Abbey v. Computer Memories, Inc.

• Decision Date: 13 May 1986
• Docket Number: No. C-85-4892-EFL.,C-85-4892-EFL.
• Citation: 634 F. Supp. 870
• Court: U.S. District Court — Northern District of California
• Parties: Steven ABBEY, On Behalf of Himself and All Others Similarly Situated, Plaintiff, v. COMPUTER MEMORIES, INC., Irwin Rubin, Raymond Brooke, Abraham Brand, Frederic A. Heim, Marshall Butler, Laurence Hootnick, Ted H. McCourtney, Jr., Frederic T. Boyer and Intel Corporation, individually; Prudential-Bache Securities, Inc., Ladenburg Thalmann & Company, Inc. and Cable Howse & Ragen, individually and as representatives of a defendant class, Defendants.

634 F. Supp. 870

Steven ABBEY, On Behalf of Himself and All Others Similarly Situated, Plaintiff, v. COMPUTER MEMORIES, INC., Irwin Rubin, Raymond Brooke, Abraham Brand, Frederic A. Heim, Marshall Butler, Laurence Hootnick, Ted H. McCourtney, Jr., Frederic T. Boyer and Intel Corporation, individually; Prudential-Bache Securities, Inc., Ladenburg Thalmann & Company, Inc. and Cable Howse & Ragen, individually and as representatives of a defendant class, Defendants.

No. C-85-4892-EFL.

United States District Court, N.D. California.

May 13, 1986.

Robert N. Kaplan, Kaplan, Kilsheimer & Foley, Edward A. Grossmann, Bernstein, Litowitz Berger & Grossmann, New York City, John E. Grasberger, Milberg Weiss Bershad Specthrie & Lerach, San Diego, Cal., Sherrie R. Savett, Berger & Montague, Philadelphia, Pa., John W. Allured, David B. Gold, A.P.C., San Francisco, Cal., for plaintiff.

J. Kelley Nevling, Jr., Rosenman Colin Freund Lewis & Cohen, New York City, Richard B. Glickman, Rosenman Colin Freund Lewis & Cohen, San Francisco, Cal., Howard R. Cabot, H. Michael Clyde, Brown & Bain, P.A., Phoenix, Ariz., Chris R. Ottenweller, Andrew J. Wistrich, Brown & Bain, Palo Alto, Cal., for defendants.

PARTIAL SUMMARY JUDGMENT

LYNCH, District Judge.

I. Background

Defendants in this case have brought a motion for summary judgment on Count I of plaintiff Abbey's complaint.¹ Count I asserts a claim under section 11 of the Securities Act of 1933, 15 U.S.C. § 77k(a) ("section 11"). Defendants argue that they are entitled to summary judgment on Count I because, among other reasons, Abbey cannot possibly trace his shares to the offering upon which section 11 liability would be based.

Section 11 provides in part as follows: In case any part of the registration statement, when such part became effective, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, any person acquiring such security ... may ... sue ....

Id.

There is no dispute among the parties that a plaintiff suing under section 11 must show that he or she purchased stock actually issued in the offering for which the plaintiff claims there was a false or otherwise misleading registration statement. Courts have universally held that "in order to have a valid § 11 cause of action, the plaintiff must plead and prove that his stock was issued pursuant to the particular registration statement alleged to be defective." Lorber v. Beebe, 407 F.Supp. 279, 286 (S.D.N.Y.1975); see also Barnes v. Osofsky, 373 F.2d 269, 271-73 (2d Cir.1967); McFarland v. Memorex Corp., 493 F.Supp. 631, 641-42 (N.D.Cal.1980), reconsideration granted, 581 F.Supp. 878 (1984). This requirement has been referred to as the "new stock," see McFarland, 493 F.Supp. at 642, or "tracing," see Kirkwood v. Taylor, 590 F.Supp. 1375, 1377-78 (D.Minn. 1984), requirement. At issue in this motion is whether defendants are entitled to judgment as a matter of law because Abbey cannot fulfill the tracing requirement described above.

On August 23, 1983, defendant Computer Memories, Inc. ("CMI") made a public offering of approximately 2,000,000 shares of common stock pursuant to a registration statement and prospectus also dated August 23, 1983 ("the offering"). It is the August 23, 1983 registration statement ("the registration statement") upon which plaintiff bases his section 11 claim.

Abbey purchased a total of 10,000 shares of CMI stock. One thousand of these shares were purchased before the August 23, 1983 offering and therefore clearly cannot form a basis for a damages claim under section 11. See Barnes v. Osofsky, 373 F.2d 269, 272-73 (2d Cir.1967). The remaining 9,000 shares were purchased on August 29, 1983, approximately one week after the effective date of the registration statement. These shares were not purchased pursuant to the offering or from any of the participants in the offering, but were purchased in the open market at a price higher than the offering's price.

Abbey purchased his shares through Fidelity Brokerage Services, Inc. ("Fidelity"), a stock broker. However, Fidelity did not actually execute the stock purchase. Instead, Fidelity placed a purchase order through its subsidiary, National Financial Services Corporation, Inc., with the Pershing division of Donaldson Lufkin & Jerette Securities Corporation ("Pershing"). Pershing then executed two purchases of CMI stock, totaling 9,000 shares, from Mayer & Schweitzer, Inc., a stock brokerage firm which serves as a market-maker for CMI's common stock.

The purchase of Abbey's CMI stock was effected between Pershing and Mayer & Schweitzer through the continuous net settlement system of the National Securities Clearing Corporation ("NSCC"). Under the continuous net settlement system used by NSCC, the CMI stock sold by Mayer & Schweitzer did not physically trade hands on the date it was purchased by Pershing. Rather, the trade was merely recorded as a part of the net adjustment made to the CMI accounts of Mayer & Schweitzer and of Pershing to reflect all of the two firms' respective trades for that day.

On September 6, 1983, the settlement date for the August 29, 1983 trade, the transfer of Abbey's CMI stock was effected between Pershing and Mayer & Schweitzer through an electronic bookkeeping entry made by the Depository Trust Company ("DTC"). The DTC maintains deposits of large quantities of various stocks for the benefit of its broker-participants. These deposits minimize the need for the physical transfer of shares when the participants engage in stock transactions among one another. Thus, all of the CMI shares purchased by Abbey were a part of the common pool of CMI shares held in DTC's vault on the day of the transfer. There is no evidence before the Court concerning whether Abbey ever took physical possession of his shares or whether they remained in DTC's vault. However, the important point for purposes of this motion is that it is undisputed that Abbey's CMI shares were at one time part of the CMI shares comingled in DTC's vault.

Defendants have submitted affidavits indicating that it is impossible for Abbey to show that his stock came from the offering. These affidavits state that the stock kept in DTC's vault was completely fungible and that it would therefore be impossible to determine the origin of Abbey's stock. Defendants argue that because it is impossible for Abbey to directly trace any of his shares to the offering, the defendants are entitled to summary judgment on Abbey's section 11 claim.

Abbey has not submitted any evidence refuting the defendants' claim that it is impossible for Abbey to directly trace any of his shares to the offering.² Rather, Abbey makes the following three arguments against granting summary judgment: (1) that section 11 does not require "direct tracing" and that Abbey can fulfill the tracing requirement by producing circumstantial evidence showing that it is more probable than not that a certain percentage of his shares were issued in the offering; (2) that because Abbey's shares were comingled with other shares held in DTC's vault, Abbey must be considered as having held a proportionate interest in all the stock held by DTC, thereby creating an issue of fact as to whether any of the comingled shares can be traced to the offering; (3) that defendants are not entitled to summary judgment because they have not shown that none of Abbey's shares came from the offering. For the reasons described below, the Court rejects each of Abbey's arguments and grants the defendants' motion.

II. Tracing Based on the Timing and Circumstances of the Trade

Abbey purchased 9,000 shares of CMI common stock approximately one week after the offering. The offering added 2 million shares of common stock to the 9 million shares previously outstanding. Abbey argues that the timing of his purchase combined with the fact that 18 percent of the shares then outstanding were new shares (2 million of the 11 million then outstanding) make it highly probable that at least some of his shares were from the offering.³ He contends that nothing in the language of section 11 precludes him from fulfilling the tracing requirement by simply showing by circumstantial evidence that a portion of his shares probably came from the offering.

Abbey's argument is inconsistent with the existing precedent. Although the language of section 11 does not clearly require direct tracing, courts have uniformly interpreted section 11 as requiring more than a showing that a plaintiff's stock "might" have come from the relevant offering. In Kirkwood v. Taylor, 590 F.Supp. 1375 (D.Minn.1984), the court granted summary judgment because none of the named plaintiffs had shown more than that they might have purchased new stock. Id. at 1383. There the court rejected three different tracing methods proposed by the plaintiffs because each only showed that the plaintiffs might have purchased new stock. Id. Similarly, in Lorber v. Beebe, 407 F.Supp. 279 (S.D.N.Y.1975), the court held that "it is insufficient that stock `might' have been issued pursuant to a defective statement. A plaintiff must show that it actually was so issued." Id. at 287. Finally, in McFarland v. Memorex Corp., 493 F.Supp. 631 (N.D.Cal.1980), this court stated that "alleging or proving that ... stock, purchased in the open market, might have been issued pursuant to the registration statement" does not fulfill the new stock requirement.⁴ Id. at 642.

Abbey argues that a direct tracing requirement is unfair because many purchasers of stock on the open market will, like Abbey, be unable to fulfill the tracing requirement. A similar argument has been previously rejected in an analogous situation. In Barnes v. Osofsky, 373 F.2d 269 (2d Cir.1967), the plaintiff argued that section 11 liability should be extended to stock traded prior to the relevant offering because of the difficulties...