Drake v. Thor Power Tool Company

• Decision Date: 15 September 1967
• Docket Number: No. 65 C 1133.,65 C 1133.
• Citation: 282 F. Supp. 94
• Court: U.S. District Court — Northern District of Illinois
• Parties: Russell P. DRAKE for and on behalf of himself and on behalf of all stockholders and former stockholders of Thor Power Tool Company, similarly situated, Plaintiff, v. THOR POWER TOOL COMPANY, a Delaware Corporation, and Peat, Marwick, Mitchell & Co., a Partnership, Defendants.

282 F. Supp. 94

Russell P. DRAKE for and on behalf of himself and on behalf of all stockholders and former stockholders of Thor Power Tool Company, similarly situated, Plaintiff, v. THOR POWER TOOL COMPANY, a Delaware Corporation, and Peat, Marwick, Mitchell & Co., a Partnership, Defendants.

No. 65 C 1133.

United States District Court N. D. Illinois, E. D.

September 15, 1967.

A. Bradley Eben, Chicago, Ill., for plaintiff.

Patrick W. O'Brien, Edmund A. Stephan, Mayer, Friedlich, Spiess, Tierney, Brown & Platt, Chicago, Ill., for Thor Power Tool Co. Frank F. Fowle, Pope, Ballard, Uriell, Kennedy, Shepard & Fowle, Chicago, Ill., for Peat, Marwick, Mitchell & Co.

MEMORANDUM OPINION AND ORDER

PARSONS, District Judge.

Plaintiff Drake complains that he purchased Thor stock through the facilities of the New York Stock Exchange at a time when the assets and profits of Defendant Thor were being fictitiously reported in its financial statements and thereupon promulgated to the public as well as to Thor's stockholders, and that when the true financial condition became known the price of Thor shares as then traded on the New York and Midwest Stock Exchanges dropped precipitously. Thor is charged with falsification of its inventory and sales figures and issuing financial statements reflecting such false figures. Peat, Marwick, Mitchell & Co., Thor's independent accounting firm, is charged with applying inappropriate accounting procedures with respect to the Thor audits and uttering untrue certifications of Thor's false financial statements. The cause is a class action on behalf of certain persons similar to plaintiff who had bought and subsequently sold their shares. In another action, Greenwald et al. v. Lind et al., 65 C 1928, a complaint was filed by persons who are still stockholders as a class action. The two suits have been consolidated.

A Rule 10b-5 claim is alleged as well as claims under § 18 and § 14 of the Securities Exchange Act of 1934, and a common law claim against Peat, Marwick.

The Defendant, Peat, Marwick, has filed a motion to dismiss the action, but the points raised in its motion had been ruled upon by Judge Hoffman in Greenwald and are controlling. However, Defendant also urges that this Court's recent decision in Jordan Building Corp. v. Doyle, O'Connor & Co., 282 F.Supp. 87, N.D.Ill., July 18, 1967, is controlling with regard to the right to sue under Section 10b-5. This memorandum is devoted to an elaboration of the holding in Jordan as the present case is found to be distinguishable.

In Jordan, this Court had granted the defendants' motion to dismiss plaintiff's complaint, which alleged a claim under 10b-5 that plaintiff had purchased debentures which were an original issue in a private sale and relied upon the representations in a prospectus of the defendant and representations of underwriters that the defendant company was in a sound financial condition when in fact the company was on the verge of economic collapse. The holding was based upon a careful consideration of the current state of the law regarding 10(b)-5.

Section 10(b) of the 1934 Act, 15 U.S.C. § 78j, 48 Stat. 891, provides:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange —

(b) To use or employ in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.

Rule 10b-5 C.F.R. 240.10b-5, as promulgated by the Securities and Exchange Commission, provides:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails, or of any facility of any national securities exchange —

(a) To employ any device, scheme or artifice to defraud.

(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statement made, in the light of the circumstances under which they were made, not misleading, or

(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.

Whether Congress intended that an implied private civil remedy exists with reference to 10(b), 15 U.S.C. § 78j, and Rule 10b-5 is questionable. Ruder, Civil Liability Under Rule 10(b)-5: Judicial Revision of Legislative Intent, 57 Nw.U.L.Rev. 627 (1963). Nevertheless, beginning with Judge Kirkpatrick's opinion in Kardon v. National Gypsum Co., 73 F.Supp. 798 (E.D.Pa. 1947), the courts have consistently found that Section 10(b) and Rule 10b-5 imply a remedy for private relief. The issue is no longer raised in litigation. Klein, The Extension of A Private Remedy To Defrauded Securities Investors Under SEC Rule 10B-5, 20 U. of Miami L.Rev. 81 (1965), and cases cited therein. Jennings and Marsh, Securities Regulation: Cases and Materials, at 777 (1963); Fratt v. Robinson, 203 F.2d 627, 37 A.L.R.2d 636 (9th Cir. 1953); Robinson v. Difford, 92 F.Supp. 145 (E.D.Pa.1950); Speed v. Transamerica Corp. (D.C.Del.1951) 99 F.Supp. 808; Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2d Cir. 1952); Fischman v. Raytheon Mfg. Co., 188 F.2d 783 (2d Cir. 1951); A. T. Brod & Co. v. Perlow, 375 F.2d 393 (2d Cir. 1967); Vine v. Beneficial Finance Company, 374 F.2d 627 (2d Cir. 1967). This civil remedy has been recognized in the Seventh Circuit as well. James Blackstone Memorial Library Ass'n v. Gulf, M. & O. R. R., 264 F.2d 445 (7th Cir. 1959) cert. den. 361 U.S. 815, 80 S.Ct. 56, 4 L.Ed.2d 62 (1959); Dasho et al. v. The Susquehanna Corp. et al., 380 F.2d 262 (7th Cir., June 26, 1967); Kohler v. Kohler Co., 280 F.Supp. 808 (E.D.Wis.1962); Northern Trust Co. v. Essaness Theater Corp., 103 F.Supp. 954 (N.D.Ill.1952).

The courts have used Rule 10b-5 to expand the range of liability in the realm of securities transactions, thereby creating a Federal common law which is in a state of flux. King, Recent Developments Concerning the 1933 Securities Act, and 1934 Securities Exchange Act, 20 U. of Miami L.Rev. 919 (1966); Note, 52 Mich.L.Rev. 893. A recognized authority on the law of securities has expressed his reaction to this development:

* * * What has happened to Rule 10b-5, the great Freeman rule, always reminds me of a cartoon of the time showing Mussolini dictating to his secretary, and the caption was, "Miss Baccigalupi, take a law."

Whenever I try to explain to a foreign lawyer, as I have on a number of occasions, how we have developed in this country a scheme for grappling with the problems of insider preferences and so on, more and more I become increasingly ashamed, and that is the only word I can use at this sort of jurisprudence. It is awfully hard, really, to explain with a straight face, how it is that this came about in this great country of ours. It is a development that, needless to say, I applaud. It was long overdue. But do we have to go on indefinitely basing this whole revolutionary change on a section of the Exchange Act that says it shall be unlawful for any person in the purchase or sale of any security to engage in any act or practice that the S.E.C. prescribes as manipulative or deceptive? How big a house of cards can we continue to build on that? This is backdoor jurisprudence with a vengeance. Loss, History of S.E.C. Legislative Programs And Suggestions for A Code, 22 Bus.Lawyer 795, 796 (1967).

The use of 10b-5, as encouraged by the Securities and Exchange Commission, has lead to the emergence of a Federal law of corporations. Matter of Cady Roberts & Co., CCH Fed.Sec.L. Rep. p. 76803 (1961); Ruder, Pitfalls In the Development of A Federal Law of Corporations By Implication Through Rule 10b-5, 59 Nw.U.L.Rev. 185 (1964-65).

Though the investor and the general public are entitled to legal protection, the development of law in this area requires a consideration of a myriad of complex factors involving corporate and business factors, as well as possible effects upon the national economy. The courts, taking a case by case approach, are not equipped to deal with these problems. Ruder, supra. The law is in a state of confusion and needs codification. Somers, Rule 10b-5: Notes for Legislation, 17 West.Res.L.Rev. 1029 (1966).

One writer, in pointing up the confused and chaotic nature of securities law, refers to an example similar to the fact situation in Jordan, though involving a public offering and sale of a registered security by a public utilities holding company. The complaint, in alleging misrepresentation of a material fact regarding the debentures, alleges violations of § 11, § 12(2), § 17(a) of the Securities Act and § 9(e), § 10(b) and Rule 10b-5, § 15(c) (1) and Rule 15cl-2, and § 18(a) of the Securities Exchange Act. The sections cited reveal differences not only in their substantive content, but also in the allocation among the parties of the burden of proof with respect to substantive matters. The sections differ regarding materiality, reliance and causation, exercise of care, measure of damages, jurisdiction, and costs and attorneys' fees. The writer then concludes:

The result of the foregoing discrepancies is, of course, that the plaintiff will carefully pick and choose both the substantive provision and the procedural avenue best suited to him. Consequently specific safeguards relating to burden of proof, defenses, statutes of limitations and other conditions to recovery which were thought appropriate by the Congress when it enacted the specific civil liability provisions are entirely avoided. The result is that the issues, the underwriter, the broker-dealer and others have

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