SUPT. OF INSURANCE v. BANKERS LIFE & CAS. CO.
Legal provision: Securities Act of 1933, the Securities and Exchange Act of 1934, or the Williams Act
Argument of Arnold Bauman
Chief Justice Warren E. Burger: We will hear arguments next in number 60, Superintendent of Insurance of the State of New York against the Bankers Life and Casualty.
Mr. Bauman, you may proceed whenever you are ready.
Mr. Arnold Bauman: Mr. Chief Justice and may it please the Court.
This case appears in this Court as a result of a grant of certiorari to review the affirmance of judgments by the Second Circuit Court of Appeals which affirmed a motion of the District Court, dismissing the complaint in this case, on the basis that the complaint did not present an instance of Federal jurisdiction under Rule 17 of the Security Act of 1933 or Rule 10 and, I beg your pardon, Section 10 and Rule 10 (b) 5 of the Security Act of 1934.
As I am certain, the Court is aware, I shall say, merely very briefly that Section 17 (a) of the 1933 Act deals with the usage of interstate facilities of interstate commerce in connection with the stock frauds involved in the purchase of securities.
Section 10 (b) which is reproduced at page 3 of our brief as well as Rule 10 (b) (5) was later passed, a year later, and I respectfully urge upon the Court that it was passed to cover the loopholes, to make up for the loopholes which Congress left when it passed Section 17 (a) of the 1933 Act.
Now, I should like merely to refer to one part of Section 10 (b) because it is at the crux and at the center of the argument that I intend to make.
Section 10 of course states that “it shall be unlawful for anyone by use of means of interstate commerce to use or employ any deceptive device,” and of course I am leaving up irrelevant words, “in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or,” or and I shall come to the reason for that emphasis, “for the protection of investors.”
I think I can say now before I discuss the facts with the Court that the reason I stressed the “or” in Rule 10 (b) (5) is because I respectfully submit that the Court below, both Courts below, Judge Herlings (ph) in the District Court and the United States Court of Appeals for the Second Circuit, both tended to read the protection, the words “in the public interest” as synonymous with the “protection of investors.”
And I respectfully submit to this Court that when rule was promulgated, the exchange had in mind, I beg your pardon, when that Section was passed, the Congress had in mind a different test for that which is alleged to have been in the public interest from that which is necessary for the protection of investors.
Justice William J. Brennan: Mr. Bowman.
Mr. Arnold Bauman: Yes sir?
Justice William J. Brennan: It is a term a issue in this case, in connection with the purchase of (Inaudible)
Mr. Arnold Bauman: Your honor, I was just this moment coming to that.
I was about to say that Rule 10 (b) (5) presents or gives rise to the second or another one of the issues in this case, in that it in effect paraphrases Section 17 (a), but then adds as Mr. Justice Brennan has called to my attention, in his very last words, that it prohibits unlawful actions in connection with the purchase or sale of any security.
Now, the Court of Appeals and I should like to use part of my time to discuss the facts with the Court because I think they are very important in this case, but in order to put it in focus, I would like to submit that the Court of Appeals felt that where a securities transaction is pure in itself, in other words, securities worth X dollars are sold for X dollars, even though that is part of an -- and an integral part, indeed a -- an absolutely necessary part of an overall fraudulent scheme to fact that neither the securities transaction was impure nor were the processes of a marketplace, solely to use the words of the opinion below, that in such a case as long as the -- as the securities transaction is pure, the Court below felt that it was not “in connection with a securities transaction.”
Now, with the Court's permission I should like to address myself to the facts of this case because as I say in my view they are -- they are that important.
I should say at the very first that I appear as a representative of the Superintendent of Insurances of the State of New York who as a result of the transactions which I am about to relate was appointed liquidator of Manhattan Casualty Company, a New York Insurance Company and of course the liquidator was appointed by the Supreme Court of the State of New York and functions under an order of such appointment.
Until January 24, 1962, Bankers Life was the sole stockholder of Manhattan Casualty Corporation.
On that day Bankers sold its Manhattan stock to a group consisting of a man named Bourne and another man named Begole, who had no money at all as will come out in a moment, for five million dollars.
It had previously been arranged with the Irving Trust Company that at the closing of this Manhattan Stock, Irving would appear with the check for five million dollars and at the closing, at the sale from Bankers Life to Bourne and Begole, a representative, an officer of Irving Trust did in fact appear with a check made up in the sum of five million dollars payable to Bankers Life.
This was delivered at the -- at the closing. I should point out that in this point of time and indeed to the best of my knowledge, until after the close of business on January 24th, 1962, Manhattan casualty had no account to them, nonetheless, Irving did issue this check of five million to Bankers Life obviously to pay for the stock which was being transferred.
Shortly after the closing of the stock, a new Board was elected and the Board convened.
Unknown Speaker: (Inaudible)
Mr. Arnold Bauman: Yes sir, and the Board convened.
It was represented, and I believe the record best indicates that it was represented at that meeting by the Chairman of the Board, new Board of Manhattan, the man Begole whom I previously made reference as a purchaser that Manhattan's portfolio of Government Securities, US Government Bonds and Securities totaling some $4,854,000.00 was an undesirable investment from the point of view of the corporation and recommended to the Board of Directors that in order to bet at the corporate position, these bonds should be sold and the money invested in a certificate of deposit.
The Board of Directors, believing that the sale of its portfolio of Government Securities totaling almost some five million dollars was so going to be altered, voted a resolution relying on the misrepresentations of the Chairman, authorizing the sale of the portfolio of Manhattan's government funds.
They were rapidly sold.
Justice Byron R. White: Is this, how were they sold, did they use some (Inaudible)
Mr. Arnold Bauman: I am not -- they were sold to the Second District Securities and I am not certain whether or not in that sale an instrumentality of the stock exchange was used, I do not believe so Mr. Justice White.
Justice Byron R. White: (Inaudible) What is the unification of the stock exchange where the Federal Statute require that?
Mr. Arnold Bauman: No sir, it does not.
Under Section 10 in Rule 10 (b) (5) it is not required that security sold be either listed or unlisted or --
Justice Byron R. White: How about (Inaudible)
Mr. Arnold Bauman: I think the reason we are here has not to do along with the -- with the sale of those securities, but the fact that payment, a check in the sum of five million dollars, the payment to Bankers Life was in fact mailed to Chicago, the home offices of Bankers Life.
Justice Byron R. White: I know that is not an issue to me, securities (Inaudible).
What did it (Inaudible)?
Mr. Arnold Bauman: I just verified my own recollection.
These securities were not sold, the $4,853,000.00 worth of Manhattan bonds were not sold on the stock exchange.
Justice Byron R. White: Well, (Inaudible), however, if they did not (Inaudible) they could (Inaudible)
Mr. Arnold Bauman: Your Honor -- does Your Honor mean Mr. North, the SEC's representative?
Justice Byron R. White: (Inaudible) How about you -- your position is --
Mr. Arnold Bauman: My position Your Honor is this.
There were two securities transactions in the connection with either one of them this Court -- Federal jurisdiction was properly invoked.
In the first instance, you had the sale of Manhattan's Security, I beg your pardon, the sale of the stock of Manhattan from Bankers Life to Bowlin, Bourne and Begole.
That's securities transaction number one and under Section 10, does not have to involve listed securities.
Justice Byron R. White: I know, but it has to be nevertheless involved with (Inaudible)
Mr. Arnold Bauman: Well, in connection with jurisdiction as I say, although it does not appear as an issue here, I will respect --
Justice Byron R. White: (Inaudible)
Mr. Arnold Bauman: Exactly, in payment of those very securities by the way.
Justice William J. Brennan: In payment of Manhattan Stock?
Mr. Arnold Bauman: Yes sir.
Justice William J. Brennan: (Inaudible)
Mr. Arnold Bauman: Well, there is a man in this case whose name is Garvin, and Mr. Garvin was a note broker and dealt, a member of the Firm of Garvin Bentel also a defendant and apparently a large dealer in certificates of deposit and basically a note broker and a stock broker.
In some manner, Bourne and Begole, now Bourne was a similar fellow from Boston, Bourne got together with Garvin and we contend, Superintendent of Insurance contend that Garvin arranged, indeed it is absolutely provable that Garvin arranged with Irving Trust to show up at the closing of the Manhattan Stock with a check for five million dollars and Garvin was --
Justice William J. Brennan: (Inaudible)
Mr. Arnold Bauman: Sir, and Garvin likewise arranged the afternoon transactions which as I will come to in a moment were designed to cover-up what had happened in the morning.
Now, I started to respond to Mr. Justice White's question if I might, Mr. Chief Justice, I should like to come back to that.
I have indicated to the Court that the Superintendent of Insurance contends that there are two securities transactions here and we rely as a matter of fact on both of them.
We think that the Court of Appeals was wrong when it said that we will not reach the question in connection with the sale of the Manhattan securities as to whether or not this is in connection with, because as to those securities you not being either a buyer nor a seller do not have standing.
So as to that transaction they never did get to the question, although I might point out that Judge Hayes, who dissented in the Court of Appeals, dissented without talking about standing but simply said “These transactions were obviously at the core of a fraud and I dissent.”
As to the sale of the government securities, the Court of Appeals fragmented the fact situation here, did not look at the actual fraud but said as I indicated to the Court before that since the stock transaction itself was pure, since value was received by the company and true value for these government bonds, all you have here is a misappropriation of proceeds of the sale.
It's corporate mismanagement, it's corporate waste and we do not feel that is appropriate under 10 (b), under Rule 10 (b) (5).
So, it is in connection with those two transactions that I press upon the Court the view that, and I will come to this a little later, that Birnbaum, which is a principal case on the question of the buyer-seller status under Rule 10 (b) (5), it being a Second Circuit Case in which Justice Hahn wrote the opinion many years ago, I shall urge upon the Court that in connection with Rule 10 (b) (5) that the limitation of the buyer-seller rule of Birnbaum is a -- is an artificial limitation and while I would understand that an expansion of it might somewhat increase Federal litigation, I respectfully suggest that speaking only as a representative of creditors that whether or not the Court wishes to extend 10 (b) (5) beyond buyer and seller, I respectfully suggest that there should be a third category beyond buyer and seller, namely that a representative of creditors, because certainly when one talks about, making regulations in the public interest or in the interest of investors, it seems to me that the Congress had to be talking about creditors and the representatives of creditors.
Indeed in the brief, we cite the cases, most recent one of which is Bails (ph) and going back to Hooper which is a landmark case of the Fifth Circuit, which has dealt with this problem over and over and over again and I respectfully suggest that a reading of those cases will show that it has consistently permitted a representative of creditors, a trustee in bankruptcy, a receiver, a person like the liquidator who presumably does precisely the same thing as those gentlemen do, except that because it is an insurance company it is covered by State Law, and so I would suggest that Birnbaum should be extended to include such a person in the interest of the creditors which I suggest are in the interest --
Justice William J. Brennan: You mean if creditor's representative (Inaudible) or what?
Mr. Arnold Bauman: I would -- I --
Justice William J. Brennan: (Inaudible) on the insurance's action selling bonds --
Mr. Arnold Bauman: Yes.
Justice William J. Brennan: They were sold at five and a half.
Mr. Arnold Bauman: That is precisely --
Justice William J. Brennan: (Inaudible) of the representative of creditors of Manhattan to be allowed to stand in the shoes of (Inaudible) to satisfy the requirement of the sale?
Mr. Arnold Bauman: That is precisely what I am suggesting and I suggest that because when a person is designated in such a capacity, being a superintendent, a liquidator, a receiver or whatever, he is there, his interests are varied and many.
His interest are to see that the, that all creditors, all people involved with the corporation, that the corporation discharges its obligations to any and all people to whom it owes obligations.
Justice Potter Stewart: What other creditors in Manhattan in the record?
Mr. Arnold Bauman: The creditors Manhattan at the present time, Your Honor are mostly policy holders, people with claims against Manhattan.
Justice Potter Stewart: Now, that is what creditors are, people with claims against you or insurance --
Mr. Arnold Bauman: Well the, there is the (Voice Overlap), they are the public, there are the insured public.
Justice Potter Stewart: Was there any indication in any of these pleadings as to who they are or if they have been, if their claims have been unsatisfied as declared?
Mr. Arnold Bauman: There is a reference in the reply brief to that, a short reference in the reply brief to the fact that there are claims outstanding and as damages, if we ever get to the trial that we will prove those damages at the trial and they will be among other things the claims of the creditors sir.
Now, I want to come back, if I may to the events of that January 24th afternoon and because we are now at the situation where through a fraudulently induced representation of the Board, the Board has authorized the sale of Manhattan's Government securities.
They have now been sold.
The proceeds have been put into the Irving Trust Company which issued the first five million dollar check and in addition Manhattan sends over enough money I think it's $150,000.00 in cash to cover the difference between $4,854,000 and five --
Justice William J. Brennan: (Voice Overlap) Now we are talking about Manhattan?
Mr. Arnold Bauman: Yes sir, yes sir.
Justice William J. Brennan: (Inaudible) and how is it to know --
Mr. Arnold Bauman: Yes sir, and so now Irving has been fully repaid for the five million dollar check, it is whole.
However, at this point in time may it please the Court, Manhattan has minus five million dollars and is very near, if not actually insolvent in a regulated industry, I have one in which the insurance, the Superintendent of Insurance regularly visits and inspects.
So in order to make this scheme good one had to come up with the scheme to create a paper asset which would take the place on the Manhattan balance sheet of the five million dollars which the corporation have been looted.
Now, what happened there?
Mr. Bourne, I beg your pardon, Mr. Garvin then arranged an afternoon check, most of these transactions I have told you about until now occurred in the morning.
In the afternoon the representative, the Irving Trust Company shows up at Belgian-American Bank and Belgian-American Trust, that is really two entities, but one organization, I shall refer to them as Belgian-American Bank and this representative has a second check for five million dollars.
Whereupon, Belgian-American Trust Company issues a certificate of deposit in the name of Manhattan Casualty Company for five million dollars.
This is endorsed by the conspirators and the so called loan is arranged with Belgian-American Bank to one of Bourne's companies called New England Note for five million dollars.
The Belgian-American Trust CD which was paid for with Irving Trust Company money is used as collateral for the five million dollar loan to New England Note, but proceeds of the so called New England Note loan are then immediately delivered to Irving Trust's representative so he came with the check for five million dollars and went back with the check for five million dollars and once again Irving Trust withhold.
Now, where were we at, at that point?
At this point now, the Manhattan is out five million dollars.
It carries the Belgian Trust certificate of deposit, even though it is hypothecated as cash on its balance sheet.
Justice William J. Brennan: Does not reveal hypothecation?
Mr. Arnold Bauman: Does not reveal hypothecation in any way.
It carries that five million dollars, it's penal fraud because there is not any five million dollars.
Justice Potter Stewart: Well upon whom?
Mr. Arnold Bauman: Fraud on Manhattan Casualty.
Justice Potter Stewart: Who is defrauded?
This is a case, it seems to me where a fellow took over a corporation and looted it and he was the sole owner and so who was defrauded?
Mr. Arnold Bauman: The people who were defrauded are the public who have seven figure claims against this corporation.
The people who are defrauded, if the corporation sir is an entity at all, if the corporation is an entity I would respectfully suggest to you that because it showed five million dollars in assets it did not have on its balance sheet, it is perfectly conceivable to me that people relied on that balance sheet, people outside the company and those are the people we are talking about as the public, the people who wrote policies, the people who have claims against the company and those are the people whom I am concerned here.
So that at the end of January 24th, Manhattan was out five million, Mr. Bourne and Begole had the stock for nothing there was a fraudulent asset on the books and as time went on Irving caused –
Justice William J. Brennan: Mr. Bauman can you tell us what Mr. (Inaudible) in connection now with the second transaction, there was a bond of (Inaudible)
Mr. Arnold Bauman: Well, my answer to you sir is this.
It is my contention that all of these transactions to which I have alluded were part of one overall scheme.
Justice William J. Brennan: And it's all looked to that (Inaudible) the initial five million dollar check of Irving (Inaudible)?
Mr. Arnold Bauman: Yes sir, that is right.
Justice Byron R. White: Well, part of the deal though is fully accepted transaction (Inaudible).
I know you don't agreed with them?
Mr. Arnold Bauman: I know that Court of Appeals may have said that but it means to me that --
Justice Byron R. White: At least, they were right with that (Inaudible)
Chief Justice Warren E. Burger: I think we will let you answer Justice White after lunch Mr. Bauman.
Mr. Arnold Bauman: Yes sir.
Chief Justice Warren E. Burger: Mr. Bauman you are about to answer Mr. Justice White.
Mr. Arnold Bauman: Yes sir, I am.
Chief Justice Warren E. Burger: I am sure you are better prepared to answer it now.
Mr. Arnold Bauman: Then I am, I appreciate the opportunity to prepare for that.
As a matter of fact, Mr. Justice White and members of the Court, throughout the years of this litigation that question has never risen, but the answer is perfectly obvious and I shall give it.
In connection with the sale of all the securities there were innumerable confirmations sent through the mails in connection with the sale of the $4,854,000.00 of US Government Securities.
There were confirmation sent through the mail.
In connection with the sale of those securities there were telephone calls made, using instrumentalities that give jurisdiction pursuant of the security fraud.
Well, that is it and I am sorry I was not better equipped to answer Your Honor's question before luncheon recess.
Chief Justice Warren E. Burger: One of those is so obvious that you have not see that right away?
Mr. Arnold Bauman: Absolutely right sir.
I want to use my remaining time also perhaps to clear up an earlier answer I made to Mr. Justice Brennan.
I want to make clear to the Court, if I may that so far as the US Government Securities are concerned, the $4,854,000, we feel that we have met every single element of 10 (b) (5) and we think that the elements of 10 (b) (5) are as follows.
One, that the Board of Directors was deceived.
Two, that $4,800,000 worth of Manhattan's Securities was sold as a direct result of that deception.
Three, the corporation gave up five million dollars in securities and got nothing.
Now, both Judge Herlings in the District Court and that I believe the United States Circuit Court for the Second Circuit held and as to that transaction and that series of transactions there was no question of my standing to sue or the liquidator’s standing to sue because Manhattan was in fact the seller of security.
It was in connection with the transaction involving the sale of the Manhattan shares between Bankers Life and the buyers that they invoked the Birnbaum doctrine.
And again, I want to say that the fragmentation of this one overall scheme which had it as its sole purpose, the looting of the company of five million dollars without the sale of securities, it could not possibly have happened is where I thought company from the Second Circuit.
Justice Potter Stewart: The Board of Directors was deceived by this sole stockholder?
Mr. Arnold Bauman: Yes.
Justice Potter Stewart: Who -- directors were therefore his representatives as managing the company that he fully owns, is that right?
Mr. Arnold Bauman: Well, he was a sole stockholder.
He elected him, yes.
But when the Court says --
Justice Potter Stewart: And directors generally represent the stockholders of the corporation.
Mr. Arnold Bauman: Well, Mr. Justice Stewart, it seems to me that while he may be elected by the stockholders he has certain public responsibilities as well as indeed if he has many to the person who elected him.
It seems to me that there are penal statutes, I beg, I withdraw the word penal, there are statutes which impose responsibility, financial responsibility for acts of directors beyond his obligations to the person or persons who elected him.
I do say that, point I do want to stress again is that if the corporate entity has any meaning at all, it has got to be separate on the pod from both its stockholders and directors and whereas here, a liquidator or receiver stands in the shoes of the corporation as opposed to the individual who may own the corporation.
He has or should have the right to assert public claims involved in the responsibilities of the corporation to the public.
Justice Byron R. White: Well, that position would be the same if all the directors helped secure the loan problem.
Mr. Arnold Bauman: Yes, Mr. Justice White, it would be.
Justice Byron R. White: So that he can take it even to see after all (Inaudible).
Mr. Arnold Bauman: That is correct, that is correct.
Justice Potter Stewart: Whom did he deceive, assuming Mr. Justice White’s hypothesis that the directors and the sole stockholders had all had full knowledge of this looting, then who would have been deceived?
Mr. Arnold Bauman: The public who would have relied on the statement of Manhattan’s assets.
Justice Potter Stewart: On its balance sheet?
Mr. Arnold Bauman: Yes sir, but I do hasten to assure the Court if I may that that is not the situation in this case.
The Board was not fully in on this.
As a matter of fact, the Board was deceived.
I hope the Court will forgive me for emphasizing that.
I merely attempted to reply to Mr. Justice White’s question which is argued in our brief.
There is one other point I want to mention quickly because I notice I have a very short time to go and that is there is cited and relied upon by my adversaries, case of Field against Lowe (ph) which is a District Court case in the Eastern District of New York written by Judge Zwack.
That was a case involving a common law conversion.
It was a case in which because it was a common law conversion and their sole stockholder was the one who caused it, Judge Zwack felt that he had ratified the fraud and therefore there was no cause of action.
I merely want to specify that that case which is relied upon by my adversaries differs so strongly from this fact situation because one thing is, that case dealt with the State Common Law of Conversion.
It did not attempt to interpret 10 (b) (5) and there were no allegations of deceit on the Board of Directors of that corporation.
The factual situation is entirely different.
it is not based on the statute that we are here to discuss and indeed I respectfully refer the Court to the opinion in Bails in the Fifth Circuit which is cited in the brief and which comes out exactly on the opposite side of this question of does knowledge by all the stockholders constitute ratification.
Thank you very much.
Justice Harry A. Blackmun: Mr. Bauman I take it for (Inaudible)
Mr. Arnold Bauman: Yes sir.
May I recommit one sentence in addition to that?
Justice Harry A. Blackmun: I would like that.
Mr. Arnold Bauman: The mere fact, and this is dealt within the brief Mr. Justice Blackmun, is if in fact there is a State remedy that as we cited and discussed in the brief, does not oust us of Federal jurisdiction if in fact we do fall within the Section 10 (b) and Rule 10 (b) (5).
In other words, Your Honor will find in the cases particularly in the Fifth Circuit the repeated statement and other statements at the fact to that there may exist a State remedy in no ways affects the Federal remedy.
Chief Justice Warren E. Burger: Thank you Mr. Bauman.
Argument of Walter P. North
Mr. Walter P. North: Mr. Chief Justice and may it please the Court.
The commission is grateful for the opportunity to participate in this argument before and today.
You have, on many occasions permitted us to file amicus briefs, but participation of the argument means even more to us now, try to make good use of the time you have awarded us.
I like to start in substantially where the counsel for the petitioner left off on this question of fragmentation which is, in my way of thinking the thing that caused the Court below to go wrong and is the point at which the argument is now made by the opposition in support to that result is also erroneous.
On pages two and three of our briefs, we quote both Section 17 from the 1933 Act which has the anti fraud provision there and Section 10 (b) in Rule 10 (b) (5) from the 1934 Act.
And I direct the Court’s attention to this difference between the two which I say the Court below overlooked entirely.
Section 17 (a) says it shall be unlawful for any person in the offer or sale of any security by use of interstate so on and so forth to employ fraud.
In other words, the fraud must be in the offer or sale of any security.
Whereas in the 1934 Act, the requirement is not that the fraud be right inside of the sale or purchase itself, but that it be in connection with the purchase or sale.
Now, you are not ascribing anything, any meaning at all to those words and that difference between these two statutes, if your rule as a Court below did, that there is not a case stated under 10 (b) from 10 (b) (5) in this case then I would direct your attention at the bottom of page three and the top of page four, to the fact that Rule 10 (b) (5) has three sub paragraphs.
I submit that the Court below refused to take any cognizance of sub paragraphs one and three of that rule.
They fragmented this thing down to the point where they refused to look at it as an overall scheme device or artifice to the fraud, which is the words used in sub paragraph one or to look upon it as sub paragraph three says “as engaging in an act, practice or course of business which operates as a fraud or a deceit upon any person.
They analyzed this case solely in terms of the second paragraph of the second sub paragraph of Rule 10 (b) (5) and even there, took an unduly limited and restricted view of it because it says “that it should be unlawful to make any untrue statement of material facts or to omit those state -- a material fact in connection with purchase or sale of securities.
As counsel has already said, there is abundant evidence that they did misrepresent to the directors and they did fail to disclose to the directors their true intention as to what they are going to do with the proceeds of this sale of bonds.
Remember that earlier in the day, going to the bank and got a five million dollar check written with nothing behind it.
They obviously had to be intending to convert the proceeds of the sale of the bonds in order to cover the check and that is exactly what they did, and they deceived the directors in that respect.
So I say that the Court, by refusing to look at the thing in that sort of a way, and by refusing to connect that one sale of Government bonds, which by the way is the particulars of the transaction that the government relies on in this case, they refused to look upon that as a part of an overall scheme and the other parts of which were also essential to this scheme and all of which should be considered as a package, not as individual fragmented facts.
Justice Byron R. White: You do accept whatever the bonds applied?
Mr. Walter P. North: We separate the bonds from the stock only to the extent that we say that the government relies on the bond sale as the basis for which we say the Court of Appeals below should be reversed.
Justice Byron R. White: Not the (Inaudible)
Mr. Walter P. North: Certainly not.
Justice Byron R. White: You do not need to go (Inaudible)
Mr. Walter P. North: That all, as long as we show that someone part of the scheme involved the purchase or sale or is in connection with the purchase or sale of --.
Justice Byron R. White: (Inaudible)
Mr. Walter P. North: We say the stock selling section was a part of the overall scheme.
It's the same as the bond sale and the same as these subsequent things they did, the transactions they carried out in the afternoon of that day where they went through this business of chasing themselves out around the circle and coming back where they ended exactly where they started from, that was all a part of the scheme to the defraud.
The reason that we did not dwell upon the sale of Manhattan’s own stock from Bankers Life to the defrauders as a part of our case is because that runs directly contrary to Birnbaum which says that the defrauded party must be either a purchaser or a seller, well of course Manhattan itself did not sell anything or buy anything.
Justice William J. Brennan: (Inaudible)
Mr. Walter P. North: We have suggested that on a number of occasions, we have suggested it in the Second Circuit itself.
Justice William J. Brennan: Are you suggesting?
Mr. Walter P. North: And we suggested in this case, largely just by a way of a footnote that says that we have never agreed to that theory, but we realize that in order to win this case on that ground you had to overturn Birnbaum whereas you do not necessarily overturn it and the other is context.
Incidentally I think it is quite significant in that regard that Judge Hayes, who dissented as one member of the Three Judge Panel who decided this very occasion today, he just flatly would overrule Birnbaum.
Let me read you just two sentences, his opinion is only a page-and-a-half long, as reprinted in the appendix on pages 109 and 110, just two sentences.
He says Manhattan was the victim of a “scheme to defraud,” which is the language of the of rule.
Since the vital center of the scheme, the vehicle for the perpetration of the fraud was the sale of Manhattan’s stock, it seems to me to be completely unrealistic to say that the fraud was committed “in connection with the purchase or sale of any security.”
Well, now Judge Hayes knows just as well as any of us here in the room do, that the sale of Manhattan's stock did not involve Manhattan as either a purchaser or as a seller.
And he is saying in so many words that when you have got an overall scheme to defraud, you do not fragment it to look at the overall scheme and if any part of it was in connection with the purchase or sale of securities, that is the answer.
The answer does apply in the question of whether the plaintiff himself happened to be a purchaser or a seller and it seems to me that anything short of that simply overlooks the difference in wording between Section 17 of the 1933 Act and Section 10 (b) and Rule 10 (b) (5) or the 1934 Act because the one says it must be in connection with the sale or as the other -- the one says it must be in the sale or in the purchase, whereas the other says that it has to be in connection with a purchase or sale by any person.
I would like to deal, just a moment with this question of whether we are pursuing a purely self inflicted fraud that really did not hurt anybody because Mr. Begole or Mr. Begole and Bourne themselves were the sole owners of this corporation.
That kind of a position of course overlooks the community of interest which a corporation represents over and beyond the interest of the stockholder or stockholder alone.
If you had, for example a corporation that had outstanding bonds or debentures or other form of debt securities, you certainly would not say that they want, that that interest was not to be protected and likewise the interest of other creditors and policy holders is all a part of the overall community that the statute is designed to present to protect, not just to protect alone the shareholder, who in this case was the sole shareholder who was the one who perpetrated the fraud.
Justice Byron R. White: (Inaudible)
Mr. Walter P. North: You mean under 10 (b) (5)?
Justice Byron R. White: (Inaudible)
Mr. Walter P. North: The representative of the creditor certainly would have that right and here the plaintiff in this case is the Superintendent of Insurance.
Justice Byron R. White: (Inaudible)
Mr. Walter P. North: Pardon?
Justice Byron R. White: (Inaudible) to bring derivative actions on behalf of the corporation?
Mr. Walter P. North: No I do not say that, but I do not think that is the key thing here.
The key thing here is that the action is being brought by the Superintendent of Insurance derivatively on behalf of the corporation which in turn had some creditors so that the creditors are a part of the community of interest which is being protected by this suit under 10 (b) (5).
Justice Byron R. White: Are those creditors' claims been unsatisfied?
Mr. Walter P. North: I do not know to what extend there are still outstanding unsatisfied claims, I think I have to refer that question maybe to private counsel but I do know that --
Justice Byron R. White: The important fact of the creditors have been paid in full, would not that be a relevant fact?
Mr. Walter P. North: In the process to whatever extent the creditors have been paid, I will assume that in the process, someone else has been subrogated to their right.
Superintendent of Insurance is not bringing this action on behalf of Mr. Begole, that is certain and there is abundant authority for the proposition that creditors are entitled to protection.
Your own case here of Pepper versus Litton which is cited in our brief, while it predates the Federal Securities laws, makes it perfectly clear that a so-called self inflicted fraud by somebody who controls a corporation still cannot be relied upon as a means of defeating the action which is brought on behalf of creditors or anyone who is dealt with or contracted with the corporation.
Justice Byron R. White: So you look at this as something like the transfer by a corporation and fraud of creditors?
Mr. Walter P. North: Yes something of that.
Justice Byron R. White: That might have (Inaudible) an act of bankruptcy reasons.
Mr. Walter P. North: That is right, if that could be.
The leading case I think in this area that actually does come under the Federal Securities Laws whereas Pepper versus Litton just before the 1934 Act.
The leading case that does come under the Federal Securities Laws is the Hooper versus Mountain State's case and in there it was plainly held even though the corporation itself was controlled by the person who committed the fraud, the fact did not mean that there could not be recovery for the benefit of creditors or anybody else who had dealt with the corporation in reliance on the Court with transaction and the Bail's case which is referred to here earlier is to the same effect and it is so recent that this does not even appear on our brief, it was decided since our brief was written.
And I think it is important in this connection to note that Congress at the very time it was drafting this statute had in mind, in relation to insurance companies, the fact that creditors and policy holders could be involved.
The House Report, I am paraphrasing or quoting now on facts away from the footnote in page 27 of our brief, the House report on the bill which became the 1934 Act noted that over 15 million individuals hold insurance policies, the values of which is dependent upon the security holdings of insurance companies.
That is quoted exactly from the House Report.
The Senate Report went on to observe that the current value of securities held by insurance companies and consequently the welfare of the countless individuals who have a financial interest in such institutions is directly effected by the activities, he is talking now about his activities in the trading and sale of securities.
So while it can be said that Congress was not perhaps directly concerned with creditors and policy holders as such to the extent that part of the community of interest that makes up an insurance company is creditors and policy holders that is a part of what Congress was directing itself to when it enacted the anti fraud provisions of the 1934 Act.
Justice Byron R. White: Would you take the thing of course that the sale of the bonds went through and there had been no previous intention to steal the money and then one of the officers, they just walk off with the cash”?
Mr. Walter P. North: Well that would be a little harder case but --
Justice Byron R. White: Well, it is the proceeds, you will suddenly get the idea walking back to the bank that it might be well to go to South America and you go, the (Voice Overlap) never gets the proceeds.
Mr. Walter P. North: I would not be prepared to conceive if there would not be a 10 (b) (5) action even under those circumstances, but this case is much stronger than that because there was a pre-conceived plan or scheme to do this very thing and the sale of the securities was a part of that scheme.
Justice Byron R. White: It does not Court of Appeals think that perhaps the securities laws, what intended just to cover ordinary fraud by director and officer and it would be difficult to contain the reach of the 10 (b) of this case would cover?
Mr. Walter P. North: That is a part of the type of reasoning of the Court below used in this case, but as long as you maintain the integrity of the requirement that the fraud be in connection with the purchase or sale of securities.
There is certainly no danger that that Federal Securities Laws is going to take over the whole field of the corporate mismanagement and looting, and everything else whereas securities transactions are not involved.
The securities transaction must still be a part of the fraudulent scheme in order for the (Voice Overlap)
Justice Byron R. White: Even if that would be true, you say, even if you eliminated the purchase or seller requirement, as long as there was a sale somewhere?
Mr. Walter P. North: Mr. Justice White I assume you are talking now about the requirement that the plaintiff himself be a purchaser or a seller.
I think that the requirement of the purchaser or seller himself or the plaintiff himself be a purchaser or seller can be done away with and still not make this Federal Securities Laws and the fraud provision, an undue incursion upon the State Law of fraud, as long as in connection with the purchase or sale.
That is why I would say that even this initial sale of all of Manhattan's stock to Begole should come within the purview of this and would, in some other circuits though obviously it cannot in the Second Circuit unless and until the Birnbaum case is overruled.
Chief Justice Warren E. Burger: I think your time is up, Mr. North.
Mr. Walter P. North: I believe it is, Your Honor and I am sorry if I ran over.
Thank you very much.
Chief Justice Warren E. Burger: Mr. Karatz.
Argument of William W. Karatz
Mr. William W. Karatz: Mr. Chief Justice and may it please the Court.
Plaintiff's basic contention here is that a claim under the Federal Securities Laws is stated because Manhattan's sole shareholder misappropriated Manhattan's funds insofar as the proceeds from the sale of Manhattan's bonds were concerned.
There are at least two reasons why plaintiff is wrong in asserting that Manhattan has any claim under Federal Law in connection with this transaction.
First, there was no deception of or damage to Manhattan because Manhattan's sole shareholder knew of, participated in, benefited from and fully ratified the allegedly fraudulent transaction.
Since Manhattan, by way of its sole shareholder could not have been deceived, suffered no damage, there was no Federal fraud in connection with the sale of any security, either the Manhattan bonds or anything else.
Now, Mr. Bowman and Mr. North have suggested that there is something to a corporation other than its shareholders.
I would suggest that it is standard corporate law that when shareholders fully ratify the action taken by a corporation, that becomes corporate action.
Now, it may be that such action would constitute a fraud on creditors, as long established common law in this area.
If corporate insiders by their actions with regard to the corporation in someway damage creditors, creditors have remedies at common law and by statute in all of the States.
They have remedies by way of an action for fraudulent conveyance.
They have actions by way of, an action for illegal dividend.
There was no need for Congress to provide creditor remedies.
Those remedies already were available to creditors and I suggest that if you have sole stockholder approval of an action, certainly under Federal Law and in Federal Securities Law, there can be no fraud on the corporation.
Justice Harry A. Blackmun: Why is it so important to you though to be in the State Court rather than in the Federal Court?
Mr. William W. Karatz: Your Honor, if I may be very frank about the reason why we are here today, and quite frankly I am glad I am here today because I think this is an important issue of law because Chief Judge Ryan invited the defendants to make a motion to dismiss.
If I may tell you quite frankly what tactics of defense counsel was on this case, we were going to take it through the trial in the Federal Courts and then get the case dismissed, because we did not think that there was a Federal claim here.
We went all the way through years of pre-trial discovery, thousands of pages of testimonies, hundreds of documents. Chief Judge Ryan, when Mr. Parker made a motion for summary judgment, refused to decide the motion for summary judgment on its merits, stating that in his view, the complaint did not spell out a claim and suggested to counsel that a motion to dismiss be made, because he felt that this was not a federal action and that the Federal Courts in the Southern District of New York should not have to go through a trial that will take weeks, if not months.
We made that motion to dismiss, pursuant to the suggestion of Judge Ryan and we were sustained in our relief all the way up to this Court that there is no federal claim here.
Now, in response to Judge Blackman's question as to why we prefer to be in the state courts, we do not necessarily prefer to be in the state courts, Your Honor.
We just feel that that is the place where we should be because of the state of the law and I might say that as a member of the Bar of New York, I do not believe that the calendar of the Southern District should be clogged with 10 (b) (5) cases as it is today which do not rightfully belong there.
The second reason why plaintiff is wrong in asserting that there has been an injury to Manhattan in connection with the purchases or sale of the security is that this case does not involve any impurity in any security transaction.
As the courts below concluded, there can be no fraud in connection with a security transaction when none of the following three facts are involved.
First, this case does not involve the purchase or sale of any security for more or less than its fair market value.
Second, this case does not involve any actual or potential manipulation or abuse of the trading process.
Third, this case does not involve any injury to any Manhattan shareholder or to any other member of the investing public.
What this case does involve, Your Honors, is a claim that defendant Begole, the sole shareholder of Manhattan, misappropriated Manhattan funds for his own benefits and that this misappropriation was not reported to the Superintendent of Insurance of the State of New York.
Justice Harry A. Blackmun: Mr. Karatz, do you represent Irving Trust?
Mr. William W. Karatz: Yes sir.
Justice Harry A. Blackmun: What did Irving trust did all of these deals, some kind of a fee for this five million dollar check?
Mr. William W. Karatz: Now, quite frankly, Your Honor, Irving received no fee for the five -- let me break up the checks.
The first five million dollar check, the one payable to Bankers Life and Casualty Company which constituted the payment by Mr. Begole for a stock, was delivered by the Irving officer to the Bankers Life representative at the closing as a convenience to Mr. Garvin who was one of the leading members of the New York Brokerage Community.
Mr. Garvin’s house was well recognized as a leader in the area of Government bonds, securities and certificates of deposit.
I might say that the way business is done on Wall Street is by requests being made by people who are respected and those requests being honored.
Millions of dollars of businesses done everyday by all of the leading banks in New York City on word of mouth, without any paper being transferred.
Mr. Garvin came to Mr. Gunter, who is an assistant secretary of Irving Trust Company, who had known Mr. Garvin for years, who had known his brokerage house for years and requested that five million dollars be given in return for funds which would be returned to Irving the same day.
It was convenience to Mr. Garvin.
It was something which is not unusual in the Wall Street Community.
Unknown Speaker: And the second check?
Mr. William W. Karatz: The second check, Your Honor, let me say how that came about.
After the first transaction, namely the closing at Manhattan had taken place, Mr. Gunter got back to the bank.
He received a telephone call from Mr. Garvin and he said that there was a second half to the transaction.
Mr. Gunter replied to Mr. Garvin and this is all in testimony in pretrial discovery, I was not aware of any second half of the transaction and Mr. Garvin just said, well, this is just a simple check swap which is going to take place at Belgian-American Bank, there you will give five million dollars and you will get back five million dollars.
Mr. Gunter, under those circumstances did not feel that there was any reason why he should not go along with the request to this respected member of the broker’s community and did so.
Justice William J. Brennan: (Inaudible)
Mr. William W. Karatz: No sir.
There was an attempt to indicate to the court that there was a nice, clean cut arrangement whereby you had a morning transaction and an afternoon transaction.
The facts in this case are not that simple and I would refer Your Honors for a detail in statement of them to the appendix in my brief where we do try to take you step by step through these complex transactions.
In response to your question, Mr. Chief Justice Brennan, when Mr. Gunter went to Belgian-American in the afternoon, the government bonds of Manhattan had not yet been sold.
Certainly, the amount for which they were sold had not yet been indicated.
The way that this operated was that the Government bond transaction, the sale of government bonds was a private transaction between Manhattan casualty and Second District Securities, a large bond house in New York.
The bonds were gradually delivered to Second District and notices came for Second District, during the course of the day and on into the evening as to the amount which was being paid for the bonds, that the amount being paid for the bonds depended on the going rate for those bonds at that particular time of delivery.
So, during the entire course of the day, afternoon and into the evening, and I might say that Mr. Gunter’s responsibilities was in the security clearance division on the bank, the securities clearance division has to do with receipt of securities and payment for securities and literally, hundreds of millions of dollars of transactions are dealt with everyday by Irving Trust Company alone in this particular division of the bank.
So when Mr. Gunter went home that evening, which was, as I recall the testimony in the pretrial, eight or nine o’clock, he still was not sure exactly how much had been received for the securities during the course of the day.
I might also say that and as I have been pointed out to Your Honors, the bonds ultimately produced only $4,800,000 odd dollars.
A $150,000.00 check of Manhattan drawn on another bank was delivered to Irving sometime during the late afternoon of January 24.
That check was payable to the order of Manhattan Casualty Company and that check constituted a credit to Manhattan's account at Irving and in fact that is exactly what form it took, the Manhattan check, drawn in another bank, payable to itself for $150,000.00, was credited to Manhattan's account at Irving.
Justice William O. Douglas: We are told that there were false entries made by Irving Trust, is that right?
Mr. William W. Karatz: I deny that sir, they were not false entries.
The entries which remained at Irving were corrected when Mr. Gunter came to understand what he thought the true situation was, if I may sir, go into Mr. Gunter's examination before trial.
Mr. Gunter originally was led to believe by Mr. Garvin that the morning check for five million dollars would be covered by a receipt by Irving trust later on in the day of securities which would be sold and the proceeds applied to cover the five million dollar check.
Unknown Speaker: Sold by Irving?
Mr. William W. Karatz: No, sold by Manhattan, to Second District.
They would just be delivered to Irving for purposes of redelivery to the purchase of the bonds.
Mr. Gunter was also informed, as I mentioned in reply to an earlier question that the second transaction, the second five million dollar transaction was just a check swap.
Now it turned out, however, that when the documentation of what had gone on during the course of the day started to come into the bank and it started to come in on January 24, Mr. Gunter gathered that he had misunderstood what the true situation was and made the entries which complied with the written instructions which he was receiving from various people.
Now, what were the written instructions?
Mr. Gunter received sometime during the course of the day on January 24, a letter from Manhattan Casualty Company signed by Mr. Sweeny as President of Manhattan, instructing Irving to transfer five million dollars from Manhattan's account at Irving to Belgian-American.
Now, this was duly signed by a representative of Manhattan Casualty whose name appeared on Irving's books as an authorized signatory for the Manhattan account which was also opened on that January 24.
Justice Harry A. Blackmun: Do I understand that Manhattan had maintained an account with Irving?
Mr. William W. Karatz: No, Manhattan opened an account on the very day.
Justice Harry A. Blackmun: When the hundred and fifty thousand, plus or minus check came in?
Mr. William W. Karatz: That is certainly was one of the first items in it sir.
Justice Harry A. Blackmun: So this is all a brand new account on Irving's books?
Mr. William W. Karatz: Well let me say this Mr. Justice Brennan, oh I am sorry, Blackmun, it is a new account as of January 24, but Manhattan Casualty had been a customer of Irving in years past.
They were not a customer as of January 24, but it was not really a new customer, it was just a renewal of an old relationship.
To go back to Justice Douglas’ question, when Mr. Gunter, at the end of the business day or early the next day, because as I say he did not leave the bank because of the rush of business until late in the evening, saw this letter from Mr. Sweeny.
He recognized the afternoon transaction as having been a transfer of Manhattan funds to Belgian-American, a transfer which should be debited to the Manhattan account at Irving and that is exactly what he did.
Justice Thurgood Marshall: (Inaudible)
Mr. William W. Karatz: As of that time, Your Honor, well I am sorry Mr. Justice Marshall, as of which time?
Justice Thurgood Marshall: The time when he had credited it, I think it is --
Mr. William W. Karatz: Well, when all -- let me say at the time that he credited the -- well I am sorry, when he debited or credited, sir?
I mean which item are we talking about?
Justice Thurgood Marshall: Why not do it both?
Mr. William W. Karatz: Well, okay.
Let me tell you the history of the situation as so far as Irving is concerned.
Justice Thurgood Marshall: Well, when they issued the five million dollar check, how much did Manhattan have in this Irving?
Mr. William W. Karatz: When Irving issued the five million dollar afternoon check, Mr. Gunther of course did not know that he was supposed to be doing this, pursuing to the instructions of Manhattan.
At that time, he was acting pursuant to these oral instructions of Mr. Garvin saying that this was the second half of the transaction.
By the time he saw the letter from Mr. Sweeny, instructing the five million dollar transaction to take place in the afternoon of January 24, Manhattan had credited to its account the $4,800,000 proceeds from the sale of the securities plus the $150,000.00 check.
Justice Thurgood Marshall: I thought you said it was made (Inaudible) and sold them all here?
Mr. William W. Karatz: No but the bookkeeping entries were actually made on January 25th as of January 24th by the time they caught up with the –
Justice Thurgood Marshall: (Inaudible) bookkeeping, I assume that it means that the money is there, as he was not in the --
Mr. William W. Karatz: Well no sir, actually, at the time the bookkeeping entries were made, the money in fact was there.
Justice Thurgood Marshall: In the afternoon?
Mr. William W. Karatz: No, I am talking about the entries, sir to the Manhattan account.
Justice Thurgood Marshall: Yes, when was it made in the afternoon?
Mr. William W. Karatz: No, the entries to the Manhattan account were made on January 25 as of January 24, at which time they were able to catch up with all of the business which had accumulated during the day and Your Honor, once again, I have to emphasize that we are dealing here with a department of a bank which has literally hundreds of millions of dollars of transactions everyday, this is not an isolated situation.
Justice Thurgood Marshall: Which they do with just by telephone?
Mr. William W. Karatz: Pardon?
Justice Thurgood Marshall: Which they do just by telephone?
Mr. William W. Karatz: Many of them sir are done just by telephone.
Many are done on the faith and good word of people in the financial community.
If you cannot rely on that on Wall Street, then you would have to close up a good many of the financial institutions that you have today.
Let me say sir that the first entry in the Manhattan account was the crediting of the $150,000.00 check, which was received late in the afternoon of January 24th.
Have I answered your question sir?
Unknown Speaker: (Inaudible)[Laughter]
Mr. William W. Karatz: As I have stated previously, Your Honors, the unique fact in this case may indeed form the basis for a state action, based on such theories as embezzlement, fraudulent conveyance, conversion, corporate waste or violation of the New York State Insurance Law.
However, these unique facts do not, and I emphasize it, Your Honors, do not involve any wrongdoing prohibited by Federal Securities Law.
The congressional purpose, underlying the enactment of the Securities Acts was to promote free and open public securities markets and to protect the investing public from suffering inequities in trading.
These Acts were not intended to constitute a general, Federal corporation law.
In fact, Congress has often rejected the idea of a General Federal Corporate Code.
Justice Harry A. Blackmun: Mr. Karatz, I come back to my question, what real difference does it make to Irving Trust Company whether this litigation is resolved on the State side or the Federal side?
What is it that you fear to, in being brought on to the Federal umbrella at this point?
Mr. William W. Karatz: May I be very frank with Your Honor?
Justice Harry A. Blackmun: I would have you answer it because I think before the only answer you gave me was because you were reluctant to clogging the Federal Court calendars?
Mr. William W. Karatz: Here once again sir, I was going to our strategy, which possibly is something I should not do.
Quite frankly, I do not believe that my opponent is happy in the New York State Courts.
He has much more experience in the Federal Courts.
He is more familiar with finding his way around the Federal Courts.
Rightly or wrongly, that is the conclusion we have reached, that he would be unhappier in the State Courts.
It is not a question of where we would be happy.
To return to the question of the Congressional intent, Congress did not intend, by the enactment of the Securities Laws to create Federal Law which would govern every corporate management transaction.
Absent the compelling reasons, it would seem inappropriate to inject the anti-fraud doctrine of Rule 10 (b) (5) into a case where the unique question is the fiduciary duty owed by a sole shareholder to his corporation and its creditors.
Once again, I emphasize, Your Honors that State Common and Statutory Law have long provided adequate remedies for whatever creditors there may be in this picture.
And with regard to the creditors, Your Honor, let me say this.
At the time of the liquidation, all of the policy holders of Manhattan were re-insured, so those policy holders are no longer in the picture.
Insofar as any other creditors are concerned, we have strained through years of pre-trail discovery, to find out if in fact any creditor exists.
We have yet to be given any concrete information as to whether there is in fact any creditor.
Now, once again I emphasize to Your Honors that even if there are creditors, the creditors are perfectly capable of having their remedy by way of the long established State remedies.
Mr. Bowman is bringing an action in the State Court.
There is the place, under the State Law to look into the situation to see whether there are creditors and if there are creditors, to provide the proper remedy.
There is no reason why the Federal Courts, by way of an implied cause of action under section 10 (b), should preempt this entire well developed area of State Law of creditor's rights, when it is clear from the realm of the Securities Acts as a whole that Congress did not so intent.
It should be left to Congress to decide whether the enforcement of a substantial part of what is now a corporate law should be assumed by the Federal Courts, and I might say in this respect, Your Honors that Congress has not been delinquent.
Congress is constantly analyzing the Securities Acts to decide whether there should be amendments there too.
There are hearings going on across the street at the present time with regard to the possible amendment to the Securities Act.
There are also hearings going on with regard to the proper division of jurisdiction between the Federal and the State courts.
I suggest that this is something that should be left to Congress to analyze and by way of carefully held hearings, determine to what extent Congress wants to take over general Corporate Law.
The petitioner and the Commission, in urging this Court to reverse the decision of the Courts below are in effect asking if an extension of Rule 10 (b) (5) far beyond any other case.
They are in effect, asking this Court to hope that an alleged act of corporate mismanagement which does not involve a manipulation or deception intrinsic to the security transaction, to be a Federal wrong.
Such an extension of the coverage of the Securities Act is not necessary in order to carry out with Congressional intent.
I know that Your Honors have held, in prior cases, that the Securities Acts should be broadly construed so as to carry out the Congressional intent.
I happen to whole heartedly agree with that.
I also whole heartedly agree that there should be a private course of action under Section 10 (b), but I do not believe that Section 10 (b) should be construed in such a way as to bring within the scope a Federal Jurisdiction, matters which Congress never intended, the Federal Courts to exercise jurisdiction over.
Judge Herlings, in dismissing the complaint herein, not only examined the complaint, but he examined the entire pre-trial record which was years in the making.
After taking the motion to dismiss under advisement for over nine months, he came up with his, what I believe to be, well considered opinion and his well reasoned opinion, in which he concluded that under the unique facts in this action, you did not have a Federal claim.
The Court of Appeals for the Second Circuit affirmed Judge Herlings and I might say also that possibly because Judge Herlings came through with a lengthy opinion, we forget Judge Ryan.
Not only was a motion to dismiss made before Judge Herlings, but a similar motion was made before Judge Ryan, who also considered the matter in excess of nine months and then came out with an opinion, agreeing with Judge Herlings.
The Court of Appeals affirmed the opinions of both Judge Herlings and Judge Ryan and I think it's a matter of general knowledge, that it is the second Circuit, which after all has had to give the consideration to most of the Securities Acts cases and I think it is fair to say that Second Circuit has uniformly, broadly interpreted the Securities Act cases before so as to provide a remedy when one is necessary to carry out the Congressional intent.
As Judge Herling stated below, this is another of many of the recurring cases in which the question basically is, does the plaintiff belong in the State Courts or has he spelled out a federal claim.
This case, once again, I emphasize, involves a misappropriation of corporate assets by a sole shareholder or the corporation, involves no injury to any public investor, involves no purchase of sale of any security for less than its spare value and it had no effect whatsoever on any securities market.
On these unique facts, I suggest, Your Honors, that plaintiff has stated no federal claim and that he should pursue his remedy in the State Court action which was brought against the same plaintiffs, based on the same facts and in which he asked for the same damages.
If I may Your Honors, with just a few questions posed this morning for Mr. Bowman, which I might respond to, I believe Mr. Justice White asked how the bonds were sold.
I believe I have responded to that that it was a private sale, transaction between Manhattan and Second District Security.
Once again, there are no security market was involved, no public exchange was involved.
If I may go to this question of creditor standing, under the Securities Laws, it is my position that Congress did not intend to provide any rights under the Security Laws to creditors as a class.
The Securities Laws, if you read them from the beginning to the end were composed to provide remedies to security holders, to purchasers and sellers of securities.
Once again, I suggest there was no need to provide a remedy to creditors because creditors already had adequate remedy in the State Courts.
I would suggest that if you look at the Field versus Lue case, you will see, and which was referred to by Mr. Bowman and which is cited at length in my brief, you will see that it is very relevant to the issue before, Your Honors.
What Field versus Lue does is to analyze what a corporation is and in that case, it was concluded by the District Court that when the sole stockholder of a corporation ratifies and participates in a corporate transaction, it is corporate action.
The corporation they are asked -- thereafter has no remedy against the sole stockholder.
The remedy of any creditor who is damaged is by way of an action for fraudulent conveyance or some similar type of action.
Now, if the situation has resulted in a trustee and bankruptcy being appointed under the bankruptcy law, then I think the Field case clearly demonstrates the division of responsibility that a trustee and bankruptcy has.
A trustee and bankruptcy can sue on behalf of the corporation and it can sue on behalf of the creditor, but I suggest that what was happening in Field was that the trustee and bankruptcy, the plaintiff there was being told that because of the ratification of the actions by the sole stockholder, he had no cause of action on behalf of the corporation, that does not mean he does not have a cause of action on behalf of the creditors but to carry that analysis into this case, if in fact what Mr. Bowman is doing, he is suing on behalf of creditors, then I suggest that under the Birnbaum doctrine, he has no standing to sue because the creditors are not purchasers or sellers of a security and I suggest, Your Honors that Birnbaum, not only is law in the Second Circuit, it is law in all of the circuits which have carefully considered the question and I think rightfully should remain the law.
Chief Justice Warren E. Burger: Mr. Parker.
Argument of Irving Parker
Mr. Irving Parker: Mr. Chief Justice, may it please the Court.
I appear principally in the interest of respondent Bankers Life and Casualty Company as to whom the facts and the proceedings in this case are unique.
However, this Court may interpret Section 10 (b) of the 1934 Act and Rule 10 (b) (5) promulgated there under, petitioner has not and he cannot state a claim for which relief can be granted against Bankers Life.
Neither the complaint itself nor the complaint supplemented by a comprehensive discovery record provides a single, factual allegation which in any respect supports any claim against Bankers Life.
The only conceivable reason that Bankers Life was made a party to the action and is here today is that it happened to own the stock of Manhattan Casualty Company and sold it in January 1962 after months of negotiations.
The sale was arms length and the only conclusion which the record permits is that the sale was free from any impropriety in any respect whatsoever on the part of Bankers Life.
In November 1963, shortly after the action was commenced and the insurance department had completed a lengthy investigation into the circumstances which led to the liquidation of Manhattan, the petitioner, the Superintendent of Insurance, as liquidator of Manhattan was deposed.
Upon deposition, the essence of the petitioner's testimony was that he could not assert any facts to justify inclusion of Bankers Life as a party in any way connected with any of the alleged wrongs upon which the action was based.
The other speculative basis upon which Bankers Life was named a party was clearly revealed by the petitioner's testimonial admission that he could not factually support any claim against Bankers Life and to attempt to do so, he required an opportunity to conduct discovery proceedings and so petitioner proceeded to discover.
By early 1968, petitioner concluded some four and one half years of discovery.
Chief Justice Warren E. Burger: You are speaking now of the Federal discovery?
Mr. Irving Parker: Yes Your Honor, in this case.
Through his attorneys, petitioner deposed almost 40 witnesses and a master record of some 12000 pages of transcript and hundreds of documents, but petitioner still could not provide a simple factual allegation to justify retention of Bankers Life as a party for the action.
Justice William O. Douglas: That goes to the merits, does not it?
Mr. Irving Parker: Your honor, it goes to this jurisdictional question.
Justice William O. Douglas: Because there are other defendants other than Bankers?
Mr. Irving Parker: There are, Your Honor and the fact to the matter is, Your Honor --
Justice William O. Douglas: The cause of action against one of them, under the Securities Act, it should be reversed, should it not?
Mr. Irving Parker: No Your Honor, there is precedent for what I am contending for here and I will come to that, Your Honor.
In any event, in April 1968, Bankers Life moved before the District Court for summary judgment pursuant to Rule 56, on the ground that there was no trivial issue of fact as to Bankers Life and it was entitled to judgment as a matter of law.
Bankers Life was the only defendant who so moved.
When the motion was made, the petitioner indicated his need for, and he obtained sufficient time within which to search the discovery record in the hope that he could find something upon which to base an opposition to that motion.
The motion was heard upon extensive and comprehensive affidavits before Judge Sylvester Ryan, who found that petitioner had no way charged that Bankers Life had participated in the negotiations for the raising of the purchase price for the Manhattan stock or even that Bankers Life had any knowledge of those negotiations and Judge Ryan's exact words are at page 42 A of the appendix.
Nevertheless, Judge Ryan denied the summary judgment motion, but he did so expressly stating that it was not on the merits and it was without prejudice and he explained that he could not dispose of the motion because of the need first to determine petitioner's questionable claim of Federal jurisdiction and so the motions to dismiss for lack of jurisdiction were made and it is as a result of the dismissal of the complaint and its affirmance by the Court of Appeals that the respondents who made such motions are here.
As to bankers Life, it simply is not involved in the questions presented whether there was schemes or devices employed by others in connection with any transactions complained of by the petitioner or relied upon by the SEC.
The absence of any connection of Bankers Life with any schemes or devices was confirmed by petitioner's attorney in open court as long ago as November 1963, First referring to the fact of the sale of the Manhattan stock, petitioner's attorney describing his claim stated and I quote, “thereafter the complaint alleges that defendants, other than Mr. Parker's client, namely Bankers Life, entered into a scheme to cover up this depletion of corporate assets which was successful for about a year-and-a-half.”
Since the time that statement was made, petitioner has been unable to alter the admitted lack of any connection between any of the transactions complained of in Bankers Life.
The conclusion set forth at page 37 of petitioner's main brief, plainly evidences that the heart of his purported Federal claim is based upon the circumstances of the sale of the Manhattan Government bonds and the misappropriation of the proceeds of that sale with none of which Bankers Life had any connection whatsoever.
These transactions occurred after the purchaser had acquired the stock, had taken control of the company and had installed a Board of Directors.
It was petitioner's own analysis of his complaint, supplemented by the extensive discovery record, which led Judge Ryan to the conclusion that I have mentioned before, namely, that there was no charge in this entire record, whatsoever made, that Bankers Life participated in or even had any knowledge of the transactions relating to the raising of the purchase price for the Manhattan stock.
The absence of any basis for asserting any Federal claim against Bankers Life is also confirmed by petitioner's reply brief.
First, as to the brief of Bankers Life; the principal point of the brief of Bankers Life is that no Federal claim has been asserted against Bankers Life and that Federal jurisdiction does not exist as to it.
Justice Byron R. White: Are you suggesting that we can, even if we can reverse the Court of Appeals, nevertheless (Inaudible)
Mr. Irving Parker: In 30 seconds I will answer your question, if I may Your Honor.
As to the petitioner's reply brief, he has not, in any respect controverted this inescapable conclusion that there is no Federal jurisdiction as to Bankers Life or that dismissal of the complaint was unquestionably correct as to Bankers Life.
Nevertheless, we believe that the judgment below should be affirmed in all respects.
We believe further that in any event, that judgment should certainly be affirmed as to Bankers Life.
When the Court of Appeals sir, and I think I can anticipate your question because I will not overlook it, when the Court of Appeals for the Second Circuit was presented with a similar situation, involving multiple defendants in Schoenbaum against Firstbrook which is reported at 405, F. 2nd at 215, a case involving Rule 10 (b) (5), a case which was heard en banc, that court affirmed dismissal of the complaint for lack of jurisdiction in respect of that single defendant as to whom there was no showing made of any participation in the wrongs complained of.
Justice Byron R. White: Should we have to judge the Court of Appeals on that aspect of decision before we dealt with this?
Mr. Irving Parker: Dividing Bankers Life from the others, there was no occasion for them to do it Your Honor.
I think as the Court of Appeals saw it --
Justice Byron R. White: I understand that.
That they are now (Inaudible)
Mr. Irving Parker: And I think they were correct about that Your Honor and I think they are correct.
Justice Byron R. White: Assume they were wrong about that?
Mr. Irving Parker: That there was Federal jurisdiction in some form as to some parties, they still, I would think and I think that on the basis of Schaunbaum and Firstbrook, the Court of Appeals would certainly have dismissed this to us.
Justice Byron R. White: Well at least they have a time to refer?
Mr. Irving Parker: I do not see if there is any need for it, Your Honor.
Justice Byron R. White: Well, that will require us to (Inaudible)
Mr. Irving Parker: Well, I think on the basis of the briefs alone that will appear Your Honor.
I would not expect the Court to be troubled (Voice Overlap).
Unknown Speaker: How many thousand cases?
Mr. Irving Parker: There are 12,000 and I would not expect the Court to be troubled by that, but I respectfully submit, Your Honor that on the basis of the briefs alone, this will appear because the facts are there, they are uncontroverted and I think whether it is most important of all, Your Honor --
Unknown Speaker: What about Mr. Bauman?
Mr. Irving Parker: As he concede what I say?
I have not asked him, Your Honor and I do not know.
We respectfully submit Your Honor that what is before Your Honors and what Your Honors will be willing to consider, that you will see that there has been a grave injustice committed here in respect of Bankers Life and that the only way left to remedy the injustice of having made Bankers Life a party to an action in which it does not belong is to affirm dismissal of the complaint as to if, and thereby in some measure, offset the effects of the unworthy challenge to the integrity of Bankers Life in connection with a perfectly proper sale of the Manhattan stock which it made.
Thank you very much, Your Honors.
Chief Justice Warren E. Burger: (Inaudible) Mr. Bauman, did you -- I thought there were some questions pending to you that was going to be picked up, perhaps I just (Voice Overlap).
Rebuttal of Arnold Bauman
Mr. Arnold Bauman: I think perhaps I should have in luncheon recess, Your Honor.
Chief Justice Warren E. Burger: I think that (Voice Overlap)
Mr. Arnold Bauman: At least I have attempted to and --
Chief Justice Warren E. Burger: I think that was the one I was carrying in mind.
Mr. Arnold Bauman: If there is an outstanding question, I will happy to try to answer.
Chief Justice Warren E. Burger: Very well.
Mr. Arnold Bauman: Thank you sir.
Chief Justice Warren E. Burger: The case is submitted.