BLUE CHIP STAMPS v. MANOR DRUG STORES
Legal provision: Securities Act of 1933, the Securities and Exchange Act of 1934, or the Williams Act
Argument of Allyn O. Kreps
Chief Justice Warren E. Burger: We'll hear arguments first this morning in 74-124, Blue Chip Stamps and others against Manor Drug Stores.
Mr. Kreps, you may proceed whenever you're ready.
Mr. Allyn O. Kreps: Mr. Chief Justice and may it please the Court.
The important practical question before this Court is whether every security issue subject to the security laws will be the basis for a federal claim for damages by any person whenever the issue price or current market price is followed by a price rise or more directly whether any non purchaser, non seller or potential investor will have a private federal claim to speculate on the market without cost or risk of loss and at the expense of actual and existing investors and to the burden of the federal judiciary.
This statement may seem extreme and certainly simplistic but it is the inevitable practical result of the extreme and simplistic position taken by the Securities and Exchange Commission in this case by calling for the complete judicial abandonment of the purchaser-seller rule commonly known as the Birnbaum Doctrine.
The fundamental legal issue before this Court upon which this practical problem is bottomed is to determine what class of persons should be permitted to bring a judicially implied private right of action for damages under Rule 10b-5 as promulgated by the SEC to enforce the prohibitions of Section 10 (b) of the Securities Exchange Act of 1934.
Although no private right of action is set forth expressly in either Section 10 (b) by Congress or Rule 10b-5 of the SEC, the lower courts have implied such a right of action for purchasers or sellers since the Kardon case in 1946 and the Fischman case in 1951.
This Honorable Court has recognized this implied right of action for damages inter alia in both Bankers Life and Affiliated Ute, although the existence of the right of action in the plaintiffs there involved or the plaintiff's standing in the non-constitutional sense was not questioned or an issue in those cases.
The standing of the plaintiff-respondent here is in question precisely because it has never owned, never purchased or never sold the securities upon which it purports to base its alleged private claim for damages under Rule 10b-5.
Now, petitioners concede that a violation of Rule 10b-5 in connection with the issuance of these securities has been alleged in the amended complaint but petitioners contend that as a matter or law, plaintiff-respondent has no judicially implied private right of action for damages arising from the issuance of these securities precisely because any such alleged damage was not incurred by the respondent in connection with either the purchase or sale of any security by it.
There being no better point of departure in determining the merits of this contention than Rule 10b-5 itself.
It should be observed that the express prohibitions of 10b-5 are applicable “in connection with the purchase or sale of any security.”
In the Birnbaum case, the Second Circuit concluded that the Rule 10b-5 did not create an implied private right of action for non-purchasers or non-sellers or potential investors but only for the defrauded purchaser or seller.
In subsequent cases, the lower courts have recognized the salutary regulatory purpose of Rule 10b-5 and have applied a liberal definition to the words purchase or sale to imply a private right of action for damages in the so-called for seller situation without requiring a formal consummated transaction and the lower courts also have recognized that the 1934 Act expressly defines sale or purchase to include contracts for which consideration has been given to sell or purchase and have recognized an implied right of action for damages under 10b-5 in such situations.
That is not the case here because there was no legally enforceable obligation to buy or to sell and no contractual relationship existed between respondent and petitioners or any of them.
Although the Birnbaum rule has been the subject of some academic criticism, this judicially developed doctrine has resulted in a rational and predictable framework for vindication of the policies underlying Rule 10b-5.
Even while the SEC urges the abandonment of the purchaser-seller rule, it now for the first time after many years recognizes or admits to the practical detrimental consequences of increase liability exposure, strike suits, news and settlement and an impossible standard of draftsmanship imposed upon the draftsman of the prospectus if the purchaser-seller rule is not retained.
Nonetheless, the SEC advocates that the rule be abandoned so that any person making an investment decision even when not to buy, not to do anything has a private right of action under 10b-5, and so proposing this subjective standard for standing, even the SEC attempts to ameliorate the recognize detrimental consequences upon all issuers of stock and their existing shareholders by suggesting two limitations but each limitation is illusory and ineffective.
The SEC proposes first an enhanced burden of proof upon plaintiff, potential investors and non-purchasers who claimed they would have bought or sold but for the alleged 10b-5 violation.
Whatever slight burden this may place on the scale pleaders in drafting complaints, it is clear that it does not provide any means of permitting summary disposition of cases before trial.
Any recipient of a prospectus, anyone with notice of a stock issue or a recipient of a press release as in Texas Gulf Sulphur could subsequently bring a claim as to any stock having a post issue or market price rise by simply alleging receipt of the allegedly defective prospectus or the press release the fact of subsequent price increase and the obvious conclusion that he would have bought at the issue price or then market price if he had been informed correctly that the stock was a bargain or would increase in value.
Hindsight will invariably disclose some statement in a prospectus that appears to be either overemphasized as alleged here or underemphasized in the light of a subsequent price rise.
In this case, respondent watched the market price rise for over two years before filing the instant lawsuit.
In the face of the expressed statutory mandate of the 1933 Act and as reflected by rules and policies of the SEC, that all prospectuses embody a conservative philosophy.
It is apparent that such factual situations of price rise will occur not infrequently but the SEC offers the issuer no rational means of complying with the conservative disclosure standards of the 1933 Act and yet avoiding the inevitable line of potential investor claimants at the federal court house.
The second limitation by the SEC is to impose vicarious liability upon the corporation only when it benefits from the alleged violation of Rule 10b-5 by its officers.
Presumably, this limitation is a recognition by the SEC that the purposes of the securities laws are not served by forcing corporation -- corporations to pay potential investors and non-purchasers from proceeds derived from actual purchasers and actual investors.
This second limitation is also illusory since motive is not an element of a 10b-5 claim and Section 20 (a) of the 1934 Act expressly imposes such vicarious liability upon the corporation for such acts.
Thus, however meritorious, such a limitation on vicarious liability might be, Congress has not seen fit to impose it and accordingly, judicial imposition would be inappropriate.
But more fundamentally, the position of the SEC totally ignores the problem of what the substantive elements of a private claim by non-purchasers and potential investors would be.
For example, how many potential investors and non-purchasers can sue if one million shares are issued and so the $10.00 per share or $10 million to 1,000 persons, can everyone sue who received a prospectus or had knowledge of the issue but decided not to invest.
If a thousand additional potential investors did so, 10,000 and so on.
At least under the present rule, the liability is limited to those one million shares, the money damages to a maximum of $10 million since that was the total price received and the suit is limited to purchasers, only they would be able to sue for the amount paid and that assumes the diminution of the value of the stock to zero and the number of potential plaintiffs is limited to 1,000, the actual number who purchased the shares.
Under the SEC proposal, the number of potential investors and non-purchasers and thus potential plaintiffs is totally unknown and only limited to those who saw or alleged they saw the prospectus notice or news release involved and the amount of potential liability is not 10 million.
It is also unknown and without limit.
Stocks have been known to increase many times over issue price and they are innumerable post issuance opportunities to be an alleged potential investor.
Stocks are sold and resold after initial issuance and there is no limitation under the SEC proposal.
Justice Byron R. White: Mr. Kreps, --
Mr. Allyn O. Kreps: Yes Mr. Justice White.
Justice Byron R. White: Does the Court of Appeals reject the --
Mr. Allyn O. Kreps: In our view, Mr. Justice White and in the view of Judge Hufstedler in dissent, the Court of Appeals did reject the Birnbaum rule because the --
Justice Byron R. White: It didn't say it did.
It seemed to me that they said this was -- it didn't violate the rule.
Was he on that -- this because the sale followed as a result of antitrust rate.
Mr. Allyn O. Kreps: That's correct Mr. Justice White.
Justice Byron R. White: -- taking on the word beneath you to say that here's another Court of Appeals that embrace the Birnbaum rule, this didn't apply to this one.
Mr. Allyn O. Kreps: The Ninth Circuit Court of Appeals Mr. Justice White analytically rejected the Birnbaum rule because --
Justice Byron R. White: Do you want us to -- do you want us to say that where he -- that this case opposes one way or another the validity of the Birnbaum rule, just forget about the rational of the Court of Appeals and go right to the -- to what you think is the heart of the matter, the Birnbaum rule.
Mr. Allyn O. Kreps: That's correct Mr. Justice White and that is the position of the SEC and with --
Justice Byron R. White: Not all, right?
Mr. Allyn O. Kreps: That we agreed that there are particular and that is right in this case Mr. Justice White but we also think the majority of the panel below did not expressly reject the Birnbaum rule and name because it recognize that another panel of the Ninth Circuit in the Mount Clemens case had already expressly accepted the Birnbaum rule.
Judge Hufstedler in dissenting --
Justice Byron R. White: Do you think we had a -- do you think we had a considered discussion by a Court of Appeals, namely the Ninth Circuit as to whether the Birnbaum rule ought to continue?
Definitely really faced up to it, I'm talking about the Birnbaum rule as such as --
Mr. Allyn O. Kreps: Yes Mr. Justice White.
In the Mount Clemens decision, another panel of the Ninth Circuit expressly --
Justice Byron R. White: Not in this case?
Mr. Allyn O. Kreps: Not in this case, the majority did not.
Judge Hufstedler in dissent said that they should adopt the Ninth -- the Birnbaum rule that it exist in the Ninth Circuit and that the majority was trying to write around it with their so-called functional equivalent analysis which I think she correctly dissected as being without merit.
Chief Justice Warren E. Burger: Does not a Court of Appeals including the Ninth Circuit normally not permit to one panel of the Court and three judges to overrule the holdings of another panel especially if they are recent?
Mr. Allyn O. Kreps: Mr. Chief Justice Burger, I think that was the problem majority of the panel was faced with in our case and I think majority's decision and their seizing on this concept of functional equivalent is a classic law school textbook example of hard facts making bad law.
Chief Justice Warren E. Burger: But are you suggesting that what they did was do indirectly that is overruled, that's earlier panel decision without saying so by indirection.
Mr. Allyn O. Kreps: Yes, Mr. Justice Burger.
I do not think you can reconcile the reasoning or purported reasoning of the majority panel below with the panel in Mount Clemens and when we petitioned for a rehearing en banc, the panel in Mount Clemens voted for granting that rehearing en banc and we felt -- we received five votes and failed just one vote short of getting a rehearing en banc in the Ninth Circuit.
I think if we had had that rehearing, the outcome would have been different because I can seen intellectual basis for distinguishing the majority decision of the panel below from overruling Birnbaum.
They simply tried to ride around it because I think they were unduly impressed by the allegations of the amended complaint here.
Justice William H. Rehnquist: Mr. Kreps, I noticed that neither you nor your opponent seem to have cited Justice Stewart's opinion for the Court last year in the Amtrak case where the Court held that provision of one type of civil remedy excluded another.
I should think in view of the provision of Section 11 and 12 of the Act of 1933 that might be of some significance to your case.
Mr. Allyn O. Kreps: Mr. Justice Rehnquist, I concur that it is in so particularly on the -- another issue that is attempted to be raised by the SEC at the last minute and that is whether there is a private remedy under Section 17 of the 1933 Act other than is set forth in Section 12 (2) of the 1933 Act.
The problem is that there is no civil remedy whatsoever provided by Congress in Section 10 of the Act or of the 1934 Act, that's correct Mr. Justice Stewart, there is none under the 1934 Act at all expressly provided by Congress as there is under the 1933 Act and the entire remedy that is before the Court here has been judicially created commencing with the Kardon case in 1946.
Justice Potter Stewart: It never -- it never or my mistake, it has --has it ever been explicitly accepted by this Court?
Mr. Allyn O. Kreps: It has never been explicitly accepted in the sense that the standing of the plaintiff was an issue.
I think that Affiliated Ute and Bankers Life in particularly footnote 10 Bankers Life indicates that the Court accepted the concept of an implied judicial remedy under Section 10 and 10b-5.
Justice Potter Stewart: Borak draw something else, did it?
The Borak case?
Mr. Allyn O. Kreps: Yes, that did not involve that issue here.
One other --
Justice William J. Brennan: Apparently, the court -- we denied certain in -- the Court did in Birnbaum itself, is it not in 52?
Mr. Allyn O. Kreps: Yes, Mr. Justice Brennan.
Justice William J. Brennan: And then the Seventh Circuit rejected it in iscent in last June or May perhaps last October, we denied cert there, didn't we?
Mr. Allyn O. Kreps: You denied cert with three justices voting to grant cert.
I believe Mr. Chief Justice Burger, Mr. Justice White, Mr. Douglas -- Justice Douglas --
Justice Potter Stewart: If I'm not mistaken that was not a final judgment that not that that goes to the jurisdiction into the Court but it might have, I mean, in other words, the defendants might still have prevailed in that case if I --
Mr. Allyn O. Kreps: That's --
Justice Potter Stewart: If I remember correctly.
Mr. Allyn O. Kreps: That's correct Mr. Justice Stewart.
Justice William J. Brennan: You know where the Congress has ever been asked to address this question?
Mr. Allyn O. Kreps: No, I do not Mr. Justice Brennan, it certainly should be and we did not intend to urge before the Court this morning that it overruled the lower courts in recognizing a judicially and private -- implied private right for damages under Section 10 but certainly that could be a legitimate issue before this Court.
I would like to return briefly to one more example of the dangers of the rule advocated by the SEC to extend this private implied right of damages to potential investors.
Consider the potential investor who has only $1,000 to invest and consider stocks A, B, and C but buys only A, does he have a claim for -- excuse me -- a price rise of B and C?
What if stock A rises more than B and C?
Or less than B but more than C?
Then if you multiply this -- the number of stocks A, B, and C by the number of different stocks traded or issued each year and have this investor with only a thousand dollars to invest, how many lawsuits does he have?
Or in fact, does this potential investor even have to invest in any stock at all but simply use the thousand dollars for an alternative investment and play the market without cost or risk of lost and what if the alternative investment rises more than stock A, B, or C, has he been damaged no matter how fraudulent the prospectus discouraging him to purchase stock A, B, or C?
And one final problem, one of the tremendous burden on the federal courts to be forced to litigate the potential merits of all those potential investor claims brought as questionable class actions.
All claims seeking speculative lost profits.
The purchaser-seller rule as developed and refined over the past quarter century accomplishes the salutary purpose of establishing rational and predictable requirements of standing for the proper vindication of Rule 10b-5 claims with probable merit.
In aggravated cases of alleged actual fraud such as claimed in one count here, potential investors and non-purchasers have an appropriate common law remedy in state court, just as respondent is pursuing in the California State Court, but the purposes and policies of the federal security laws are not served and cannot be reconciled by allowing any and all non-purchasers and potential investors to speculate on the market without cost or risk of loss and at the expense of that security's market actual investors in a federal court system already overburdened with litigation.
Accordingly, standing under 10b-5 should not be extended judicially to such potential investors and non-purchasers as responded in the instant case.
With the Court's permission, I would reserve my remaining time for rebuttal.
Chief Justice Warren E. Burger: Very well Mr. Kreps.
Argument of James E. Ryan
Mr. James E. Ryan: Mr. Chief Justice and may the Court please.
I feel constrained to comment upon two of the arguments just made by Mr. Kreps.
One is in response to a question by the Court whether or not the Ninth Circuit in this case has abandoned the Birnbaum rule.
In the Mount Clemens case which involved the situation where there was a public auction of securities, the plaintiffs in that action brought a 10b-5 action on the grounds that they had been defrauded from making a bid at that auction.
They were not offerees such as we are in this case.
They had no transactional or causal nexus with the party selling the shares so that the Ninth Circuit in Mount Clemens found that there was no standing under 10b.
I feel by that, they did adopt the -- a portion at least of the Birnbaum rule.
Another argument that counsel has made concerns the unknown quantity of claimants that may arise if the example of an offering of a million shares and there may be 50 million people that will come later when the stock goes up and say, gee, I would have bought that stock.
That is not the situation here.
Here, we have an exact amount of shares offered to an exact amount of offerees at an exact price.
The amount of persons that could bring a claim out of this action is wholly limited.
Justice William H. Rehnquist: But how do you distinguish that situation in the language of the rule from the situation that your opposing counsel was posing to the Court and what is it in Rule 10b-5 that would -- if we allow this would prevent the many other suitors who are not precisely in your situation?
Mr. James E. Ryan: I should preface that by saying that I have seated 10 of my minutes to the counsel for SEC, he is going for the homerun and I am going for the base hit.
He is asking the Court that the Birnbaum rule in total be abolished.
I am saying that fine if that's necessary, if that will get us our day in Court then fine, but we are submitting to this Court that that is not necessary in our case.
The purchaser-seller language as we know is Court created.
10b just says that in connection with the purchaser sale, we submit that when Congress enacted that statute, it would not have needed the language in connection with if it wish to limit causes of action under that Section to strictly purchase --
Justice Byron R. White: It is a construction of the statute that the courts have been engaged in, this is not some judicial policy, it's a construction of the -- of the federal statute.
Mr. James E. Ryan: That's correct.
However, since Birnbaum was decided in 1952, the cases are legion which have attempted to get away from the harshness of that rule but the court below on our case likewise saw a harshness in the rule.
There have been the four seller exceptions.
There have been the aborted purchaser-seller exceptions.
There have been any number of exceptions including the most recent opening of the doors to injunctive relief.
Justice William H. Rehnquist: What's so harsh about it?
I mean, it's just a line drawing that you have in every single area of the law, isn't it?
Mr. James E. Ryan: Well, in the situation where you would have a case such as ours, I think that it's presented by the anomaly of the situation.
If the petitioners in this case in making their offering had persuaded the respondents to purchase some but not all of the shares to which we are entitled, then I think we clearly would have no problem with the purchaser-seller rule.
What the petitioners are suggesting is that since they're fraud, since there misleading statements were so successful that we didn't buy it at all.
That therefore, we're outside the standing requirements and we feel that that is not what Congress intended.
That is the atypical fraud which had been pointed out by several of the circuits that Congress did not intend to just outlaw the typical kinds of fraud and this is certainly an atypical kind.
This is a highly unusual situation where you have an offeror putting out securities that hopes won't sell and that's the anomaly of the situation.
I think to deny the respondent's standing in this case, to bring a 10b-5 action sanctions the total success of their fraud.
Chief Justice Warren E. Burger: You think it can be limited in that category, do you?
Mr. James E. Ryan: I do, Your Honor.
I feel that in this case, I've stressed in my briefs that we have a unique set of circumstances.
We have a unique set of facts.
I think that the Ninth Circuit recognized this.
I think when it discussed the Birnbaum rule and the exceptions there under to the effect that there had been cases where the courts have created what we may call a fiction if no else.
Whereby, they found a contract to purchase or sell.
We had situations where persons bought illusory stock.
Well, that's no purchase at all but in the present case, the Ninth Circuit saw that to deny the plaintiffs in this case standing would be harsh.
They found that the peculiar unique rights that flowed from that consent decree, that duty that was upon the petitioners herein to make a fair offering served as the functional equivalent of the contract.
And I think that this case can properly be limited to that area of exceptions that which the courts have now recognized to the Birnbaum rule.
Justice Byron R. White: What if he disagreed with you in a rational distinction and that -- and that it's a Birnbaum rule was to be followed you must lose this case?
What should we do then if we disagree with you on -- that is a limited exception possibility here?
Mr. James E. Ryan: Well, --
Justice Byron R. White: Should we reach the issue of overruling Birnbaum or not accepting Birnbaum or rejecting it or should be remanded in Ninth Circuit.
Mr. James E. Ryan: Well, I think first, if this Court feels that our case as presented in the amended complaint does not fall within one of the exceptions or is not an exception in and out of itself because its peculiarity, then I think the Court has to reach the whole Birnbaum rule on whether or not it's valid.
Justice Byron R. White: Wouldn't we have -- why wouldn't we remand under the Ninth Circuit if it ever considered attention, the Birnbaum rule assumption?
It hasn't here in this case.
Mr. James E. Ryan: Not in this case it has not, has not.
Justice Potter Stewart: But the Court of Appeals has done it on the previous case.
Mr. James E. Ryan: It did do so.
I believe that it did adopt the Birnbaum rule under Mount Clemens.
Justice Potter Stewart: And the Seventh Circuit is --
Justice Byron R. White: That's hard to believe.
Justice Potter Stewart: Done it -- done it another case and we have the benefit of their thinking on the other side.
Mr. James E. Ryan: Is and has --
Justice Potter Stewart: All things in canvas in the Courts of Appeals including this one.
Mr. James E. Ryan: There are I believe three or four circuits that have not directly reached the Birnbaum issue but --
Justice William J. Brennan: But Mr. Ryan, it think that if Judge Hufstedler is right, Mount Clemens, they did adopt, that panel did adopt the Third Circuit Rule, then the practice of the Chief Justice suggested earlier, I would suppose that we did what my brother White suggest would result automatically would it not in this panel following Mount Clemens?
Mr. James E. Ryan: If -- if this Court found that this present case did not come within one of the exception, then you would go back and I would think that the Court would follow Mount Clemens.
Justice William J. Brennan: I take that that argues ---
Justice Byron R. White: Unless it was going Birnbaum?
Mr. James E. Ryan: Pardon?
Justice Byron R. White: Unless they went on Birnbaum?
Chief Justice Warren E. Burger: This Court has on occasion when there was a conflict in panels in the Circuit and the Circuit certified the cases with doubtful question remanded and said in effect resolved your own conflicts first, is it not?
Mr. James E. Ryan: It has.
Chief Justice Warren E. Burger: But you say there is no conflict between what the panel did in Mount Clemens and what the panel did in this case?
Mr. James E. Ryan: I --
Chief Justice Warren E. Burger: The panel in Mount Clemens were apparently thought so or at least had some doubt about it, did they not?
Mr. James E. Ryan: They had some doubt about it but again, the petition for rehearing en banc was denied.
Chief Justice Warren E. Burger: What was the vote on that denial?
Mr. James E. Ryan: There were five dissenting.
If I knew the total number, I do some quick subtraction and how many voted for, was it 65?
Justice Potter Stewart: 65
Mr. James E. Ryan: 65.
Justice Potter Stewart: You have a litigation pending in the state courts haven you on this same basic claim?
Mr. James E. Ryan: No, we had that.
Justice Potter Stewart: You had too?
Mr. James E. Ryan: Yes.
Justice Lewis F. Powell: Mr. Ryan, on that same point, do you consider your state remedy inadequate and if so, in what respect?
Mr. James E. Ryan: Well, for two reasons, I consider it inadequate.
One, the burden of proof as I understand it in a states securities action is greater than it is under 10b.
Justice Lewis F. Powell: Why would that be so?
Isn't this garden variety fraud that you alleged in final analysis?
Mr. James E. Ryan: It's fraud that we alleged in the final analysis, however, the test as I understand it under the Securities Exchange Act is that the plaintiff is not required to bring in each and every one of the offerees and have him sit on the stand and say but for the fraud of the defendants, I definitely would have purchased the stock, as I understand it, it's a lesser burden of proof, that is that the misstatement on the fraud of the defendant in a particular 10b case have influenced or would have influenced his decision; whereas, under the state securities law and common law fraud, he would have to go through the normal elements of a fraud case to show actual reliance.
Chief Justice Warren E. Burger: Do you think that this kind of situation lends itself to a class action when the proof under this Ninth Circuit holding, the proof in each case would be likely to vary a great deal?
Mr. James E. Ryan: Well, again, Chief Justice, I feel that that as the rules on proof under 10b-5 actions that the decision of the investor was influenced or would have been influenced.
I don't think it creates an imponderable burden for the plaintiff in a class action.
I think were you -- I think if you first prove that the allegations or I should say the statements contained in the -- what we termed the negative prospectus are truly misleading and/or false.
Then I think that you at that point have a fraudulent conduct and I think that fraudulent conduct in and out of itself would probably affect the decision of any potential investor in this action.
Justice William H. Rehnquist: Well, can a plaintiff in a 10b-5 action even though he may never have read the prospectus simply take the stand and say, if I had read it, it would have influenced me against buying and that brings him within the class that is entitled to recover?
Mr. James E. Ryan: No, I do not think it goes that far.
I think that he would have to -- have to show some knowledge on his part of the prospectus but I don't think it needs to go to far beyond that.
Chief Justice Warren E. Burger: You indicated earlier did you that if he'd read about it in the newspaper, the Wall Street Journal for example, would that be enough even if he'd not seen the prospectus?
Mr. James E. Ryan: You're speaking of the persons that are in this selective class that I represent.
It's possible I haven't given that any thought.
I'm presuming that the persons who would come within the class in this case would be those who had received and considered the prospectus.
I suppose that a Wall Street Journal article or any other type of publications concerning this offering, if it contained misleading items and was read by a -- one of the selected offerees would sought possibly serve the same function, could like just as well dissuade him.
We feel that the test to be used in the purchaser-seller case in such as this and was applied in the Eason case is determined whether or not the plaintiffs are within that class intended to be protected by Congress.
We feel that the nature of the history of this case that being the consent decree, the duty of the petitioners to make a fair and full disclosure, a fair and full and honest offering to the plaintiffs is that it makes them that type of person intended to be protected by Congress.
The -- I see a common strain in all of the cases which have considered Birnbaum and have carved out the several exceptions and that common strain I see is a transactional or causal nexus.
Counsel has expressed concern over the opening of the floodgate should the plaintiffs of this action be permitted to have their day in Court.
I cannot strenuously enough emphasize that we are not suggesting that the man on the street who might have bought IBM this morning at 10 o'clock stands in the same shoes as the plaintiffs in this action.
Here, we had an offering that was made pursuant to consent decree.
We had a specific price.
We had a specific time.
The defendants in this case had a duty to make an offering and we do not feel that there is any relationship between the man on the street and the person who owned a right or entitlement such as we did to purchase the shares.
Justice Lewis F. Powell: Mr. Ryan, lets assume for the moment that no offering had been made at all as they have been required by the consent decree, would your clients have had a cause of action?
This cause of action?
Mr. James E. Ryan: If no offering had been made?
Justice Lewis F. Powell: None.
No offering had been made although the consent decree may have required it.
In other words, could your clients have enforced the consent decree by a suit against the petitioner?
Mr. James E. Ryan: I would like to be able to distinguish the Control Data Corporation case and the like but I don't think it can be and I don't think it's in this case.
I don't think its dispositive.
We have stated in our briefs that we do not pretend to enforce that consent decree in this action.
The purpose of the consent decree as I see it and I think is -- I'm sure as the Ninth Circuits are serves as the background in the history as to why these plaintiffs and these defendants had such a unique relationship.
Why were not the men on the street that might invest tomorrow in any stock?
That consent decree answers that question.
So, we're not attempting to enforce a consent decree.
I don't think we can.
I think the cases are clear on that, the Armour and Control Data Corporation cases.
Justice Lewis F. Powell: So you had no right under the decree and no contractual right to have a chance to buy these securities?
Mr. James E. Ryan: Well, I'm not saying that we didn't have a contractual right.
Justice Lewis F. Powell: But what was it?
Mr. James E. Ryan: Well, as the Ninth Circuit stressed, it was a functional equivalent of a contract to purchase these shares.
We should not as the Ninth Circuit said and also in the Eason I believe, we should not go for form over substance.
I think that's what we're getting at here.
Justice William J. Brennan: No, we have to say that the functional equivalent it to say it's not a context, isn't it?
Mr. James E. Ryan: You mean by the very fact you distinguished it from a contract.
Justice William J. Brennan: -- should be treated as if there were one although in fact there is none, isn't that it?
Mr. James E. Ryan: I think so.
Justice William J. Brennan: Yes.
Mr. James E. Ryan: I have nothing further.
Chief Justice Warren E. Burger: Very well.
Argument of David Ferber
Mr. David Ferber: Mr. Chief Justice, if the Court please.
The petitioner is urging this Court to sanction the doctrine that would deprive the conceded victim of a securities fraud of standing to bring any action for his damages solely because he was not a purchaser or seller of securities.
Now, there have been four cases decided by this Court that there are implied causes of action under the Securities Exchange Act, two of them involving 10b, the Associated Ute case and the Superintendent of Insurance case.
The standing of the injured plaintiff here to bring such an action is the only issue in this case before the Court.
The fraud here was that of deceiving persons who had an investment decision to make and they were deceived and for that reason they are seeking damages.
The dissenting judge below admits there was a violation of 10b-5 and the petitioner concedes it.
Justice Potter Stewart: Well, as stated, the way you just stated that broadly and that would mean and I guess you're going to argue that the broad issue that Mr. Kreps submitted to us is here.
Mr. David Ferber: I certainly think it is, it's an issue that the Seventh Circuit has said we will not adopt this doctrine.
Several circuits have held, we have -- we do adopt this doctrine and I think it is certainly right for review by this Court under those circumstances --
Justice Potter Stewart: And presented by this case?
Mr. David Ferber: And I think it is presented by this case because at least it is arguable with respect to the exemption that the court drew whether or not that is a valid exemption, and as we point out in our brief, there is probably just as much litigation now as to what is exempt under the so called Birnbaum Purchase and Seller Doctrine, as to whether or not the doctrine should be applicable.
Justice Thurgood Marshall: But what is the Ninth Circuit's Rule on it?
Mr. David Ferber: Well, the Ninth Circuit --
Justice Thurgood Marshall: As of now.
Mr. David Ferber: The Ninth Circuit is -- rule is that they believe this purchaser-seller limitation is applicable.
They are making an exception in this case because of the existence of the antitrust decree.
At about the same time a different panel of that Circuit very shortly before this opinion in the Mount Clemens case which was very similar to this in some respect, the Court determined that because the plaintiff there was not a purchaser or seller, he had no cause of action.
Now, in the Mount Clemens case, what happened was this.
A company -- 100% of the shares of a company was being sold at auction of a subsidiary of a company and financial difficulties.
The company that was in difficulties, whose shares were being sold, had an officer who had formerly been an officer of the plaintiff.
The plaintiff said, we are going to bid at that sale and this officer according to the allegations lied to him and told him that the business of the subsidiary was no good.
They didn't bid in the sale and ultimately the officer who had lied allegedly be -- it was head or an officer of a different company that ended up with that subsidiary.
Justice Thurgood Marshall: So you have one?
Do you say that the Mount Clemens followed the Birnbaum Rule?
Mr. David Ferber: That the Court relied solely on this purchaser-seller doctrine in Mount Clemens.
Justice Thurgood Marshall: I'm asking you, do you say that Mount Clemens they followed it?
Mr. David Ferber: Yes Your Honor and I think they should know --
Justice Thurgood Marshall: And in this case -- and in this case you walked around it?
Mr. David Ferber: This case, they walked around it.
Justice Thurgood Marshall: So what is the rule of the Ninth Circuit?
Walk around or --
Mr. David Ferber: Well, as in many of the other Circuits, the Ninth Circuit says we subscribe to the Birnbaum rule but we find exceptions in this case and in that case and in the other case.
Justice Thurgood Marshall: We subscribed to the Birnbaum rule when we want to?
Mr. David Ferber: Precisely.
Justice Harry A. Blackmun: Mr. Ferber, is it a fair statement to say that the Birnbaum principle was submitted to the District Court and decided in this case?
Mr. David Ferber: Yes, I believe so Your Honor.
Justice Byron R. White: To you I think it would say that the exception purportedly carved out by the Ninth Circuit really can't withstand analysis?
Mr. David Ferber: Well, I --
Justice Byron R. White: To the amendment that what's really -- if you're going to have the Birnbaum rule, the result reached below shouldn't have been reached?
Mr. David Ferber: I just can't accept that we're going to have the Birnbaum rule.
I mean, I don't know, I think that any exception to it is probably a reasonable one because it doesn't make any sense to me.
To me it is completely arbitrary.
Justice Byron R. White: In other words, both the rule and exception are fictions in your approach?
Mr. David Ferber: I think the rule is basically -- well, its arbitrary, I don't know that I can say it's a fiction.
I think the exceptions like most exceptions from it would be good.
Now, I should say though, first of all --
Justice Potter Stewart: Let me say that if you don't believe in a rule, well then you think any exception to it is fine.
Mr. David Ferber: Well, I suppose that's right.
Justice Potter Stewart: Yes.
Mr. David Ferber: But let me say this.
It does not mean the giving up the rule, does not mean that all the parade of horribles that were set forth by the petitioner would necessarily occur or would occur.
There are various distinctions.
I think there are many cases where the lower courts have talked in terms of the Birnbaum rule because other Circuits had mentioned it but that there were other reasons they could have held that the plaintiff had no action.
For example, one of the cases cited is someone against Wolfson, I can't think of the name of it at the moment but what was charged in that case was that the officers of the company had manipulated the securities and then bought some of the company's securities at a low price and subsequently manipulated it some more and sold back to the company at the higher manipulated price.
Now, the action was brought by a stockholder of the company, not as a derivative action and the Court said, well, under the Birnbaum rule, you're not a plaintiff -- a purchaser or seller, you're just a stockholder.
On the other hand, had they brought it as a derivative action, the company was certainly a purchaser or seller and I certainly don't suggest that the plaintiff in that type of situation should necessarily have a cause of action, his injury was indirect through his corporation.
On the other hand, I think that case illustrates had the plaintiff because the market was low and had been so manipulated sold his stock.
He would presumably have a cause of action under the Birnbaum rule, he would be a seller.
So, that is why I am saying that it is an arbitrary rule and I guess you're correct that it's an artificial rule.
Justice William J. Brennan: Mr. Ferber, has the commission ever asked the Congress to do anything about the Birnbaum rule?
Mr. David Ferber: Well, we don't think this Court has never acted on the Birnbaum rule.
It is not a rule as far as --
Justice William J. Brennan: -- that wasn't my question.
Mr. David Ferber: Well, no, Your Honor, I mean, I was perhaps jumping ahead.
Justice William J. Brennan: Yes.
Mr. David Ferber: What I am saying is we're --
Justice William J. Brennan: After all, it's been around for 23 years now.
Mr. David Ferber: It's been around and there had been except --
Justice William J. Brennan: And has the commission been as restive as it is now under it?
Mr. David Ferber: Well, we have filed briefs in a great many of the Court of Appeals urging that the so-called rule not be accepted and --
Justice William J. Brennan: Well, is that a reason not to go to Congress, was it?
Mr. David Ferber: Well, in part, this Court only -- a few -- about two or three years ago in Affiliated Ute and the Superintendent of Insurance was the first that this Court had made clear that there is a private cause of action under Rule 10b-5.
The District -- the lower courts for sometime had been finding such an action, but until at least there was judicial opinion at the top, there at least might have been some question in Congress why should we be running up there with him.
Justice William J. Brennan: Well, I gather, if we sustain the Birnbaum rule and the commissioner will go to Congress and ask him to overrule it.
Mr. David Ferber: I would think that that is certainly a possibility.
Chief Justice Warren E. Burger: Can you almost wait until this Court has acted or have you sometimes gone to Congress with recommendations on the basis of Court of Appeals holding?
Mr. David Ferber: I don't recall any instance where we have an interpretation of the Court of Appeals going to Congress but I don't want to say Your Honor that we never have.
Justice Byron R. White: Well, it's been around for a long time in Second Circuit and that's where an awful lot of these transactions take place.
Mr. David Ferber: That's true but the Second Circuit has been punching more holes in the rule than almost any of the other Circuits so that there are in many instances, for example, it was the Second Circuit that said that it doesn't stop an injunction, private person can enjoin.
Chief Justice Warren E. Burger: You and Mr. Ryan seem to disagree a little bit.
He at least intimates rather strongly for me that the Ninth Circuit has just punched the holes to take your phrase, punched another hole in the Birnbaum Doctrine, you're taking the position that they have wiped it out if I understood you there.
Mr. David Ferber: No, no Your Honor.
I don't say they have wiped it out.
That's why we supported the petition because we felt they hadn't wiped it out.
That they had carved out an exception where we felt they should have wiped it out.
I should say by the way on the en banc hearing, my -- I maybe wrong but I think if I'm not mistaken that there are 15 or 16 judges on the Ninth Circuit, that's one of the real big ones so that the vote of five --
Justice William H. Rehnquist: 13.
Chief Justice Warren E. Burger: 13.
Mr. David Ferber: 13 is it?
Well, I knew it wasn't just five to six, it was somewhat bigger majority that had voted against the --
Justice William H. Rehnquist: Well, the notation is that the five judges authorized the publication of their names.
I take it so -- six judges might have voted for rehearing en banc but not wanted to authorize the publication of the fact.
Mr. David Ferber: I'm sorry Mr. Justice Rehnquist, that had not occurred to me, I suppose it is possible.
Chief Justice Warren E. Burger: I suppose your position would be that it's not uncommon for Courts of Appeals or other courts, intermediate courts to evolve exceptions to rules over a period time and that sometimes the exception finally swallow up the rule.
Mr. David Ferber: That's right.
Chief Justice Warren E. Burger: But you now say that this exception doesn't swallow up the entire rule.
Mr. David Ferber: It certainly does not and it leaves this completely arbitrary rule on the books.
Justice Potter Stewart: Is there square conflict in the circuits?
Mr. David Ferber: There is a square conflict --
Justice Potter Stewart: Probably I don't get it because the Seventh Circuit has explicitly declined to follow the Birnbaum rule.
Mr. David Ferber: Exactly, Your Honor.
Justice Potter Stewart: And whether this Court of Appeals of the Ninth Circuit can be said to have done more less the same thing, in fact or not done it is rather unimportant because other Courts of Appeals have said we do follow the Birnbaum rule.
Mr. David Ferber: That's right.
And why for example -- one of the cases in the Second Circuit is illustrative it seems to me of the inequity.
Actually in that case, they ultimately did find the sale but this was a case where in connection with a tender offer, the allegations were that there had been a misleading offer.
Most of the stockholders turned over their shares, 90 some percent and the corporation therefore was merged out of existence into the other one.
This -- the man who sued was one who had not sold his securities and we urge the Court of Appeals in the Second Circuit at that time since he was not a seller in that sense to ignore, overrule their initial Birnbaum rule and the Court of Appeals however did not do that, instead, they said, well, ultimately he's going to have to sell his securities and therefore we'll treat him as a seller.
Now, it seems to us that the logic would be that this man was defrauded.
I will just like to --
Chief Justice Warren E. Burger: Your time is expired unless you just want to set us --
Mr. David Ferber: I just wanted to say that this Court in the case Borak case stated that were rights under the Securities Exchange Act have been invaded, federal courts may use any available remedy to make good the wrong done.
Chief Justice Warren E. Burger: Mr. Kreps, you have six minutes left.
Rebuttal of Allyn O. Kreps
Mr. Allyn O. Kreps: Mr. Chief Justice and may it please the Court.
With respect to the question of whether Birnbaum is actually an issue in this case and in further response to the question of Mr. Justice Blackmun, the motion to dismiss in the District Court was expressly made on the ground of the Birnbaum rule and the memorandum opinion of the District Court squarely substantiated the dismissal of the complaint on the Birnbaum rule.
With respect to whether Birnbaum is an issue here and there is inconsistency in the Circuits, we again submit that there is an inconsistency in the Ninth Circuit between Mount Clemens and the majority of the panel below and Judge Hufstedler in her dissenting opinion on page 143 of our appendix says flatly, “the result reached by the majority is inconsistent with the holding and reasoning of this Court's recent decision in Mount Clemens Industries, Inc. versus Bell” and we think that the reason the majority found it necessary to adopt this exceptionally fussy equivalent function analysis was that there as now conceded by respondent no contractual right under the consent decree and merely what the functional equivalent language says is that we in essence are finding these people third party beneficiaries of a contract or consent decree and the obvious danger of that reasoning is that every stock issue has an underwriting contract and if you apply that reasoning, you could find every underwriting contract between the issuer and the underwriting -- underwriter and the subsequent brokers as a contract made for the ultimate benefit of the potential purchasers and then you do genuinely get into the parade of true horribles which I indicated in my opening argument.
The only explanation we have for the panel below the majority going arise as much as it did is the hard facts alleged in the complaint.
But if there is any merit to those hard facts, they may be vindicated in the state court action which is currently pending.
One last point and that is with respect to Mr. Justice Brennan's question on the Eason case in the Seventh Circuit.
Should the purchaser-seller rule be abandoned or bent in any manner as the Eason case -- Eason court favored?
It should be noted that in the Eason case, the plaintiffs there in the words of the Court suffered “as investors and as principals in the transaction” and they were shareholders in the corporation that sold stock for certain assets and then they executed a personal guarantee of the liabilities of the -- of the acquired -- on the acquired assets to someone else.
They certainly could have brought an action, derivative action on behalf of their own corporation as a result of the purchase or sale and I think the language that Eason court indicates that they actually were principals involved so that may not even be a purchased departure from the purchase-seller rule.
In any event, it would not be a sufficient departure to encompass the respondent in this case because everyone concedes that they are not purchasers, not sellers, not investors and have never expended one dime, they are only seeking.
Thank you very much.
Chief Justice Warren E. Burger: Thank you Mr. Kreps.
Thank you gentleman.
The case is submitted.