BATEMAN EICHLER, HILL RICHARDS, INC. v. BERNER
Legal provision: Securities Act of 1933, the Securities and Exchange Act of 1934, or the Williams Act
ORAL ARGUMENT OF ROBERT S. WARREN, ESQ. ON BEHALF OF THE PETITIONERS
Chief Justice Warren E. Burger: We'll hear arguments next in Bateman Eichler against Berner.
Mr. Warren, I think you may proceed whenever you are ready.
Robert S. Warren: Mr. Chief Justice, and may it please the Court:
This case presents the issue of whether a tippee who knowingly receives inside information in breach of fiduciary duty, intending to use it to defraud others, may in turn sue his tipper under Section 10 of the Securities Exchange Act.
The case arose in the context of a suit before the United States District Court in San Francisco.
A Judge Schwarzer dismissed the action on motion on the basis of the following critical allegations of the complaint.
The Plaintiffs alleged that they had invested in a company known as TONM that was engaged in exploration for gold in Surinam.
They said that they did so by obtaining information directly or indirectly through the Defendant broker of a number of matters, but the following was the essential point, and that was that there was a developed gold find in Surinam, and that there would shortly be announced a joint venture with a major mining company in order to exploit that gold find.
The complaint recites that they were told that this was inside information obtained from a president or a vice president of TONM.
They said that they purchased shares of stock in TONM over a period of time from November 1979 until 1981 on the premise that this was inside information from that source.
Unidentified Justice: Was that a violation of the securities laws?
Robert S. Warren: At that particular point there is a suggestion that it would be, Mr. Chief Justice.
However, it was confirmed by what happened in or about april of 1980 when they contacted Mr. Neadeau directly.
Mr. Neadeau was alleged to be the president of TONM, and they asked Mr. Neadeau whether this information that they had learned from the broker, Mr. Lazzaro, was true, and they were told by Mr. Neadeau as follows: first, that he could not confirm or deny that information; second, he told them why, because it was not yet public.
Then he told them when it would be public.
He said you will have to wait until you see the annual report.
And then to make sure that there was no misunderstanding, that the information might be inaccurate, he told them that Mr. Lazzaro, the broker, was a very trustworthy and a good man.
Unidentified Justice: And you suggest that was a signal that in effect was a violation of the act?
Robert S. Warren: Exactly.
I suggest that the following is true, that under the analysis of this Court in Dirks, that that conduct, their subsequent trading with that information, that inside information, was in fact a violation of Section 10 of the Act, for the following reasons.
The duty in question is derivative from Mr. Neadeau.
Mr. Neadeau is the person with the fiduciary responsibility.
As President of that company he had a fiduciary responsibility to his stockholders not to selectively tell a broker and that broker's customers so that that broker's customers could trade, that broker could earn commissions, that broker's own stock could be benefitted... and these parties were told about the stock of Mr. Lazzaro and his family.
Unidentified Justice: Well, Mr. Warren, is the tippee liable derivatively through Lazzaro or directly, in your view, from Mr. Neadeau?
Robert S. Warren: The tippee here, Justice O'Connor, is liable both directly from Mr. Neadeau, through the contact with Mr. Neadeau, and derivatively by virtue of being, if you will, a subtippee from Mr. Lazzaro, knowing of Mr. Neadeau's involvement or of some counterpart of Mr. Neadeau.
Unidentified Justice: We have to look at this based on the face of the complaint, do we not?
Robert S. Warren: Exactly we do.
Unidentified Justice: And the complaint does not say, of course, how Mr. Lazzaro got his information or what it was that Mr. Neadeau told Mr. Lazzaro, if anything.
Robert S. Warren: That is correct.
All we know is--
Unidentified Justice: It could be a total fabrication by Mr. Lazzaro that he was told anything by Mr. Neadeau.
Robert S. Warren: --It could have been.
However, what we know is that the belief--
Unidentified Justice: Well, just looking at the face of the complaint, that could be true, could it not?
Robert S. Warren: --That could be true.
Unidentified Justice: And therefore, no derivative liability of the tippee through Mr. Lazzaro from the face of the complaint alone.
Robert S. Warren: --Not on the basis of what the facts are as the Plaintiffs assumed them to be.
And that's what we must look at in deciding whether they either committed or attempted to commit a violation of Section 10.
Unidentified Justice: And what is it that Mr. Neadeau said directly to the tippee that you say imposes this liability on the part of the tippee?
Robert S. Warren: First, the Plaintiffs allege, and they allege this as a charging allegation, so it is assumed that this was an important statement to them and one that they deemed important in determining to go upon this acquisition program of stock... they said they told Mr. Neadeau that they were dealing with Mr. Lazzaro and that they wanted to confirm certain information, and they said in the complaint that what they wanted to confirm was the gold strike in Surinam and the prospective joint venture with St. Joe's.
Unidentified Justice: I thought the complaint discloses that Mr. Neadeau refused to confirm or deny that.
Robert S. Warren: The complaint alleges a statement by Mr. Neadeau that the Plaintiffs allege misled them into believing that they had inside information and a jump on every other TONM shareholder in that he made a statement to them that they allege in their complaint... it must be to make it a charging allegation... was a clever confirmation while nonconfirming.
They said that he said yes, that he couldn't confirm or deny, but the realities were that when he said the reason he couldn't confirm or deny was because the information was not yet public, they would have to wait for that annual report to see that, but he did want to tell them that Mr. Lazzaro was a very trustworthy and good man.
There is only one inference from that, and if that is not... if that is not an improper transmission by Mr. Neadeau, then in the brokerage industry I believe they are going to talk about somebody being Neadeaulized because that is nothing more than a ploy, at least as they allege it, that's their charge, a ploy to indicate that they had inside information, an unfair jump on the TONM shareholders.
And they say that they acted on it.
They say in reliance on it, on the premise that they had inside information, they bought from other shareholders, and they bought at two, they bought with an advance knowledge of market conditions, and they did in fact watch the stock over a period of time from November of 1979 up to the first quarter of 1981, and indeed, in the last quarter of 1980, hit a high water mark of seven.
So based upon the information, the jumps that they thought they had, they did indeed have a jump.
They rode that stock from approximately two up to seven, and had they sold at that point, they would have actually achieved the results of their contemplated fraud.
They didn't; they held.
The stock did not pan out.
A public announcement was made contrary to the inside information announcing that the joint venture wouldn't go through; the stock went down.
So it is our position that on those facts, as disclosed on the face of the complaint, that Plaintiffs were guilty of a 10(b)(5) violation.
Now, it is understood that--
Unidentified Justice: In your view, Mr. Warren, would the in pari delicto defense always be available then to a tippee who voluntarily trades on what is represented to be insider information?
Robert S. Warren: --I believe that if the tippee, as here, is put in the position to understand that the information was received from a corporate insider with a fiduciary duty not to disclose it selectively, and as here, they know that it has been disclosed selectively for the purpose of causing the customers of a certain broker to enjoy an unfair advantage, yes.
If all they are told is we have some inside information, I think one can say at that point you don't know enough to know whether a Dirks duty has in fact been breached or has not.
Here we do.
Unidentified Justice: Do you think it is correct to say that at common law, the in pari delicto defense was available in an action for fraud?
Robert S. Warren: Yes.
When the conduct which is the equal fault is itself fraud.
In other words, obviously if we have a gambling game where someone has gambled, and that is their fault, they have gambled against the state law and they are cheated with marked cards, then you don't have equal fault because one person has a fraudulent intent and the other person just intends to gamble, a small matter.
Here, these people are alleged to have had the identical intent.
Here it is alleged that Mr. Neadeau and Mr. Lazzaro intended to commit a 10(b)(5) violation.
They intended to defraud the market.
Unidentified Justice: By what?
Robert S. Warren: I beg your pardon?
Unidentified Justice: By passing out false information or what, or by... or withholding information?
Robert S. Warren: They allege that the Defendants were engaged in what they call manipulation of the market.
At one point they had a Section 9 claim as well, but that was dismissed by virtue of nontimely filing.
Unidentified Justice: So if equal... if close to equal fault is essential for the defense to be invoked, what is the difference between... is there some difference between these... the tipper, the tipster and the tippee, in this case?
Robert S. Warren: Not a meaningful difference, in our view, because they each intended according to the allegations of the complaint as we read them to commit a fraud on stockholders.
Unidentified Justice: Well, they also... they also intended to use inside information.
Robert S. Warren: The tippees?
Unidentified Justice: Well so did the tipster.
Both of them.
Robert S. Warren: Oh, the tipster to use in side information.
Well, they allege that the inside information is not true, that the tipster was passing a wrong that information.
Unidentified Justice: Well, then, the tipster not only was purporting to use inside information, but he was also lying.
Robert S. Warren: And says, I believe, the Dirks... I'm sorry.
Unidentified Justice: And the tippee, the tippee didn't lie to anybody, he just didn't tell them what the facts were.
Robert S. Warren: Well, I don't... I suggest that the difference between an actionable misrepresentation under 10(b)(5) and an actionable nondisclosure such as under Affiliated Ute under 10(b)(5) are indistinguishable.
Unidentified Justice: Yes, but the tipster might be stuck under state law for defrauding somebody.
Robert S. Warren: --The tipster might be stuck under state law for defrauding somebody, of course.
Unidentified Justice: He wouldn't be... but the tippee wouldn't be committing a state law offense by just not... just by saying caveat emptor.
Robert S. Warren: Oh, I... perhaps I am unduly influence by the fact that I am from the State of California, but I don't think that could be--
Unidentified Justice: You have statutory.
Robert S. Warren: --I don't think that could be said in the State of California.
Unidentified Justice: You have statutory remedies.
Robert S. Warren: Well, we have, yes, we have a... yes, we are a code state.
However, we have a well developed case law in California, and we have duties of when it is necessary to disclose in order not to commit fraud, and I believe that this Court has drawn upon common law concepts as to those duties to disclose.
In Dirks, when we talk about there being fiduciary duties--
Unidentified Justice: So the tippee wants to buy some stock from some stockholder because he thinks the stock is going up.
He just doesn't tell him why he thinks the stock is going up, that would be his... would give the seller of the stock a remedy under state law?
Robert S. Warren: --No, but if he, if he had gone to a corporate insider with a fiduciary duty to that shareholder that he is going to go buy it from--
Unidentified Justice: I understand that.
Robert S. Warren: --and he gets told something by that corporate insider that is not to be revealed and is a breach of duty to do so, and he then goes and buys that stock and he doesn't disclose, yes, I believe indeed he is guilty of actual fraud.
I believe he is guilty of actual fraud under common law, under state law, and under the federal securities laws.
Unidentified Justice: If this stock had gone to 28 and then this fellow had sold it and made a very large profit, would it be subject to some vulnerability on the part of others?
Robert S. Warren: Would the plaintiffs here be subject to vulnerability to a suit by others?
Yes, indeed, I believe so.
Unidentified Justice: Now, as I read the District judge, he said he wasn't going to get into a fine tuned weighing of quantitative dishonesty, quantitative fraud, quantitative violations of the Securities Act, that he was going to weigh and did weigh what he thought was the qualitative violations, and he thought qualitatively they were in the same boat.
Isn't that about it?
Robert S. Warren: That is correct.
I believe that is exactly the fact, that the dollars weren't as important as the offense which was committed and the state of mind with which it was committed.
Now, we believe that if we are correct that there indeed was a fraud and attempted fraud committed by the plaintiffs then they should be barred because, first, the defense of in pari delicto is a part of the statutory law of the securities laws; second, it is based upon rational, reasonable and publicly accepted considerations; and third, the government here has failed in any respect to show that its enforcement will inhibit the enforcement of the securities laws.
First, as to the legislative point, Rule 10 is based upon the statutory section 10 which simply prohibits manipulative and deceptive practices.
As such, if construed to have a private remedy, it is a very general, federal tort standard with the contours to be set by the court.
In Briscoe v. LaHue, however it is correctly pronounced, it was said that when Congress passes such a very general federal tort even for very good and important purposes such as the civil rights statutes, it is presumed to be aware of the common law land the existing of common law defenses and to accept them into that tort structure.
This is particularly appropriate with regard to Section 10 because of the savings clauses that are found in Section 16 of the '33 act and 28 of the '34 act which accept common law remedies and deem them to continue in effect.
The federal courts uniformly, in applying Section 10, have adopted common law defenses based upon the conduct of plaintiffs, for example, laches, waiver, estoppel, ratification, consent, limitations, all of those based upon conduct by the plaintiffs have been accepted.
One of them has been in pari delicto.
The federal courts have applied in pari delicto in securities actions, and indeed, in the Kuehnert case in 1969, applied it to an action much like that here, also involving the tipper/tippee type of situation.
Unidentified Justice: Mr. Warren, can I interrupt with one question?
Robert S. Warren: Yes, sir.
Unidentified Justice: I guess one of the problems is what really is equal fault in cases of this kind, and if I understand your colloquy with Justice White, you say it really doesn't make any difference whether the tipster was telling the truth or not; in either event it is equally bad.
Robert S. Warren: Yes--
Unidentified Justice: Is that... in other words, supposing you had a case in which a tipster... a broker says to a customer, I just talked to the president of the company and they are about to buy a gold mine, and in one case that is just no basis in fact for it; in the other case it's totally true.
Would you... and the customer then goes out and buys 100 shares of stock.
Would you say in neither case could the customer recover?
Robert S. Warren: --I would say in neither case could the customer recover, and if it is true, of course, as pointed out in Kuehnert and pointed out in Tarasi, it is likely that there will be no need to worry about the problem because all concerned will be wealthy.
Unidentified Justice: Well, no, not because... at the time he tells him, it is true, but then a month later the deal falls apart.
You know, that is... arguably that might have happened here.
I don't know.
Robert S. Warren: There's that possibility.
Unidentified Justice: So that at the time of the transaction, though, everybody was dealing in at least not a false way.
You say there is no difference between the case where he tells the truth and the one where the broker lies.
Robert S. Warren: Oh, well, in the former case, we also will leave out now the wealthy because it didn't pan out.
However, because we have no bad intent on the part of the defendant, we can also forget about it because there is no cause of action.
The in pari delicto defense assumes that there is fault on each side.
Unidentified Justice: Well, there is intent in both case to trade on inside information.
In the one case it is false inside information; in the second case it's true.
Robert S. Warren: Yes.
Unidentified Justice: And it seems to me that one could make a stronger argument that when everybody thought it was true but they just thought they would make a little money on the side, that you would say they are equally guilty, but it is a little different if he... I just... if one of them is lying and the other one didn't realize it.
Robert S. Warren: I understand, Justice Stevens, but I don't think, still, in your first postulate, there would be any cause of action at all because the two parties may have engaged in inside trading, but there would be no relationship between the inside trading and the loss.
In other words, the party who received the tip would not have a cause of action against the party who gave the tip because of the concept of inside trading, there would be no deception.
Unidentified Justice: But there would be... isn't it a violation of the securities law to give inside information in that situation?
Robert S. Warren: Perhaps insofar as the SEC is concerned, but not insofar as a private right of action is concerned.
Unidentified Justice: Well, why not?
If he acts on illegally acquired information, the stock instead of going up goes down, why hasn't he been injured?
Robert S. Warren: Because there's no deception, there's been no violation as to him.
The violation occurs in the inside information case as to the party who doesn't know about it.
It's the superior knowledge improperly obtained that makes the violation.
Unidentified Justice: So you are saying that the broker who gives inside information, truthful inside information to a customer, does not violate the statute?
Robert S. Warren: Not to the customer.
He may indeed to the stockholders from whom the customer buys the stock and with whom the customer deals, but no, a broker who gives inside information, true inside information to a customer and is truthful as between that customer there is no violation as to that customer, there is no tort.
There is no violation.
There will be a violation as far as the SEC is concerned because that customer then goes out and commits a fraud upon the third party, but the customer has no claim whatsoever.
Unidentified Justice: Well, I don't understand your as to.
There is or is not a violation.
If the SEC could call it a violation, there's a violation of the rules.
Robert S. Warren: But they call it a violation not because the broker did something bad to the customer--
Unidentified Justice: That may be the reason why, but I still say there is a violation, as I understand the law, and it conceivably, it could cause an injury to the person who acts on the basis of the information.
Robert S. Warren: --But the person against whom the violation is perpetrated is not the customer, it is the stockholder out there, and yet under your postulate, you are having the customer come in and sue, and it is not the customer who has been misled under those circumstances.
The customer has been told the truth.
And if the customer has been told the truth, the customer has no claim.
Unidentified Justice: Well, why don't we leave out all these... why don't you just say that the insider, the tipster is, say, an officer of the corporation.
Robert S. Warren: All right.
Unidentified Justice: And he tips a friend.
We are going to buy a gold mine.
Robert S. Warren: Yes.
Unidentified Justice: And that friend then goes out and buys a bunch of corporate stock without revealing anything, without revealing that he is dealing in inside information.
Robert S. Warren: Yes.
Unidentified Justice: Those people he bought the stock from have a cause of action against him.
Robert S. Warren: They do, yes.
Unidentified Justice: Yes, they do.
And does the tippee have a cause of action against the tipster?
Robert S. Warren: No.
Unidentified Justice: What if it... but that's only on the assumption--
Robert S. Warren: He has not been wronged.
He has not been deceived.
Unidentified Justice: --Yes, but that's only on the assumption though that the inside information is true.
Suppose it is false.
There is no dealing in inside information at all.
He has not revealed any inside information.
That is just a dream world.
And so wouldn't the tippee then have a cause of action against the fellow who is passing out false information?
Robert S. Warren: He would but for the existence of the in pari delicto defense, that's right.
Unidentified Justice: Well, I know, but--
Robert S. Warren: That's the one hypothetical--
Unidentified Justice: --In this case, in this case, in this case you are comparing, as Justice Stevens and I were pursuing before, you are comparing dealing in inside information with deliberate fraud.
Robert S. Warren: --No, but the--
Unidentified Justice: And the only, in really inside information case, the tipster has breached his duty to the stockholders.
Robert S. Warren: --Justice White--
Unidentified Justice: And you are trying to enforce that also through the tippee.
Robert S. Warren: --Justice White, an insider trading case is an actual fraud.
It is not different from an actual fraud, it is--
Unidentified Justice: On whom, on whom?
Robert S. Warren: --on the shareholder that sells the stock.
Unidentified Justice: All right.
Robert S. Warren: The shareholder that sells the stock without being told the truth, that's the fraud.
Unidentified Justice: It's a breach of fiduciary duty.
Is that... you can call it that or anything.
Robert S. Warren: Well, it is a--
Unidentified Justice: That's fraud, a type of fraud.
Robert S. Warren: --It is a fraudulent or deceptive practice under Section 10.
Unidentified Justice: And you say that's... if that's all the... and you think that the tipster who does that... suppose he just lies, as I said.
Do you think that is... that he has committed a fraud on the stockholders?
Robert S. Warren: No.
Unidentified Justice: If he just lies?
Robert S. Warren: If he just lies to his customer, he has defrauded his customer.
Unidentified Justice: All right, he has lied to his friend, and he has committed on fraud on the stockholders of the corporation.
Robert S. Warren: That's right, he has just defrauded his friend.
Unidentified Justice: And so then I would think you still think, though, in that case there would be in pari delicto defense.
Robert S. Warren: I do, if the customer, knowing of the wrongful breach of fiduciary duty, capitalized on it to his own benefit to go out and commit the fraud that he intended to commit on the customer.
He is a fraudulent party just as the defendant, and that's the only hypothetical in which in pari delicto can arise.
If there is no cause of action against the defendant in the first place, we are not talking about in pari delicto, we are talking about no claim.
Unidentified Justice: Mr. Warren--
Robert S. Warren: Yes.
Unidentified Justice: --Dirks seemed to talk in terms of a requirement that the insider, the tipster, act for personal gain.
Now if in this case the only thing on the face of the complaint that we look to is Mr. Neadeau, is it clear that he was acting for personal gain?
Robert S. Warren: It's clear that the plaintiffs had every reason to believe that he was acting for personal gain, and it is their mind set that we look at.
Unidentified Justice: Well, did Dirks look at what the tippee thought, or did Dirks also speak in terms of a requirement that the tipster be acting for personal gain?
Robert S. Warren: In the case of in pari delicto, I think we are looking at what the tippee thought, but let's add both.
Unidentified Justice: So suppose the tipster just let it slip at a golf game, no personal gain at all.
Robert S. Warren: Now, that's correct, that's correct.
However, in this case, what is clear here is that Mr. Lazzaro told them that he had in side information from that officer.
They called the officer, and he told them it was nonpublic in other words, they shouldn't have it, that nobody else would receive it until later, but that Mr. Lazzaro was a very good and trustworthy man, he knew they were dealing with Lazzaro, he knew they were going to buy the stock, he knew that would benefit Lazzaro, it would make Lazzaro look like a very smart man.
Unidentified Justice: Well, how does that relate to any personal gain by Neadeau?
Robert S. Warren: It was made clear in Dirks, I thought, that on an objective fact basis we would look to see whether there was any benefit to the insider, meaning wrongful desire to secure something for himself, either monetarily, or to give--
Unidentified Justice: Well, did the complaint allege that Mr. Neadeau was going to gain personally?
Robert S. Warren: --It did not say those words.
However, it never will.
Unidentified Justice: Well, since we look only at the Complaint, it looks to me like you don't have in pari delicto defense here.
Robert S. Warren: Justice O'Connor, we look at the facts in the complaint, and those facts, while they don't say he personally gained, they show that he did personally gain.
They show that he gifted or benefitted a stock broker.
He selective released information in a way that would benefit that stockbroker.
It alleges that he himself owned a hundred thousand shares of stock.
It is alleged that the stock broker owned the shares of stock--
Unidentified Justice: And drove the price up.
Robert S. Warren: --And it drove the price up, yes, for the benefit of all.
So the facts alleged show that personal gain.
We don't need to have the complaint say it in fact was--
Unidentified Justice: Could I ask you one quick question?
Do we judge this case, or does the record show, or are there findings as to whether or not the tipster here conveyed both true and false information or only true or only false?
Robert S. Warren: --All right.
The fact is that the comparison of I believe it is paragraphs 16 and 33 of the complaint, 16 being the representations, and 33 being the falsity, shows that we have a mixture, in other words, that they don't contend there wasn't any gold find; they quarrel with its state of development.
They don't contend that there were no joint venture negotiations they simply quarrel with the stage at which those negotiations had progressed.
Unidentified Justice: So you think that the Complaint on its face alleges that part of it is false and part of it is true?
Robert S. Warren: I think that is correct.
I think, on the other hand, it wouldn't make any difference whether it was all false.
Unidentified Justice: I know, I know.
Robert S. Warren: Because as in the case of Judge Weinfeld, I believe that is beside the point.
I believe that an attempt to commit wrong based upon what you believe is criminal activity is plenty enough for in pari delicto.
It is plenty enough for punishment for crime.
Your Honor, if I may, I am through.
I'm very sorry.
Chief Justice Warren E. Burger: Mr. Knudsen?
ORAL ARGUMENT OF GEOFFREY P. KNUDSEN, ESQ. ON BEHALF OF RESPONDENTS
Geoffrey P. Knudsen: Mr. Chief Justice, and may it please the Court:
This case is not an insider trading case.
It is a case in which the complaint alleged a common, garden variety fraud, and the fraud was perpetrated on the Plaintiffs.
The fraud was, as the complaint alleges was a planned... a plan conceived by the Defendants to manipulate the price of stock in TONM, not for the benefit of all, but for the benefit of the Defendants alone.
As part of the scheme, the Defendants--
Unidentified Justice: Well, would that make it any less a violation of 10(b)(5)?
Geoffrey P. Knudsen: --Pardon me?
Unidentified Justice: That he was... the narrowness of, the scope of the fraud.
Geoffrey P. Knudsen: Well, the scope of the fraud, as alleged in the complaint, would have some effect in terms of interpreting whether the Plaintiffs could be considered to be of equal fault or in pari delicto, but the complaint itself is meant to alleged a... just a fraud 10(b)(5) violation in the context of a market manipulation, and that the plaintiffs were injured by it.
What makes it a little bit different is that the complaint alleges that the Plaintiffs, who ended up losing their money, were utilized as an instrumentality of the Defendants' fraud.
In other words, it was the intent of the Defendants to provide intentionally false information alleged to be inside to the Plaintiffs.
They initiated the contact, they did it for purposes of having the Plaintiffs trade, driving the price of the stock up.
They never intended the Plaintiffs to benefit from that market manipulation, and in fact, as the Complaint alleges, when the Plaintiffs indicated some desire to sell when the stock got up at its higher levels, they continued the fraud so that they would continue to hold on to their stock by saying, wait, it will go higher, it will go higher.
So it is not a situation where the Defendants and the Plaintiffs embarked upon a conspiracy to somehow utilize inside information.
It is solely a situation where the defendants are alleged to have embarked upon scheme to defraud the market and defraud these plaintiffs.
Unidentified Justice: Well, would the tippee in this case have been... be liable to those people that he bought stock from?
Geoffrey P. Knudsen: Because the allegations are that the information was false, there would be no liability.
Unidentified Justice: Because?
Because nobody, there was no actual use of inside information?
Geoffrey P. Knudsen: No one was injured.
There's nothing... he wouldn't have a duty to disclose false information, particularly in the context of--
Unidentified Justice: So you think we have to read the complaint as alleging everything was false.
Geoffrey P. Knudsen: --I think you need to read the complaint as alleging everything is false.
That's what the charging allegation is--
Unidentified Justice: Well, let's assume we don't agree with you, part fault, part true, and so there was some use of inside information, which the person who bought the stock on the open market didn't disclose.
Geoffrey P. Knudsen: --Well, I don't think you can look at the face of the complaint and then conclude that the allegations are part false and part true.
The central allegation of the complaint is paragraph 16, that the defendants were engaged in--
Unidentified Justice: I know, but let me just give you my question again.
Geoffrey P. Knudsen: --Okay.
Unidentified Justice: Let's assume we don't agree with you and that the complaint says part true, part false.
Now what about the position of the tippee vis-a-vis the person he bought stock from without disclosing?
Geoffrey P. Knudsen: Would he have liability?
Unidentified Justice: Yes.
Geoffrey P. Knudsen: To the extent that there was damage to such a person--
Unidentified Justice: So the answer is yes.
Geoffrey P. Knudsen: --Related to the true information.
Unidentified Justice: So he failed to disclose, and he could be held liable under the securities laws.
Geoffrey P. Knudsen: If he received true information.
Unidentified Justice: Yes, exactly.
Geoffrey P. Knudsen: Right.
Unidentified Justice: So at least he is delicto.
Geoffrey P. Knudsen: To the extent that he receives true information, he would be delicto, in delicto.
Unidentified Justice: Exactly.
Geoffrey P. Knudsen: That's right--
Unidentified Justice: And the argument would... then the question would come down, is it in pari delicto.
Geoffrey P. Knudsen: --Okay, and in terms of deciding in pari delicto, then if you are trying to decide it on the face of the complaint, assuming that you read the complaint that some is true and some is false, the complaint in my opinion would be a very bad device to make that determination of in pari delicto.
Unidentified Justice: Yes, but it was made below.
Geoffrey P. Knudsen: Well, it was made by the district--
Unidentified Justice: That's why the cast is here.
Geoffrey P. Knudsen: --It was made by the District Court, and that was my argument in the 9th Circuit, that it would be a bad device to use.
But the 9th Circuit read the complaint as charging an intentional fraud, all of the information false.
That's actually what the 9th Circuit concluded, was that--
Unidentified Justice: So as far as they are concerned, there was no use of inside information at all.
Geoffrey P. Knudsen: --I don't think that they decided the issue of whether it is inside information in the context of this--
Unidentified Justice: Well, if it was false, it wasn't.
Geoffrey P. Knudsen: --No.
I think that the 9th Circuit assumes that there is a line... there was a line of authority that says if you have a tippee attempting to trade on inside information, that he may be guilty of a violation, but concluded in the circumstances of the allegation of the complaint where an intentional fraud being perpetrated on the Plaintiffs was alleged, that more or less as a matter of law those parties could not be in pari delicto.
That is not inconsistent with the common law.
Unidentified Justice: I agree with you, I agree with you.
Geoffrey P. Knudsen: Which at common law, if you have an actual fraud and the determination, there is a public policy issue if withholding the relief would do more to offend public morals, then in pari delicto would not apply, and that is the situation that the 9th Circuit addressed and said if there is a fraud aimed at these Plaintiffs and aimed at the market, then to withhold relief or to withhold the opportunity to pursue their claim would be more offensive in the concept of... in the context of in pari delicto.
Unidentified Justice: Do you agree with your friend's response when I put to him this question, that if this stock had gone up to 28 and then this gentleman sold out at 28, would you be subject to a claim for recovery from them, and then after that it dropped to where it did drop, 1 or less?
Would the purchasers of that stock have been able to recover from this fellow?
Geoffrey P. Knudsen: I'm into Justice White's problem in the sense that if you read that there is some true inside information or nonpublic information and some false, and the stock goes to 28 based on an activity of trading, and then there is this true information about the gold find, yes, there would be liability.
The Complaint was meant to alleged a market manipulation that did not involve true information, or at most, partially true information solely for purposes of market manipulation.
Unidentified Justice: I take it you concede there was market manipulation here?
Geoffrey P. Knudsen: Absolutely, but that is not the activity that my... that was done unknowingly with my clients and the Plaintiffs as an instrumentality of that, and they were not part of a conspiracy to benefit from that market manipulation, and in fact, they lost money, and that is why they have come forward and asserted their claims.
Unidentified Justice: I don't understand how you can say that in response to the Chief Justice's question.
You say if they had been smart enough to sell out before it dropped, they would be liable to other parties if part of the information was truthful.
At least they thought it was truthful when they were relying on the inside information, didn't they?
That's why they bought it.
Geoffrey P. Knudsen: Yes, that's correct.
Unidentified Justice: Now, why isn't that a violation?
Why wouldn't they be liable to the people to whom--
Geoffrey P. Knudsen: I said they would if the information was true information.
Unidentified Justice: --What difference does it make?
They thought it was true at the time they engaged in the trades, didn't they?
That's the whole hypothesis of the fraud.
So how can their blameworthiness depend on whether the information turns out to be true or false?
I don't understand.
Geoffrey P. Knudsen: Well, I think that the hypothetical becomes a little difficult to deal with because if it is false information, the stock doesn't go to 28.
Unidentified Justice: Well, it may have as long as people think the information is true.
This talk about this gold mine over wherever this place was--
Geoffrey P. Knudsen: --Oh, I see, and they sell out in the context of--
Unidentified Justice: --They sell out when... you say they wanted to, and they were talked out of selling out.
--The market goes up on the basis of public perception, not reality.
Geoffrey P. Knudsen: --That's absolutely right, and that's what is charged by the complaint.
They would have liability to the extent that they received true information, and you are asking would they also have liability to those folks that sold their stock even though the market was going up because of false information?
And I would say no because--
Unidentified Justice: Isn't it almost certainly true that some of the information is going to be true?
You are not going to assume the burden of proving every single statement alleged in there was false, are you?
I mean, in these facts, there is always a mixture of truth, even in the most gross fraud.
Do you assume that you have to prove that every statement in the complaint was false?
Geoffrey P. Knudsen: --No.
I assume I have to prove that there was an intentional scheme to manipulate the market utilizing my clients, providing them--
Unidentified Justice: And the scheme involved a mixture of--
Geoffrey P. Knudsen: --Essentially--
Unidentified Justice: --half truths and truths and falsehoods.
Geoffrey P. Knudsen: --But essentially false information.
Unidentified Justice: Well, I just have difficulty understanding how your... whether your client was engaged in wrongdoing turns out... depends on whether he finds out later that the information was false or not.
Geoffrey P. Knudsen: Well, to the extent my client is engaged in wrongdoing may not depend on that at all unless you look at it in the context of perhaps this court's Chiarella and Dirks analysis, and then you have to look at a duty to disclose, and then the question comes up how can you have a... how could the insider have a duty to disclose false information because that is the very thing you don't want to happen, but in ignoring that distinction recently drawn, yes, I think the SEC's position would be that it doesn't matter whether it is true or false, my clients are in delicto, as Justice White said.
The question becomes if they are intentionally manipulated, are they in pari delicto.
In terms of the Plaintiffs' position, their position is there is no equality of fault in those situations where they are being utilized unknowingly as a market manipulator because--
Unidentified Justice: May I ask you just one other question?
Geoffrey P. Knudsen: --Sure.
Unidentified Justice: Then I will get it all off my chest.
Supposing your theory... I realize you are relying on a fraud theory, but supposing you had a case in which a plaintiff just said he got inside information which he relied on and was true and so forth and so on, but the stock didn't... the deal fell through and the stock didn't go up as much as he expected it.
Do you think the plaintiff has a cause of action there?
Your opponent says no, there is no cause of action absent fraud.
Geoffrey P. Knudsen: Well, I say he has no cause of action because you don't have the degree of scienter on the Defendant that would be required by Ernst & Ernst for a 10(b) violation, I agree.
Unidentified Justice: He would know he is deal... he is passing out inside information, he knows he has a duty not to do so.
The customer, the broker, knows it is inside information, knows the law says you are not supposed to do this, you say there is no scienter?
That's the answer?
Geoffrey P. Knudsen: Maybe I misunderstood your question.
Unidentified Justice: Everybody is telling the truth.
This is my hypothesis.
Geoffrey P. Knudsen: Everyone is telling the truth.
Unidentified Justice: The broker says they just found a gold mine, they are going to make a billion dollar deal, it is a good buy, it is inside information, don't tell anybody.
Geoffrey P. Knudsen: Right.
Unidentified Justice: You trade on it, and the stock goes up for a while, but then the deal falls through, but everybody is dealing on inside information.
Does the customer of the stock broker have a cause of action against the stock broker for dealing in inside information?
Geoffrey P. Knudsen: No, I don't believe so because of the scienter requirement for... because it is not an insider... he doesn't have a claim for insider trading.
If he has a claim against a broker for anything, it is for fraud under 10(b)(5), and that would require scienter, which would require some intentionally false or recklessly false information imparted to him, and your hypothetical is it is true.
Unidentified Justice: So what it boils down, it is all right to trade on inside information as long as it is true.
Geoffrey P. Knudsen: Pardon me?
Unidentified Justice: What it boils down to is it is all right to trade on inside information as long as it is true.
Geoffrey P. Knudsen: No, that's a different question.
The Plaintiff, someone trading on true inside information is going to be liable for criminal sanction.
The SEC can proceed against him, and anyone selling his stock who loses, incurs injury, can proceed against him.
But that doesn't necessarily... that's really a separate question.
That doesn't necessarily make that person in pari delicto with a person who intentionally misleads him and provides him intentionally false information.
You see, he's not suing... in that case you are not considering the context of the tippee vis-a-vis the broker.
You are looking at the tippee vis-a-vis the regulators or vis-a-vis someone who lost money to whom he might have a duty to disclose the correct information.
In any event, given the legislative history of the insider trading sanctions act, I think they place the primary responsibility with the brokers and the insiders.
I think this Court's decisions that indicate that the tippee liability is derivative indicate that the person at the tippee level is going to be, in the common law sense, even the common law sense, of in pari delicto, not of equal fault.
And the facts... thank you.
Chief Justice Warren E. Burger: Mr. Kuhlik?
ORAL ARGUMENT OF BRUCE N. KUHLIK, ESQ., PRO HAC VICE, FOR SECURITIES AND EXCHANGE COMMISSION, AS AMICUS CURIAE IN SUPPORT OF RESPONDENTS
Bruce N Kuhlik: Thank you, Mr. Chief Justice, and may it please the Court:
I would like to focus on what the Commission believes is the dispositive factor in this litigation, and that is the furtherance of the public interest in deterring violations of the federal securities laws.
We think that there can be no doubt that allowing this lawsuit to go forward in the circumstances as we now believe them to be will further, will best further the deterrence of violations of Section 10 (b) and Rule 10 (b)(5).
Now, deterrence of wrongdoing is an important component of the in pari delicto defense as it has developed at common law.
The courts engaged in a flexible balancing of relative fault in order to determine which party was the primary wrongdoer who should be deterred in the first instance, and we think that in the federal regulatory scheme presented in this case where private actions such as those under Rule 10(b), or excuse me, Rule 10(b)(5), makes an important contribution to enforcement of the federal securities laws.
We think that the Court's decision in Perma Life Mufflers which held the defense unavailable in a private action under the antitrust laws because the defense would not further the deterrent purpose of the Sherman and Clayton Act, we think that that case requires that the defense be applied here only if it will further the purposes of the securities laws.
Now, I would like to turn first to the deterrence of wrongdoing by brokerage professionals and insiders.
I don't think there can be any doubt that allowing the lawsuit to go forward will deter brokerage sales people such as Mr. Lazzaro here from perpetrating frauds on their clients.
That is the whole purpose of the action to be implied.
And the only question then becomes whether or not there is some other overriding factor on the other side in terms of perhaps encouraging wrongdoing by persons in the position of the Plaintiffs that would, as I say, override this deterrent impact on the brokers.
And we think that that overriding factor on the other side just isn't present.
In the Commission's view, allowing this action to go forward will not unduly encourage illegal tippee trading.
In the first place, allowing the suit to go forward will deter brokers from giving information in the first place.
It will cut that inside information off at the source.
It won't be there for the tippees to trade on.
In the second place, investors in the position of the Plaintiffs, in the Commission's view, are often unsophisticated, certainly as compared with the brokerage professionals here, it might be believed that they were unsophisticated, unschooled in the law, and we think that for that reason the brokerage professionals are far more likely to respond to the deterrent impact of not allowing the defense here than ordinary investors would be to the deterrent impact on their trading of allowing the defense.
And I think that--
Unidentified Justice: May I ask just one question?
Bruce N Kuhlik: --Yes, Justice Stevens.
Unidentified Justice: Assuming after trial there is a findings that everything everybody said was entirely truthful; is there liability or not?
Bruce N Kuhlik: On whose part?
Unidentified Justice: Well, does the Plaintiff recover from the Defendant in this case?
Bruce N Kuhlik: --If all of the information was truthful--
Unidentified Justice: It's all inside information, but it was truthful.
Bruce N Kuhlik: --Then I do not believe they could recover because they would not have been deceived.
Unidentified Justice: All right.
Bruce N Kuhlik: I think when tippees consider whether to trade on inside information, they do not consider seriously the possibility of recovery in court if the information turns out to be false.
They trade on tips from trusted friends, from their broker, and they will go ahead and trade on it if they believe it.
I don't think it would be reasonable to assume that a person would trade, invest substantial sums of money on information believing there to be a substantial possibility that the whole information is false, simply on the chance, just the chance that they might recover later in a legal action.
Unidentified Justice: So your submission is that we ought to just, in this case at least, forget the notion of equal fault?
Bruce N Kuhlik: No, Justice White, I believe--
Unidentified Justice: I should say that no matter whether they are equal or not, enforcement of the securities laws is so important that the defense should not be allowed.
Bruce N Kuhlik: --My position is that the enforcement of the securities laws is so important that the defense should only be allowed where it will further the purposes of the securities laws, even if in a particular case the fault of the parties were relatively equal.
But I might add that, you know, I will get to this.
We don't believe that this is even a close case as to equal fault.
We think it is quite clear that the insider and the brokerage professional here were of greater fault--
Unidentified Justice: Because?
Bruce N Kuhlik: --Because they abused their special position in the scheme of the capital market system and in the scheme of the enforcement of the securities laws to perpetrate a fraud on the investors.
Unidentified Justice: Well, the tippees, assuming there was some true information that wasn't disclosed, the tippees also are in trouble, aren't they, with the people they bought from.
Bruce N Kuhlik: It is true that if--
Unidentified Justice: Under the securities law.
Bruce N Kuhlik: --Under the securities laws, Justice White, if a plaintiff could prove that the investors here traded on inside information knowing that information or being on notice that that information was received in breach of a fiduciary duty of an insider and that that caused a trading loss to some other group of investors, then they would be liable, but--
Unidentified Justice: Well, but that is... you think that is less reprehensible than what the broker and the tipster did?
Bruce N Kuhlik: --I believe it is, and that the--
Unidentified Justice: Because of their special position?
Bruce N Kuhlik: --Because, well, of a number of factors.
Because of their special position, but also because they are the people who instigated the fraud here They are the people who took advantage of the plaintiff investors, engaged them in a scheme, abused their position of trust to make them believe that they were trading on inside information when in fact it was the plaintiffs all along who were the intended victims, excuse me, and the actual victims of the fraud, and in this regard, I might add that the brokers and insiders such as those here, in the Commission's view, have a much greater opportunity to jeopardize the integrity of the market systems.
They are continually in a position to come into inside information, to represent or to misrepresent to their clients, to their friends, to their investors that they have access to this sort of information.
And the brokerage professionals such as Lazzaro here occupy a key position.
They control access to these markets.
If a plaintiff wants to trade, he has to do it through a broker, and it is up to the brokers to be... they are required to be conversant with the law, to be conversant with Commission rules, regulations and the statute, and it is up to them in the first instance to guide the trading of their clients into lawful channels.
And that position of trust was abused here.
And if the Commission is to be able to uncover these sorts of frauds perpetrated on investors, the only realistic way for most of these frauds to come to light is through private actions such as these, and I think there can be no doubt that the investors would have little incentive indeed to bring these sorts of actions to light because by doing so, they expose themselves to possible criminal and civil sanctions.
So without the incentive of recovering their investment, it is most, most unlikely that these sorts of frauds would be uncovered.
And finally, we would note in regard to the position of the parties here, that in the Commission's view, the in pari delicto defense should be available in those securities actions where the plaintiffs, perhaps the investors, have instigated an illegal scheme, are truly involved in a conspiracy with a broker for their mutual benefit.
But that is not what we have here.
That is why I would like to turn then to the comparative fault of the parties.
The Petitioner claims that under the common law, a plaintiff who is guilty of fraud is barred from recovering under the in pari delicto doctrine under all circumstances.
Unidentified Justice: Could I ask you in this connection, please, if all the information that the broker and the insider handed out was false, all of it was false, and they knew it to be false, and they passed it out to the investor who acted on it thinking it was true inside information, he buys stock, the stock goes down, is then the investor liable to the people he bought from?
Bruce N Kuhlik: If all of the information is false, Justice White, I don't believe that the other parties to the trade would have an action.
Unidentified Justice: Yes, because there really, he wasn't using inside information.
Bruce N Kuhlik: But he... there was nothing that he used that he should have disclosed to them that--
Unidentified Justice: Exactly.
Bruce N Kuhlik: --caused them the loss in those circumstances.
Unidentified Justice: Yes.
In that event, he wouldn't be in delicto at all.
Bruce N Kuhlik: Well, he might not be, although I believe--
Unidentified Justice: What would he be?
Bruce N Kuhlik: --Well, some of the cases, Justice White, speak in terms of moral blame--
Unidentified Justice: They may be similar cases, but your view is that he wouldn't be in delicto at all.
Bruce N Kuhlik: --He would not be in delicto, he would not have violated--
Unidentified Justice: So, but he... but certainly his rights were violated at the outset.
Bruce N Kuhlik: --I might have misspoken, Justice White.
In our view, if all of the information were false, then another party to a trade wouldn't have had a private action against the investors here, but the Commission most certainly would have.
If the Commission could have proved that the investors believed the information to be true, they believed it to be inside information that they had obtained in breach of an insider's duty, or they had notice of such a breach, the Commision most certainly could bring an action, civil or criminal action for an attempted violation of the law.
So in that respect, even if all of the information is false, it may well be that the investors here have attempted to violate the law.
Unidentified Justice: I see.
Bruce N Kuhlik: At this posture of the case, we don't believe the complaint conclusively shows that.
Under the common law, it was not enough simply, or it is not enough now, as the common law has developed, that the plaintiff simply has engaged in a fraud.
A more refined balancing takes place that takes into account the deterrent purposes of the law and the actual degree of wrongdoing.
And we cite a number of cases in our briefs where, for example, a plaintiff who believed he was defrauding others by engaging in a fixed foot race was allowed to recover, notwithstanding the in pari delicto doctrine, from the parties who had defrauded him, because the race in fact was fixed against him.
Finally, I would note that we believe it makes little sense to adopt a rule that would distinguish solely on the basis of whether the investors had noticed that the information they were trading on was inside or indeed was information obtained in breach of an insider's duty because we wouldn't want to allow brokers to escape liability simply by couching their tips in terms of inside information.
If there is nothing further--
Chief Justice Warren E. Burger: Thank you, gentlemen.
The case is submitted.
Unidentified Justice: The Honorable Court is now adjourned until tomorrow at 10:00.