Angelastro v. Prudential-Bache Securities, Inc., PRUDENTIAL-BACHE

• Court: United States Courts of Appeals. United States Court of Appeals (3rd Circuit)
• Writing for the Court: ADAMS
• Citation: 764 F.2d 939
• Parties: , Fed. Sec. L. Rep. P 92,076 Laura ANGELASTRO, on behalf of herself and all others similarly situated, Appellant in 84-5427, v.SECURITIES, INC. and Bache Halsey Stuart Shields, Inc., Appellants in 84-5401.
• Docket Number: PRUDENTIAL-BACHE,84-5427,Nos. 84-5401
• Decision Date: 12 June 1985

Page 939

764 F.2d 939 54 USLW 2007, Fed. Sec. L. Rep. P 92,076 Laura ANGELASTRO, on behalf of herself and all others
similarly situated, Appellant in 84-5427,
v.
PRUDENTIAL-BACHE SECURITIES, INC. and Bache Halsey Stuart
Shields, Inc., Appellants in 84-5401. Nos. 84-5401, 84-5427. United States Court of Appeals, Third Circuit. Argued Feb. 26, 1985.
Decided June 12, 1985.

Page 941

Richard D. Greenfield, Robert P. Frutkin, Susan Schneider Thomas (argued), Greenfield, Chimicles & Lewis, Haverford, Pa., for appellant in No. 84-5427.

Leonard Barrack, Daniel E. Bacine (argued), Samuel R. Simon, Barrack, Rodos & Bacine, Philadelphia, Pa., for appellants in No. 84-5401.

Daniel L. Goelzer, Gen. Counsel, Jacob H. Stillman, Associate Gen. Counsel, David A. Sirignano (argued), Asst. Gen. Counsel, Gerard S. Citera, Gordon K. Fuller, Washington, D.C., for S.E.C., Amicus Curiae; Paul Gonson, Sol., of counsel.

Before ADAMS, WEIS and WISDOM, ^* Circuit Judges.

OPINION OF THE COURT

ADAMS, Circuit Judge.

This appeal presents the issue whether alleged misrepresentations and nondisclosures by a brokerage firm regarding the credit terms of a margin account fall within the ambit of section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. Sec. 78j(b) (1982) (Exchange Act), and two rules promulgated thereunder by the Securities and Exchange Commission (SEC). The district court concluded that even if proved such deceptive practices could not be deemed "in connection with" the purchase or sale of a security, and dismissed plaintiff's claims under section 10(b) of the Exchange Act and Rule 10b-5, 17 C.F.R. Sec. 240.10b-5 (1984); it did determine, however, that plaintiff could institute a private action under Rule 10b-16, 17 C.F.R. Sec. 240.10b-16 (1984). We agree that a private action may be brought under Rule 10b-16, and therefore will affirm the district court's ruling on that issue. However, because we conclude that misrepresentations and nondisclosures regarding a margin account may be "in connection with" the purchase or sale of a security, we will reverse the order dismissing the section 10(b) and Rule 10b-5 claims.

I.

Laura Angelastro, the plaintiff, maintained a margin account with Bache Halsey Stuart Shields, Inc., a national securities brokerage firm. On April 4, 1983, Angelastro filed suit in district court on behalf of herself and all others who purchased securities from 1977-82 ¹ through margin accounts maintained by defendant Prudential-Bache Securities, Inc., or its corporate predecessor, Bache Halsey Stuart Shield, Inc. ² The complaint asserted that Bache misrepresented and failed to disclose material information regarding the interest rates applicable to its margin accounts, purportedly in violation of section 10(b) of the Exchange Act and Rules 10b-5 and 10b-16.

Defendants moved, pursuant to Fed.R.Civ.P. 12(b)(6), to dismiss the complaint for failure to state a claim upon which relief could be granted. Holding that the activities alleged in the complaint were not undertaken "in connection with" the purchase or sale of any securities, the district court dismissed Angelastro's Rule 10b-5 claim.

Page 942

Angelastro v. Prudential-Bache Securities, Inc., 575 F.Supp. 270 (D.N.J.1983). The court rejected, however, defendants' argument that no private right of action exists under Rule 10b-16, and held that the complaint did state a claim under that rule.

The district court certified its decisions on both Rules 10b-5 and 10b-16 for interlocutory appeal pursuant to 28 U.S.C. Sec. 1292(b) (1982). In June of 1984, we granted the parties' motions for certification. This interlocutory appeal is limited to two issues: (1) whether alleged fraud regarding the credit terms of a margin account may be "in connection with" the purchase and sale of securities within the meaning of section 10(b) of the Exchange Act and the Commission rules promulgated thereunder; and (2) whether a private right of action exists under Rule 10b-16.

II.

Section 10(b) ³ and Rule 10b-5, ⁴ the basic anti-fraud provision promulgated thereunder, interdict the misrepresentation or omission of material facts in connection with the purchase or sale of any securities. A Rule 10b-5 claim requires, inter alia, that the misrepresentation be made "in connection with" the purchase or sale of a security. See Ketchum v. Green, 557 F.2d 1022, 1025 (3d Cir.), cert. denied, 434 U.S. 940, 98 S.Ct. 431, 54 L.Ed.2d 300 (1977). ⁵ The purpose underlying section 10(b) and the rules adopted under it is to insure that investors obtain disclosure of material facts in connection with their investment decisions regarding the purchase or sale of securities. See Affiliated Ute Citizens v. United States, 406 U.S. 128, 151, 92 S.Ct. 1456, 1471, 31 L.Ed.2d 741 (1972). Rule 10b-5 claims typically involve alleged misrepresentations with respect to the merits of a particular security. For example, nondisclosure of insider information concerning the value of securities states a claim under the rule. See, e.g., Shapiro v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 495 F.2d 228 (2d Cir.1974); SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir.1968) (in banc), cert. denied, 394 U.S. 976, 89 S.Ct. 1454, 22 L.Ed.2d 756 (1969). Such a misrepresentation is obviously made "in connection with" the stock that is subsequently sold or purchased.

Rule 10b-5 also encompasses misrepresentations beyond those implicating the investment value of a particular security. The Supreme Court has declared that section 10(b) must be read "flexibly, not technically and restrictively." Superintendent of Insurance v. Bankers Life and Casualty Co., 404 U.S. 6, 12, 92 S.Ct. 165,

Page 943

169, 30 L.Ed.2d 128 (1971). In Bankers Life, the Supreme Court permitted a section 10(b) claim to proceed in an action concerning the misappropriation of bond sale proceeds to cover "rubber" checks previously used to purchase securities. 404 U.S. at 6, 92 S.Ct. at 165. In the course of its discussion, the Supreme Court interpreted the "in connection with" language of section 10(b) to require that the plaintiff has "suffered an injury as a result of deceptive practices touching [the purchase or] sale of securities." Id. at 12-13, 92 S.Ct. at 169-70. This Court has construed the "touching" requirement as mandating that there be some "causal connection between the alleged fraud and the purchase or sale" of a security. Tully v. Mott Supermarkets, Inc., 540 F.2d 187, 194 (3d Cir.1976); see also Ketchum v. Green, 557 F.2d at 1028; Liberty National Insurance Holding Co. v. Charter Co., 734 F.2d 545, 555 (11th Cir.1984) (noting that the "in connection with" element requires a causal relationship between the claimed deception and a subsequent purchase or sale).

In keeping with the Supreme Court's statement that the "in connection with" language be read broadly, many courts have found the requisite causal nexus in situations involving the course of dealing in securities. Cf. Jaksich v. Thomson McKinnon Securities, Inc., 582 F.Supp. 485, 494 (S.D.N.Y.1984) (fraud directly related to the trading process meets the "in connection with" requirement); A.T. Brod & Co. v. Perlow, 375 F.2d 393, 397 (2d Cir.1967) ("a 10b-5 action will survive even though the fraudulent scheme or device is unrelated to 'investment value' "). For example, many courts have found the allegations of churning ⁶ state a claim under Rule 10b-5. See, e.g., Costello v. Oppenheimer & Co., 711 F.2d 1361, 1368 (7th Cir.1983); Thompson v. Smith Barney, Harris Upham & Co., 709 F.2d 1413 (11th Cir.1983); In re Catanella and E.F. Hutton and Co., 583 F.Supp. 1388, 1405, 1410-11 (E.D.Pa.1984). The fraud present in a churning operation does not concern the merits of the individual securities bought and sold but rather the excessiveness of the number of transactions in the aggregate.

Similarly, several courts have found a broker's failure to explain the risks of trading on margin to be actionable under Rule 10b-5. For example, in Arrington v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 651 F.2d 615, 619 (9th Cir.1981), the Ninth Circuit rejected the defendant's argument that fraud "in connection with the method of financing the purchases of securities, not with the purchase itself" fell outside the coverage of Rule 10b-5. The court held that misrepresentation of the risks of buying securities on margin in a declining market may be considered fraud "in connection with" the purchase of securities." Id.; see also Catanella, 583 F.Supp. at 1413; Yancoski v. E.F. Hutton & Co., 581 F.Supp. 88, 92 (E.D.Pa.1983). Many other types of fraud involving the trading process, rather than the investment value of a particular security have also been found to come within the scope of section 10(b) and Rule 10b-5. See, e.g., McGrath v. Zenith Radio Corp., 651 F.2d 458 (7th Cir.) (inducement to tender stocks by false promise of future employment), cert. denied, 454 U.S. 835, 102 S.Ct. 136, 70 L.Ed.2d 114 (1981); Marbury Management, Inc. v. Kohn, 629 F.2d 705 (2d Cir.) (misrepresentation that broker-trainee was stockbroker and portfolio management specialist), cert. denied, 449 U.S. 1011, 101 S.Ct. 566, 66 L.Ed.2d 469 (1980).

In Steinberg v. Shearson Hayden Stone, Inc., 546 F.Supp. 699 (D.Del.1982), the court was confronted with precisely the question at issue here. There the court held that a claim of failure to disclose material facts regarding credit terms of a margin account is actionable under Rule 10b-5. Although not discussed explicitly, the court necessarily found misrepresentations of the credit terms of a margin account to be "in connection with" the purchase

Page 944

or sale of a security. See also Establissement Tomis v. Shearson Hayden Stone, Inc., 459 F.Supp. 1355, 1361-63 (S.D.N.Y.1978) (suggesting that a 10b-5 action can be maintained for various margin violations).

As noted, this Court has construed the "in connection with" language as requiring some causal...