The opinion of the court was delivered by: BARRY
Plaintiffs, four individual purchasers of the stock of the defendant Mamatech Corporation, bring this action against Mamatech; the underwriter and broker of the securities, Blinder, Robinson & Co., Inc. ("Blinder, Robinson"); the law firm and accounting firm that participated in the preparation of the prospectus; and various individuals, alleging securities fraud, liability for violation of civil RICO,
and various pendent state law claims. The accounting firm, Alexander Grant & Co. ("Alexander Grant"), now moves to dismiss under Federal Rules of Civil Procedure 9 and 12(b)(6). For the reasons that follow, that motion will be granted.
The facts as alleged in the complaint are relatively uncomplicated. Although their stories differ somewhat in detail, each of the plaintiffs relate the same tale. At some point, each was telephoned by defendant Goldberg, an employee of Blinder, Robinson, and convinced by her that the stock of the Mamatech corporation, then trading around a dollar a share, would soon skyrocket to over $ 4.00 a share when the general public became aware of "insider information" to which Goldberg was privy. Based upon these representations, each of the plaintiffs bought significant stakes in Mamatech only to see their money lost as the price of the stock plummeted.
Whatever the merits of that aspect of this case, there is more. Assuming for a moment that Goldberg did engage in activity violative of the securities laws, it would not be the first time that an employee of Blinder, Robinson has rubbed up against securities regulators. In fact, Blinder, Robinson has a somewhat spotty record with the Securities and Exchange Commission ("SEC"), the National Association of Securities Dealers ("NASD"), and various state regulatory bodies. According to the complaint,
Blinder, Robinson has been the subject of cease and desist orders, sanctions, or injunctions in at least eleven different states as well as enforcement actions resulting in censure, fines, and injunctions by the SEC and NASD. When the prospectus offering Mamatech stock to the public was issued, it failed to reveal Blinder, Robinson's various brushes with the nation's securities regulators and the Honorable John W. Bissell, in deciding earlier filed motions to dismiss in this case, has already held that this failure was a "material omission for purposes of stating a claim under 10(b) and Rule 10b-5."
Section 10 and Rule 10b-5
Section 10 of the Securities Exchange Act of 1934, 15 U.S.C. § 78j, makes it unlawful to "employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance in contravention" of any rule promulgated by the SEC designed to protect the investing public. Rule 10b-5, in turn, makes it unlawful: (1) "To employ any device, scheme, or artifice to defraud," (2) "To make any untrue statement of a material fact" or to omit to state a material fact so that the statements made "in light of the circumstances," are misleading, and (3) "To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person."
This tort, although statutory in nature, sounds in the common law of fraud and deceit and retains, in a modified form, the common law elements of duty, breach, causation, and damage. See Huddleston v. Herman & MacLean, 640 F.2d 534, 547 (5th Cir. 1981) (10b-5 claim derived from common law action for deceit), modified on other grounds, 459 U.S. 375, 74 L. Ed. 2d 548, 103 S. Ct. 683 (1983). More precisely, these elements are incorporated into the following test. In order to make out a claim under 10b-5, a plaintiff must allege (1) a misstatement or an omission (2) of material fact (3) made with scienter (4) on which plaintiff relied (5) that proximately caused his injury. Huddleston, 640 F.2d at 543. In the instant case, as indicated previously, Judge Bissell has already held that a material omission was made with respect to the failure to disclose Blinder, Robinson's previous misdeeds. This holding resolves, in a general sense, the breach component contained in elements (1) and (2) above, and after Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128, 31 L. Ed. 2d 741, 92 S. Ct. 1456, reh'g denied, 407 U.S. 916, 32 L. Ed. 2d 692, 92 S. Ct. 2430 and 408 U.S. 931, 33 L. Ed. 2d 345, 92 S. Ct. 2478 (1972), satisfies the causation-in-fact component found in elements (2) and (4). Affiliated Ute, 406 U.S. at 153-54 (fact that omission is material in the sense that a reasonable investor might have considered it important in the making of this decision satisfies elements of reliance and "causation in fact").
Defendant asserts, however, that two important pieces of plaintiffs' puzzle are still missing: (a) that even assuming that a breach has occurred that breach was not of any duty owed by Alexander Grant to plaintiffs and (b) that, at best, plaintiff has merely alleged "transaction", and not "loss", causation. The absence of either, defendant argues, makes plaintiffs' claims defective as a matter of law. Assuming, without deciding, that defendant owed some duty to plaintiffs,
I now hold that plaintiffs have failed to allege sufficient facts to state a claim that plaintiffs' losses were proximately caused by defendant's alleged breach. Accordingly, plaintiffs' securities claims against Alexander Grant must be dismissed.
Reliance, Transaction Causation, and Loss Causation
As noted previously, a 10b-5 claim retains much of its common law flavor. Specifically, like the common law of deceit, it is necessary for a plaintiff to plead reliance on the defendant's fraudulent conduct. Where the alleged fraud is an affirmative misrepresentation of fact this element of reliance is easily proven. The plaintiff need only allege that he relied upon the misrepresentation in making the investment decision. Difficulties arise, however, when the alleged fraud involves, as it does in this case with regard to the allegations against Alexander Grant, an omission of fact. Obviously, a question of what a plaintiff would have done if a fact had been disclosed is more difficult than what a plaintiff actually did in reaction to an affirmative statement.
This difficulty in alleging reliance in an omission case was resolved by the Supreme Court in Affiliated Ute. In that case, the Court held that a plaintiff in an omission case could, at least as an initial matter,
meet the reliance requirement of a 10b-5 action by demonstrating that the omitted fact was "material in the sense that a reasonable investor might have considered [it] important in the making of [his] decision . . ." Affiliated Ute, 406 U.S. at 153-54. This showing, the Court held, "establish[ed] the requisite element of causation in fact." Id. at 154. Thus, by equating materiality with reliance a plaintiff in an omission case could overcome the common law hurdle of reliance.
Some courts have noted this relationship between a material omission and causation in general in order to hold that the proximate cause element of a 10b-5 claim has been sufficiently alleged. Illustrative is Sutton v. Shearson Hayden Stone, Inc., 490 F. Supp. 98 (S.D.N.Y. 1980) In Sutton, the defendant asserted that its failure to inform a customer about complaints filed against the salesman in charge of plaintiff's account was not material, and even if material, was not the proximate cause of plaintiff's loss. In rejecting this defense the court stated: