Fischman v. Raytheon Mfg. Co.

• Citation: 188 F.2d 783
• Decision Date: 23 April 1951
• Docket Number: Docket 21935.,No. 190,190
• Parties: FISCHMAN et al. v. RAYTHEON MFG. CO. et al.
• Court: U.S. Court of Appeals — Second Circuit

188 F.2d 783 (1951)

FISCHMAN et al. v. RAYTHEON MFG. CO. et al.

No. 190, Docket 21935.

United States Court of Appeals Second Circuit.

Argued March 14, 1951.

Decided April 23, 1951.

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Louis H. O. Fischman, New York City, for plaintiffs-appellants.

Debevoise, Plimpton & McLean, New York City (Eli Whitney Debevoise and George N. Lindsay, Jr., New York City, of counsel), for defendants-appellees.

Before SWAN, CHASE and FRANK, Circuit Judge.

FRANK, Circuit Judge.

As we understand the preferred stockholders' position, they are content to rest their claim on the first cause of action and pursuant to Section 11 of the 1933 Act. They complain merely of that part of the order requiring security as a condition of their repleading to allege facts showing that the statute of limitations had not run. The common stockholders do not complain of the dismissal of the first cause of action as to them, nor do they contend that the second cause of action should not be amended to allege the use of the mails or some means or instrumentality of interstate commerce or of some facility of a national security exchange. They do assert that the order erred in barring them from including in an amendment of the second cause of action any allegation of "untrue statements of a material fact or omission to state a material fact in the prospectus or registration statement or both." They also complain of the exaction of security as a condition of their repleading.

1. The trial judge and the defendants reason as follows: (a) The 1933 and 1934 Acts must be read together as parts of a single statutory scheme, especially as the statute which enacted the 1934 Act also amended the 1933 Act. (b) The common stockholders have no claim under § 11 of the 1933 Act, since they purchased no securities which were the subject of the prospectus and registration statement. (c) Congress imposed restrictions on a suit under that section e. g. a short statute of limitations, and discretion in the court to require security in some circumstances. (d) It cannot reasonably be supposed that Congress intended that the common stockholders, under the 1934 Act, could maintain a suit for the very conduct not actionable at their suit under § 11 of the 1933 Act. (e) Especially is this true of a suit under Section 10(b) of the 1934 Act, for that section does not impose restrictions similar to those imposed by § 11 of the 1933 Act. (f) Therefore the common stockholders may not allege, as part of their claim, any misleading statements in or omissions from the prospectus or registration statement.

We do not agree with items (d), (e) and (f) of this argument. A suit under § 11 of the 1933 Act requires no proof of fraud or deceit, and such a suit may be maintained only by one who comes within a narrow class of persons i. e. those who purchase securities that are the direct subject of the prospectus and registration statement (here the purchasers of preferred stock). But proof of fraud is required in suits under § 10(b) of the 1934 Act and Rule X-10 B-5,¹ which was validly promulgated by the S. E. C. pursuant to that section. Congress reasonably, and without inconsistency, allowed suits of that sort which (1) are free of the restrictions applicable to a suit under § 11 of the 1933 Act and (2) which are not confined to those persons who may properly sue under that section but which include all who are the victims of the fraud. We think that when, to conduct actionable under § 11 of the 1933 Act, there is added the ingredient of fraud, then that conduct becomes actionable under § 10(b) of the 1934 Act and the Rule, at the suit of any defrauded person, whether or not he could maintain a suit under § 11 of the 1933 Act.²

Were this not true, Section 11 of the 1933 Act, designed to protect investors even when there is no fraud, would afford a shelter or sanctuary for those who defraud investors. To illustrate: A corporation and its "insiders" put out a prospectus and registration statement, relating to a very small issue of preferred, which apparently complies with the provisions of the 1933 Act but which, as they well know, is false; this they do with the successful aim of fraudulently inducing some investors to purchase the preferred from the company but also other investors to purchase a much larger amount of the company's common from the "insiders". The fraud-doers would be delighted to reimburse the purchasers of the small amount of the preferred and to avoid liability to the defrauded purchasers of the large amount of the common. If the position taken by the defendants in the instant case were correct, the defrauded purchasers of the common in the illustrative case would have no redress whatever under the statute. This position we think untenable.³

Section 10(b), to be sure, does not explicitly authorize a civil remedy. Since, however, it does make "unlawful" the conduct it describes, it creates such a remedy.⁴ As the suit here is "at law," the New York six-year statute of limitations — New York Civil Practice Act, § 48(2) and (5) — applies.⁵

The second cause of action alleges, in general terms, fraudulent conduct, injurious to the common stockholders, in the use of the prospectus or registration statement. The common stockholders should be permitted to amend by alleging, with sufficient particularity,⁶ facts showing such conduct, within the meaning of the statute.⁷ Consequently, we think that portion of the order permitting "an amended complaint alleging a cause of action not based upon any alleged untrue statement of a material fact or omission to state a material fact in the prospectus or registration statement or both," if construed to mean that the amended complaint may contain no reference to the prospectus or registration statement, places too narrow a restriction upon the common stockholder plaintiffs.

Section 9(a) (4) of the 1934 Act also requires allegations and proof of fraud. Moreover, it does impose restrictions somewhat like those imposed on a suit under § 11 of the 1933 Act. The common stockholders should be permitted to amend (if they can do so) by alleging facts showing that the defendants deliberately used the prospectus or registration statement for the purpose of fraudulently inducing the purchase of common stock sold by the defendants and that, in this fraudulent purpose, the defendants were successful vis a vis the common stockholders here.

We construe Section 18(a) of the 1934 Act as applicable to a document filed with a national securities exchange. If the registration statement or prospectus or other document was thus filed, something more occurred than the conduct covered by § 11 of the 1933 Act. Nothing in that section is therefore inconsistent with a remedy under § 18(a) of the 1934 Act. Accordingly, the common stockholders may also maintain their action under that section if (but only if) they amend to allege a filing with a national securities exchange.

2. Section 11(e) of the 1933 Act authorizes the trial court to require security. Section 13 of that Act prescribes a short statute of limitations for a Section 11 suit i. e. such a suit must be brought "within one year after the discovery of the untrue statement or the omission, or after such discovery should have been made by the exercise of reasonable diligence". On the basis of affidavits filed by plaintiffs and defendants, the trial judge said: "I feel that the plaintiffs should be required to file an undertaking pursuant to section 11 of the Act of 1933. The plaintiffs' affidavits charge matters far afield of the allegations of the complaint, but they do not dispel the notion that they knew of the alleged misleading statements and the like long before they presently assert. I direct, therefore, that the plaintiffs shall file an undertaking in the amount of $3,000 to cover all the defendants without prejudice to an application of any of the defendants for an increase as the situation develops." Nevertheless, the trial judge held that the preferred stockholders might file an amended complaint containing allegations sufficient to bar the running of the statutory period.

Sections 9 and 18 of the 1934 Act each contains a short period of limitations and each also authorizes the exaction of security for costs, etc.⁸ But Section 10 of the 1934 Act contains neither such provision. Although the trial judge permitted the common stockholders to replead, yet, as noted above, he required a bond as a condition of repleading by either the common or preferred stockholders. Neither the preferred nor common stockholders complied with this bond condition, and a final order was entered dismissing the complaint. On their appeal from that order, plaintiffs may challenge the validity of the bond requirement, since their failure to comply with it led to the final order of dismissal.

We consider the requirement premature as to both the preferred and the common. Passing the question whether the judge's "feeling" and "notion" about the knowledge of the preferred stockholders sufficed to show a lack of "merit,"⁹ we think that, as amendment of the complaint was permitted, consideration of whether a bond should be exacted must be postponed until the amended complaint has been filed. This conclusion as to the common stockholders is reinforced by the fact that, if and insofar as the amended complaint may allege a valid claim only under Section 10 of the 1934 Act, the judge will have no authority to require a bond.

When the complaint is amended, if such a requirement is, on the then state of the record, proper as to either or both the preferred or common stockholders, there should be no exaction of a joint undertaking covering all causes of action, but the requirement should be limited to those causes of action as to which the statute authorizes a bond.

Reversed and remanded.

Appendix

The complaint reads as follows: "Plaintiffs, above named, by Louis H. O....