 (S.D.N.Y.1976), a brokerage firm for several years engaged in an allegedly illicit arrangement with the Skelly Oil Company involving the sale and repurchase of bonds. Two years after this relationship had ceased, the brokerage firm went bankrupt, and its limited partners, who had allegedly invested due to the favorable financial picture made possible by the bond dealings, brought an action under the securities acts against the firm‘s general partners and Skelly. Finding that the brokerаge firm‘s financial collapse was due to developments other than the consequences of the sale-repurchase agreement, Judge Weinfeld granted Skelly‘s motion for summary judgment, stating:
To accept plaintiffs’ theory would extend liability for fraud beyond the immediate and foreseeable consequences of one‘s wrongdoing and in effect make Skelly the permanent accomplice of the Schweickart general partners in all their subsequent parking transactions with others; it would subject Skelly to strict liability for any future depredations by those general partners long after Skelly had ceased to have any dealings with Schweickart, even for deeds done with others years later, of which Skelly had no knowledge. This is causation run riot.
This fundamental principle of causation is equally well illustrated in the context of cases arising under Section 14. In Mills v. Electric Auto-Lite Co., supra, the Supreme Court held that where proxies are obtained
Where there has been a finding of materiality, a shareholder has made a sufficient showing of causal relationship between the violation and the injury for which he seeks redress if, as here, he proves that the proxy solicitation itself . . . was an essential link in the accomplishment of the transaction.
Id. 396 U.S. at 385, 90 S.Ct. at 622.8
Where the misleading proxy solicitation is merely a first step which ultimately results in losses from an unrelated or supervening cause, relief cannot be obtained under Section 14. Weisberg v. Coastal States Gas Corp., 609 F.2d 650, 654 (2d Cir. 1979), petition for cert. filed, 48 U.S.L.W. 3619 (U.S. Feb. 5, 1980); Maldonado v. Flynn, 597 F.2d 789, 795-96 (2d Cir. 1979); see also Galef v. Alexander, 615 F.2d 51, 65-66 (2d Cir. 1980). For example, if corporate officers are elected through solicitations which failed to disclose a material lack of qualifications, and those improperly elected officers subsequently proceed to harm the corporation and its shareholders through acts of deceit, waste or mismanagement which were not themselves authorized by the proxies, a suit to permit recovery of resultant damages will not be permitted. See, e. g., Limmer v. General Telephone and Electronics Corp., CCH [1977-78 Transfer Binder] Fed.Sec.L.Rep. ¶ 96,111 (S.D.N.Y.1977); Levy v. Johnson, CCH [1976-77 Transfer Binder] Fed.Sec.L.Rep. ¶ 95,899 (S.D.N.Y.1977).9
Essentially the same situation is presented by the case at bar. But for Kohn‘s misrepresentation of his expertise, plaintiffs might not have purchased the ill-fated stocks which he touted. Like the improper election of incompetent or larcenous officers, his misconduct was a precondition of the eventual loss. But since the actual damage in both cases stemmed from supervening events unrelated to the misstatements that induced the transactions, the chain of causation has been broken and recovery may not bе had.
It might only be added that there seems to be no policy justification for the refusal to give effect to the traditional standard of causation. The mission of
The majority offers no compelling rationale for its refusal to abide by the acknowledged standard of causation. It is emphasized that the misrepresentation in issue not only prompted the initial purchase but was later repeated so as to cause the retention of the stocks. This observation has no bearing on the principle governing this action. First, the trial judge did not make such a factual finding, and I do not believe that it can be “implied” from the opinion below. Factual support for such an approach appears to be lacking, since it may have been that Kohn‘s stocks all went into an immediate tailspin after their purchase by plaintiffs, and that they simply remained in this sorry state, or perhaps even revived somewhat, following Kohn‘s subsequent misrepresentations.10 More significantly, this claim even if supported by the record would not supply the missing element of causation. The fact that the defrauded parties retained their stock after a reprise of Kohn‘s deception is no more the cause of the stock‘s loss of value than was Kohn‘s initial misrepresentation.
Because I view the causation issue as dispositive I would not consider whether it is permissible or advisable for this Court to formulate on plaintiffs’ behalf theories of Wood, Walker‘s liability which were not averred in the pleadings, actively litigated or resolved by the trial court, see Opinion of the District Court, 470 F.Supp. 509, 515 n.11. Consequently, I intimate no view on the merits of those issues.
The judgment as to Wood, Walker should be affirmed and as to Kohn, reversed.
Notes
[T]here would have to be a showing of both loss causation—that the misrepresentations or omissions caused the economic harm—and transaction causation—that the violation in question caused the appellant to engage in the transaction in question.
507 F.2d at 380 (emphasis in original; footnote omitted). However, most commentators have construed this term to connote the necessary causal nexus between the securities transaction and the injury, rather than the requisite connection between the violation and the injury. See, e. g., Jennings & Marsh, Securities Regulation at 1068-69 (4th ed. 1977). Judge Frankel, concurring in the result in Schlick, expressed reluctance about the phrase coined, see 507 F.2d at 384, and other courts have been noticeably reluctant expressly to adopt this language. See, e. g., Moody v. Bache & Co., Inc., 570 F.2d 523, 527 n.7 (5th Cir. 1978); St. Louis Union Trust Co. v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 562 F.2d 1040, 1048 n.11 (8th Cir. 1977), cert. denied, 435 U.S. 925, 98 S.Ct. 1490, 55 L.Ed.2d 519 (1978).
It therefore has the potential of creating a windfall recovery to a plaintiff in the nature of indemnification against the risks of the vicissitudes of the market, and at the same time saddling defendants with payments far out of proportion to the damage caused by their fraud.
416 F.Supp. at 1384. See also Federman v. Empire Fire and Marine Ins. Co., 74 F.R.D. 151 (S.D.N.Y.1976), rev‘d in part on other grounds, 597 F.2d 798 (2d Cir. 1979).
a shareholder has made a sufficient showing of causal relationship between the violation and the injury for which he seeks redress if, as here, he proves that the proxy solicitation itself, rather than the particular defect in the solicitation materials, was an essential link in the accomplishment of the transaction.
396 U.S. at 385, 90 S.Ct. at 622. This rule does not mandate a relaxation in the standard of causation suggested here since the violation in Mills lay not in the directors’ advising approval of the merger, but in the procurement of shareholder acceptance of the plan through a failure to reveal that their ostensibly loyal directors who were recommending the proposal, were in fact corporate double agents.