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GRUMET v. SHEARSON/AMERICAN EXPRESS

May 24, 1983

Grumet
v.
Shearson/American Express, Inc., et al.



The opinion of the court was delivered by: THOMPSON

 This securities action comes before the court upon motions for summary judgment by the two defendants, Shearson/American Express, Inc. ["Shearson"] and its broker Stuart Travis. By order dated January 4, 1983, this court denied defendants' motions to dismiss the original complaint provided that plaintiff file an amended complaint within 20 days of that order. On January 20, 1983, plaintiff filed a seven-count amended complaint. The gist of this complaint is that Travis fraudulently induced plaintiff to purchase certain stocks which later turned out to be unprofitable.

 Travis was responsible for two securities accounts in which plaintiff had an interest. As in the original complaint, plaintiff sets forth basically five improper actions on the part of Travis in the amended complaint. On February 25, 1982, Travis induced plaintiff to purchase stock of Wainoco Oil Company. The stock of Wainoco is traded on the New York Stock Exchange. To induce that purchase, Travis allegedly told Grumet that he had "inside information" from a member of Wainoco's board of directors that Texas General was planning to acquire Wainoco and that such "inside information" was reliable and trustworthy. In addition, Travis purportedly represented to plaintiff that the price of Wainoco stock would rise from $19 per share to $30 to $32 per share in the near future. Grumet also asserts that Travis told him that he had bought $200,000 worth of Wainoco stock for his own account and $5,000 worth of that stock for the father-in-law of the Wainoco director who told Travis about the proposed acquisition or merger.

 Shortly after plaintiff purchased the Wainoco stock, the price of the stock started to fall. After relating his concern to Travis in a March 1982 conversation, Travis allegedly told Grumet to "hang tough -- the story is true." Following Travis' advice to purchase additional Wainoco stock, Grumet then purchased another 2,000 shares on March 16 and 17, 1982. The price of Wainoco stock continued to fall, however, and Grumet sold shares of that stock at a substantial loss to cover his margin requirements.

 Plaintiff claims that Travis knew that his statements concerning Texas General's plan to acquire Wainoco were false or that Travis acted recklessly in making such statements. Grumet posits that Travis failed to investigate the facts underlying the impending acquisition and did not secure or attempt to secure any confirmation from Texas General or any other reliable source.

 Grumet contends that Travis' conduct violated section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, as well as section 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a). Plaintiff asserts that Shearson violated section 17(a) of the Securities Exchange Act of 1933 and section 20(a) of the Securities Exchange Act of 1934. Plaintiff has also sought to invoke this court's pendent jurisdiction for his state law claims.

 Defendants' motions for summary judgment are predicated primarily upon the defense of in pari delicto, meaning literally "of equal fault." Defendants also challenge plaintiff's proof of causation and the availability of a private right of action under section 17(a), as well as raise the equitable defenses of estoppel, laches, waiver and ratification.

 If summary judgment is granted based upon the in pari delicto defense to the 10b-5 claim, the complaint will be dismissed in its entirety. Although the United States Court of Appeals for the Third Circuit has recently declined to reach the question of whether there is a private right of action under section 17(a), Walck v. American Stock Exchange, Inc., 687 F.2d 778, 789 n.16 (3d Cir. 1982), section 17(a) is substantially identical to Rule 10b-5 and the same facts are pleaded as a violation. Id. The analysis of the impact on the regulatory scheme of application of the in pari delicto defense to a 10(b) action, infra, would not appear to change significantly for a 17(a) claim. Thus, if the 10b-5 claim is dismissed, the 17(a) claim will be dismissed as well. Plaintiff also contends that several of Travis' representations cannot in any manner be deemed "inside information." Thus, plaintiff asserts that acceptance of the in pari delicto defense would, nevertheless, preclude dismissal of the complaint. The court cannot accept this argument. In his complaint, plaintiff stated unequivocally that without the inside information he would not have entered into the transactions in question. See complaint, paras. 16, 17. Thus, if plaintiff cannot rely upon alleged misrepresentations of inside information, there cannot be the requisite causation. In addition, if there is no basis for liability on the part of Travis under the federal securities laws, the federal claims against Shearson must also be dismissed. Finally, if the federal claims are dismissed, the court will dismiss the pendent state law claims. Lechtner v. Brownyard, 679 F.2d 322, 327 (3d Cir. 1982).

 Turning now to the merits of the in pari delicto defense and the interplay of that defense with comprehensive federal regulatory schemes, the court is not writing on a clean slate. In Tarasi v. Pittsburgh Nat'l Bank, 555 F.2d 1152 (3d Cir.), cert. denied, 434 U.S. 965, 54 L. Ed. 2d 451, 98 S. Ct. 504 (1977), the Third Circuit applied the doctrine of in pari delicto to a securities fraud action based upon use of inside information. While plaintiff attempts to distinguish Tarasi in a variety of ways, including by questioning whether or not Travis is really an insider or whether different policy considerations apply to a broker as opposed to a corporate insider, for the following reasons the court finds these distinctions unavailing.

 It is now well-settled that the anti-fraud provisions of the federal securities laws require that certain persons possessing material non-public information bearing upon the value of an enterprise's securities not buy or sell such securities unless they first disclose this information. See, e.g., SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968) (en banc), cert. denied sub nom. Coates v. SEC, 394 U.S. 976, 22 L. Ed. 2d 756, 89 S. Ct. 1454 (1969). See also Staffin v. Greenberg, 672 F.2d 1196, 1202 (3d Cir. 1982). This rule was first invoked in interpreting rule 10b-5 in the context of insiders or a corporation itself trading on inside information about corporate assets or prospects. Brudney, Insiders, Outsiders, and Informational Advantages Under the Federal Securities Laws, 93 Harv. L. Rev. 322 (1979). "Tippees" of insiders have been held liable under rule 10b-5 because they have a duty not to profit from the use of inside information. Chiarella v. United States, 445 U.S. 222, 230 n. 12, 63 L. Ed. 2d 348, 100 S. Ct. 1108 (1980). The tippee's obligation arises from his role as a participant after the fact in the insider's breach of his fiduciary duty. Id.

 In Tarasi, supra, defendant bank officer allegedly told plaintiffs that two corporations were going to merge and that his bank, another defendant, was behind the merger. The bank officer stated that the stock of one of the corporations would probably double in value and that bank insiders were investing heavily in the securities of the two corporations. The merger never occurred and plaintiffs suffered losses as a result.

 The court stated that the doctrine of in pari delicto would bar a party from recovering damages if his losses were "substantially caused by 'activities the law forbade him to engage in.'" Id. at 1156-57, quoting Perma Life Mufflers, Inc. v. Int'l Parts Corp., 392 U.S. 134, 154, 88 S. Ct. 1981, 20 L. Ed. 2d 982 (Harlan, J., concurring and dissenting) (emphasis in original). The court noted that the doctrine should be applied only when it can fairly be said that the plaintiffs' fault is substantially equal to that of the defendant. Id. at 1157. In addition, before denying recovery, the court must assess the impact of such a result on the enforcement of the statutory scheme. Id. at 1159.

 The court first determined that, as a matter of law, plaintiffs' unlawful conduct was of sufficient magnitude to invoke the application of the in pari delicto doctrine. Id. at 1161. As "tippees," plaintiffs were under an obligation either to make full disclosure before engaging in the transactions in question or to refrain from trading until the information was made public. Id. In addition, there was no question but that plaintiffs' misconduct was voluntary. Id. at 1161, 1162. The court appeared to make a general statement that tippees are to be considered in pari delicto with tippers. Id. at 1162. The court explained that the voluntary unlawful acts of the ...


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