Sanders v. John Nuveen & Co., Inc.

• Decision Date: 08 June 1977
• Docket Number: Nos. 74-2047,75-1260,s. 74-2047
• Citation: 554 F.2d 790
• Parties: Fed. Sec. L. Rep. P 96,030 Henry T. SANDERS, Plaintiff-Appellee, v. JOHN NUVEEN & CO., INC., et al., Defendants-Appellants.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 790

554 F.2d 790

Fed. Sec. L. Rep. P 96,030

Henry T. SANDERS, Plaintiff-Appellee, v. JOHN NUVEEN & CO., INC., et al., Defendants-Appellants.

Nos. 74-2047, 75-1260.

United States Court of Appeals, Seventh Circuit.

Argued Dec. 10, 1976.

Decided April 22, 1977.

As Modified on Denial of Rehearing En Banc June 8, 1977.

Milton H. Cohen, Allan Horwich, Chicago, Ill., for defendants-appellants.

Harvey L. Pitt, Gen. Counsel, Washington, D. C., for Securities & Exchange Comm.

Richard Orlikoff, Robert J. Peters, Chicago, Ill., for plaintiff-appellee.

Before CASTLE, TONE and WOOD, Circuit Judges.

HARLINGTON WOOD, Jr., Circuit Judge.

On April 19, 1976, the United States Supreme Court granted defendants' Petition for Certiorari, and vacated this court's order entered on October 30, 1975, in Sanders II, ¹ 524 F.2d 1064 (7th Cir. 1975), and remanded the case for reconsideration in light of the Supreme Court's intervening decision in Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976), reversing 503 F.2d 1100 (7th Cir. 1974). On May 28, 1976, the defendants moved this court to summarily reverse the judgment below. That motion has been taken with the case.

As the facts are fully set forth in Sanders I and II only a brief factual recap for convenience is included here. This is a class action brought for and in behalf of forty-two purchasers of fifty-three short term notes in the aggregate face amount of $1,612,500 purchased during a seven month period in 1969 and 1970. Defendant John Nuveen & Co., Inc., was found to be the underwriter of that commercial paper issued by Winter & Hirsch, Inc., a consumer finance company, during that period just prior to the default of Winter & Hirsch, Inc., on its obligations in 1970. The remaining defendant corporations were found to be "controlling persons" of Nuveen.

In Sanders II the principal question was stated to be "whether an underwriter of short term commercial paper who acted in the mistaken but honest belief that financial statements prepared by certified public accountants correctly represented the condition of the issuer is liable to its customers for losses sustained as a result of the issuer's default." 524 F.2d at 1066. The district court held Nuveen liable on the theory that it breached a duty to make reasonable inquiries that would have led to the discovery of issuer's fraud. This court affirmed.

The problem now is to determine the effect of Hochfelder on this case. In Hochfelder the majority held that "scienter", that is, an intent to deceive, manipulate or defraud, is required to establish a private cause of action for damages under § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) and Rule 10b-5 thereunder, 17 C.F.R. 240.10b-5. Negligence is not sufficient. The Court added: "In certain areas of the law recklessness is considered to be a form of intentional conduct for purposes of imposing liability for some act. We need not address here the question whether, in some circumstances, reckless behavior is sufficient for civil liability under § 10(b) and Rule 10b-5." 425 U.S. at 194 n. 12, 96 S.Ct. at 1381. The Court further noted that there are certain express civil remedies subject to significant procedural restrictions provided in the Securities Act of 1933, ² allowing recovery for negligent conduct including the remedy provided in § 12, ³ and explained that "Section 12(2) creates potential civil liability for a seller of securities in favor of the purchaser for misleading statements or omissions in connection with the transaction. The seller is exculpated if he proves that he did not know or in the exercise of reasonable care, could not have known of the untruth or omission." ⁴

Plaintiff's complaint as amended asserts claims under §§ 12(2) and 17 of the Securities Act of 1933, 15 U.S.C. §§ 77l (2) and 77q, §§ 10(b) and 20 of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b) and 78t, and Rule 10b-5 of the Securities Exchange Commission, 17 C.F.R. 240.10b-5.

In Sanders II this court found Nuveen's liability to rest on Rule 10b-5. ⁵ The first issue to be resolved is whether or not that holding remains valid. That depends on whether the record justifies a finding of "scienter" as defined in Hochfelder. In Sanders II this court viewed Nuveen's conduct as being mistaken but honest in belief. The trial court based its holding on negligence. Upon reconsideration, we find that the record is barren of any showing of actual intent to deceive, manipulate or defraud. Thus, the judgment cannot be supported on that basis.

In Hochfelder the Supreme Court left open the question of whether or not in some circumstances "reckless behavior", which was not there defined, could constitute scienter for civil liability under § 10(b) and Rule 10b-5. We believe, contrary to Nuveen's urging, that "reckless behavior" can be sufficient to constitute scienter. We have already so held in Bailey v. Meister Brau, Inc., 535 F.2d 982 (7th Cir. 1976), and recently and more specifically in Sundstrand Corporation v. Sun Chemical Corporation et al., 553 F.2d 1033 (7th Cir. 1977). Sundstrand explains that the standard in Bailey is akin to a reckless standard though phrased in terms of "blinded by conflict of interest" and "wantonly ignored". Sundstrand more definitely defines recklessness in the context of omissions by adopting as a base the definition in Franks v. Midwestern Oklahoma Development Authority, CCH Fed.Sec.L.Rep. P 95.786 at 90.850 (W.D.Okl.1976):

reckless conduct may be defined as a highly unreasonable omission, involving not merely simple, or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it.

In view of the Supreme Court's analysis in Hochfelder of the statutory scheme of implied private remedies and express remedies, the definition of "reckless behavior" should not be a liberal one lest any discernible distinction between "scienter" and "negligence" be obliterated for these purposes. We believe "reckless" in these circumstances comes closer to being a lesser form of intent than merely a greater degree of ordinary negligence. We perceive it to be not just a difference in degree, but also in kind. Plaintiff argues for something less, relying in part on Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 95 S.Ct. 1917, 44 L.Ed.2d 539 (1975), where Mr. Justice Rehnquist, writing for the Court about the tort of misrepresentation and deceit, stated that "the typical fact situation in which the classic tort misrepresentation and deceit evolved was light years away from the world of commercial transactions to which Rule 10b-5 is applicable." 421 U.S. at 744-745, 95 S.Ct. at 1929. That comment is made in relation to privity of dealing. Personal contact between potential defendant and potential plaintiff in "today's universe of commercial transactions" is recognized as the exception and not the rule. The Court in Blue Chip Stamps limited the benefit of Rule 10b-5 to actual purchasers or sellers of securities, and excluded those who claim they did not enter into a transaction which later turned out to be better than they had anticipated because of an alleged misleading and pessimistic prospectus. That case does not hold that none of the old concepts of fraud and deceit, or recklessness, have application in the present context.

In the present case the trial judge found that Nuveen, due to negligence, made misleading statements of material fact and omitted to make statements of material fact necessary to make the statements not misleading in selling the notes to members of the plaintiff class. Underlying is the finding that Nuveen's investigation of the issuer was deficient and that an appropriate investigation would have revealed the issuer's fraud. There was no finding that Nuveen's acts of commission or omission were reckless, that is, that they were so highly unreasonable and such an extreme departure from the standards of ordinary care as to present a danger of misleading the plaintiff to the extent that the danger was either known to the defendant or so obvious that the defendant must have been aware of it. On reviewing the record we likewise find no basis to sustain the judgment because of any reckless conduct on the part of Nuveen.

Therefore, at this point, as we now view the case, we must determine whether we are compelled to allow Nuveen's motion for summary reversal of the judgment below, or whether upon remand to this court the permissible scope of our reconsideration is broad enough to permit consideration of other pleaded issues which were originally present in the case and which were not expressly or impliedly ruled upon by the Supreme Court in Hochfelder. We may not contravene a specific instruction or disregard the disposition of any question of law contained in the mandate. Nuveen relies on Hermann v. Brownell, 274 F.2d 842 (9th Cir. 1960), cert. denied sub. nom., Herrmann v. Rogers, 364 U.S. 821, 81 S.Ct. 56, 5 L.Ed.2d 50, but that case stands only for the proposition that upon remand the jurisdiction of an appellate court is limited to those particularized points which were assigned for consideration, if the mandate was in that form. However, the remand in the present case was broadly stated to be "for further consideration in light of Hochfelder." Other issues not within the compass of the mandate are thereby not precluded from consideration. Sprague v. Ticonic National Bank, 307 U.S. 161, 59 S.Ct. 777, 83 L.Ed. 1184 (1939). See also Illinois Bell Telephone Co. v. Slattery, 102 F.2d 58 (7th Cir. 1938), cert. denied, 307 U.S. 648, 59 S.Ct. 1045, 83 L.Ed. 1527 (1939).

Following that view we must next examine the other causes alleged by plaintiff and an additional approach urged by Amicus Curiae. ⁶ Plaintiff asserts...