O'Connor & Assoc. v. Dean Witter Reynolds, Inc., 81 Civ. 1354(MEL).

• Decision Date: 30 December 1981
• Docket Number: No. 81 Civ. 1354(MEL).,81 Civ. 1354(MEL).
• Parties: O'CONNOR & ASSOCIATES, an Illinois Limited Partnership, individually and on behalf of all other similarly situated, Plaintiffs, v. DEAN WITTER REYNOLDS, INC., a Delaware corporation, individually, and as agent for certain of its customers and registered representatives, Dean Callander, Bruce Seligman, Fred Collins, Mike Kemp, Larry Hayden, Robert Gilbert, Ann Marie Bero, Stephen Bradley, David Kupht, John Damsen, John Hanson, individually, and as customers and registered representatives of Dean Witter Reynolds Inc.; William Miller, Glen and Pamela Jackson, Ralph Raulli, Daniel Sharp, Cynthia Smith, Nolan Brunson, Jr., Jane Dunn, Wendy Craven, Dennis Martino, Quaker Hill Development Corporation, a California corporation, and Thomas A. Reed, individually, and as customers of Dean Witter Reynolds Inc.; certain unnamed customers of Dean Witter Reynolds Inc.; A. G. Becker Incorporated, a Delaware corporation, William E. Goldberg, John Pierce, Robert Rafford, individually, and as customers and registered representatives of A. G. Becker Incorporated; Patrick N. Macintyre, individually and as a customer of A. G. Becker Incorporated; Amax Inc., a New York corporation; and Standard Oil Co. of California, a Delaware corporation, Defendants.
• Court: U.S. District Court — Southern District of New York

529 F. Supp. 1179

O'CONNOR & ASSOCIATES, an Illinois Limited Partnership, individually and on behalf of all other similarly situated, Plaintiffs, v. DEAN WITTER REYNOLDS, INC., a Delaware corporation, individually, and as agent for certain of its customers and registered representatives, Dean Callander, Bruce Seligman, Fred Collins, Mike Kemp, Larry Hayden, Robert Gilbert, Ann Marie Bero, Stephen Bradley, David Kupht, John Damsen, John Hanson, individually, and as customers and registered representatives of Dean Witter Reynolds Inc.; William Miller, Glen and Pamela Jackson, Ralph Raulli, Daniel Sharp, Cynthia Smith, Nolan Brunson, Jr., Jane Dunn, Wendy Craven, Dennis Martino, Quaker Hill Development Corporation, a California corporation, and Thomas A. Reed, individually, and as customers of Dean Witter Reynolds Inc.; certain unnamed customers of Dean Witter Reynolds Inc.; A. G. Becker Incorporated, a Delaware corporation, William E. Goldberg, John Pierce, Robert Rafford, individually, and as customers and registered representatives of A. G. Becker Incorporated; Patrick N. Macintyre, individually and as a customer of A. G. Becker Incorporated; Amax Inc., a New York corporation; and Standard Oil Co. of California, a Delaware corporation, Defendants.

No. 81 Civ. 1354(MEL).

United States District Court, S. D. New York.

December 30, 1981.

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Coffield, Ungaretti, Harris & Slavin, Chicago, Ill., (Michael W. Coffield and Robin J. Omahana, Chicago, Ill., of counsel), Kimmelman, Sexter & Sobel, New York City, (Mortin L. Kimmelman and Arthur H. Sobel, New York City, of counsel), for plaintiffs.

Jackson & Nash, New York City, (Lawrence P. McGauley, Christopher S. Rooney, Jeffrey G. Steinberg, New York City, of counsel), for Dean Witter Reynolds, Inc., Ann Marie Bero, Stephen Bradley, Dean Callander, Fred Collins, John Damsen, Robert Gilbert, John Hanson, Larry Hayden, Mike Kemp, David Kupat, Ralph Raulli and Bruce Seligman.

Brown, Wood, Ivey, Mitchell & Petty, New York City, (Henry F. Minnerop, Joseph G. Riemer, III, Kent E. Daiber, New York City, of counsel), for A. G. Becker Incorporation, John Pierce and Robert Rafford.

Lukens, St. Peter & Cooper, San Francisco, Cal., (William M. Lukens, Martha Rosenberg, San Francisco, Cal., of counsel), for William Goldberg.

Sullivan & Cromwell, New York City, (Richard Urowsky, New York City, of counsel), for Amax, Inc.

J. Anthony Hale, Houston, Tex., Burns, Jackson, Summit, Rovins & Spitzer, New York City (Stuart A. Summit, Ronald L. Mayers, New York City, of counsel), for Cynthia Smith.

LASKER, District Judge.

On March 5, 1981, the board of directors of Amax, Inc. ("Amax") announced publicly that Standard Oil of California, Inc. ("Socal") had made a proposal, conditioned on approval of the Amax board, to acquire the equity interest in Amax not already owned by Socal at a price of approximately $78.50 a share, nearly double the then-current market price of $38.50 per share. The total value of Socal's offer was approximately four billion dollars, making it the largest takeover bid in history at the time it was announced. Simultaneous with the announcement of the proposal, the Amax board announced its decision to reject the offer. When the market opened on March 6th, after the temporary halt in trading that accompanied the announcement, the market price of Amax stock rose approximately eighteen points and the price of the most heavily traded series of Amax options rose substantially.

O'Connor & Associates ("O'Connor") trades stock and options for its own account. Between February 23, 1981, and March 6, 1981, O'Connor sold call options on Amax stock. On March 10, 1981, O'Connor commenced this action, alleging that unknown insiders at either Socal or Amax or both had "tipped" inside information concerning the Socal takeover bid to unknown customers and registered representatives of Dean Witter Reynolds, Inc. ("DWRI") and A.G. Becker, Inc. ("Becker"), and that the customers and registered representatives had purchased Amax call options prior to March 6, 1981, with knowledge of the proposed merger. In addition, O'Connor alleges that DWRI and Becker substantially assisted its customers with knowledge that or in reckless disregard of whether the customers were trading on the basis of material, nonpublic information. O'Connor claims that it is entitled to relief under sections 10(b) and 14(e) of the Securities Exchange Act, 15 U.S.C. §§ 78j(b) and 78n(e), Rules 10b-5 and 14e-3 of the Securities and Exchange Commission ("SEC"), 17 C.F.R. §§ 240.10b-5 and 204.14e-3, and under common law fraud principles.¹

On March 10, 1981, O'Connor was granted a temporary restraining order preventing DWRI and Becker from distributing any profits realized from purchases of Amax call options in the two weeks immediately preceding the public announcement of Socal's takeover proposal. DWRI and Becker were also directed to furnish O'Connor with the names of all those who had made purchases of Amax call options beyond a threshold amount in the period immediately preceding the public announcement, with the understanding that the restraining order would be lifted if O'Connor was unable to demonstrate that the buyers of the Amax call options were not financially responsible or were not within the jurisdiction of the court. On March 16, 1981, after DWRI and Becker made the required disclosures, O'Connor amended its complaint and named as defendants the DWRI customers and 12 DWRI employees and a customer and three registered representatives of Becker whose names had been disclosed. In addition, O'Connor moved for an order of attachment. When O'Connor was unable to demonstrate its entitlement to an attachment, its motion was denied and the restraining order was lifted.

DWRI, on behalf of itself and several of its employees,² Amax, Becker, on behalf of itself and two employees,³ Cynthia Smith and William Goldberg now move to dismiss the complaint. For the sake of clarity, we consider motions presenting common issues together.

I.

William M. Goldberg, a registered representative of Becker, Cynthia Smith, a customer of DWRI, and Becker, move to dismiss the complaint pursuant to Fed.R. Civ.Pr. 12(b)(6) on the ground that the complaint fails to state a claim under either § 10(b) of the Securities Exchange Act or § 14(e) of the Williams Act because it does not allege a fiduciary relationship between themselves and O'Connor.

The thrust of the argument is that, because O'Connor traded in options rather than the actual shares of Amax, the insiders did not stand in a fiduciary relationship with O'Connor. Relying on the Supreme Court's opinion in Chiarella v. United States, 445 U.S. 222, 230, 100 S.Ct. 1108, 1115, 63 L.Ed.2d 348 (1980), defendants emphasize that trading on the basis of material, nonpublic information constitutes a fraudulent practice under the securities laws only if there exists a special relationship between the alleged wrongdoer and the sellers of the security that could give rise to a duty to disclose. They argue that such a duty does not arise in such impersonal market transactions as alleged here because corporate insiders owe fiduciary duties only to the shareholders of the corporation, not to options traders involved in arm's length transactions who are each betting on the future movement of the underlying stock. Accordingly, it is claimed, the only persons to whom alleged tippees of the corporate insiders owe a duty not to trade on such information are the shareholders of the corporation. Moreover, the defendants assert that there is no precedent for an options trader to maintain a suit against corporate insiders under §§ 10(b) or 14(e) of the Securities Exchange Act and that extending a corporate insiders' duties to options traders would vastly expand the potential liability under the Securities Act of the corporation, its directors, officers and employees to a broad and increasing category of investors with which the corporation has no relationship. Finally, it is argued that options trading is an inherently high-risk form of trading involving the possibility of huge gains and losses and that, since the corporation and its officers, directors and employees have no control over such trading, they should not be considered to have fiduciary duties of disclosure to option traders.

O'Connor responds that since options are "securities" as defined by the Securities Exchange Act, 15 U.S.C. § 78c(a)(10), the prohibitions of § 10(b) against fraudulent conduct in connection with a sale or purchase of a security are properly applied to options transactions. Moreover, O'Connor contends that the increasing volume of options trading supports rather than undercuts the applicability of the investor protections contained in the 1934 Act. Although options trading is a somewhat risky market transaction, O'Connor maintains that there is no rational basis for exposing options traders to the additional risk of loss caused by fraudulent conduct on the part of others in the market.

O'Connor emphasizes that the risk involved in options trading is a direct function of the price movements of the underlying stock and that options traders therefore stand in the same functional position vis a vis information concerning the corporation's fortunes as those who trade in corporate stock itself. O'Connor further asserts that the options writer is either a holder of the security at the time he enters into the options contract (covered options) or obligates himself to purchase the security (naked options), and therefore is owed fiduciary duties by corporate insiders to the same extent as shareholders. O'Connor argues that to exempt options trading from the coverage of § 10(b) would be to create a gaping loophole in the securities laws for unscrupulous insiders who could thereby trade in options instead of the underlying stock and thus avoid the prohibitions on insider...