In re Fortune Systems Securities Litigation

• Decision Date: 17 September 1984
• Docket Number: No. C-83-3348A WHO.,C-83-3348A WHO.
• Citation: 604 F. Supp. 150
• Court: U.S. District Court — Northern District of California
• Parties: In re FORTUNE SYSTEMS SECURITIES LITIGATION.

604 F. Supp. 150

In re FORTUNE SYSTEMS SECURITIES LITIGATION.

No. C-83-3348A WHO.

United States District Court, N.D. California.

September 17, 1984.

COPYRIGHT MATERIAL OMITTED

David B. Gold, John W. Allured, San Francisco, Cal., for plaintiffs.

Stephen Kapustin, Philadelphia, Pa., for C.E. Pappas, M.D.

Melvin R. Goldman, Janet M. Cooper, Paul R. Dieseth, Morrison & Foerster, Bruce G. Vanyo, Philip R. Rotner, Douglas Y. Peters, McCutchen, Doyle, Brown & Enerson, San Francisco, Cal., for defendants.

OPINION

ORRICK, District Judge.

This Court, heretofore having had the benefit of excellent, extensive oral argument, granted defendants' motions for dismissal of two counts of the complaint, alleging violations of §§ 17(a), 15 U.S.C. § 77q(a), and 12(2), 15 U.S.C. § 77l, of the Securities Act of 1933 (the "1933 Act").¹ Because questions involving the interpretation of those two sections occur frequently and because the decision of the district courts, courts of appeal, and Supreme Court are in apparent conflict, the Court deems it of importance in this case to state its reasons for its rulings in more detail than it did in open court following oral argument.

I

Plaintiffs² alleged in their second amended consolidated complaint that defendants committed numerous violations of federal and state securities laws in connection with the initial public offering of Fortune Systems Corporation's common stock on March 3, 1983. The seven-count complaint included claims under §§ 11 and 12(2) of the 1933 Securities Act (Counts I and II, respectively); § 10(b) of the Securities Exchange Act of 1934 (the "1934 Act") and Rule 10b-5 (Count III); California Corporations Code §§ 25400 and 25401 (Counts IV and V, respectively), common law fraud and deceit (Count VI); and negligent misrepresentation (Count VII). The first amended consolidated complaint contained a count based on § 17(a) of the 1933 Act as well.

The disputes raised in this litigation stem from Fortune Systems' initial public offering of five million shares of common stock. The stock was sold pursuant to a Registration Statement filed with the SEC, effective March 4, 1983. Plaintiffs allege that the Registration Statement and Prospectus contained untrue statements of material fact and omitted material facts necessary to make other statements not misleading.

Shortly after going public, Fortune Systems disclosed decreased product orders, delivery delays, and a significant loss for the quarter ending June 30, 1983, resulting in a sharp decline in the price of the stock.

The complaint names numerous individuals and entities as defendants, who can be described under the following categories: (1) the Corporation,³ its officers and directors (including defendants Friedman, Bachar, Henson, McCafferty, Pennington, Schreiber, Toutain, Thomas, Dunn and Van Den Berg); (2) the selling shareholders (including defendants Thomson Communications, Inc., First Capital Corporation, Brentwood Associates II and III (affiliated venture capital limited partnerships), and Greyhound Computer Corporation); and underwriters⁴ (including co-lead underwriters, First Boston Corporation, and Alex. Brown & Sons and Montgomery Securities, both investment partnerships).

Defendants' dismissal motions raised two particularly important issues, namely, whether § 17(a) of the 1933 Act carries with it an implied private damages remedy, and whether the complaint's allegations of the defendants' status as "sellers" are sufficient to state a cause of action under § 12(2). The Court deals with these matters below.

II

The Ninth Circuit has not had before it a case squarely raising the question of the availability of a private cause of action under § 17(a) of the 1933 Act. See Stephenson v. Calpine Conifers II, Ltd., 652 F.2d 808, 815 (9th Cir.1981). In Stephenson the parties and the district court proceeded under the assumption that such a cause of action did exist, and the issue was not raised on appeal. Nonetheless, the circuit considered, in passing, the remedies available for violation of the section. Without analysis, the court agreed with Judge Friendly's concurrence in SEC v. Texas Gulf Sulphur, 401 F.2d 833, 867 (2d Cir. 1968), and found:

"In light of the minimal differences between § 17(a) of the 1933 Act and § 10(b) of the 1934 Act, we think the reasoning of the Second Circuit is persuasive and find that a private right of action exists under § 17(a)."

Id. at 815.

Perhaps because the parties had not themselves considered the issue, the Stephenson court failed to apply the Supreme Court-mandated analysis for deciding whether a private cause of action may be implied by a statute that does not explicitly provide such a right. See generally Cort v. Ash, 422 U.S. 66, 95 S.Ct. 2080, 45 L.Ed.2d 26 (1975); Touche Ross & Co. v. Redington, 442 U.S. 560, 99 S.Ct. 2479, 61 L.Ed.2d 82 (1979); Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11, 100 S.Ct. 242, 62 L.Ed.2d 146 (1979). Further, the Stephenson court did not recognize that Aaron v. SEC, 446 U.S. 680, 100 S.Ct. 1945, 64 L.Ed.2d 611 (1980), severely undercuts, if it does not altogether destroy, the assumptions explicitly made by Judge Friendly in Texas Gulf Sulphur. These obvious gaps in Stephenson compel this Court to consider the availability of a private action for damages under § 17(a) of the 1933 Act.⁵

A

Section 17(a) of the 1933 Act declares it unlawful for any person in the offer or sale of a security (1) to employ a device, scheme or artifice to defraud; (2) to obtain money or property by means of an untrue statement of material fact or omission of a material fact; or (3) to engage in any practice that operates or would operate as a fraud or deceit on the purchaser. The section does not, however, specify a remedy, although §§ 20 and 24 empower the Securities and Exchange Commission (the "SEC") to sue for injunctive relief and to prosecute violators via criminal proceedings. See 15 U.S.C. §§ 77t, 77x. Whether an investor may bring a civil damages suit under the section, analogous to the well-accepted private right of action under § 10(b) of the 1934 Act, has been explicitly left open by the Supreme Court. (Aaron v. SEC, supra, 446 U.S. at 689, 100 S.Ct. at 1951).

The Supreme Court formerly took an expansive view of the availability of private causes of action under federal statutes, reasoning that when Congress has legislated against some activity, the courts should "be alert to provide such remedies as are necessary to make effective the congressional purpose." J.I. Case v. Borak, 377 U.S. 426, 433, 84 S.Ct. 1555, 1560, 12 L.Ed.2d 423 (1964). In the two decades since that decision, the Court has been repeatedly called on to imply private rights of action into federal statutes that provide none, and has adopted a more analytic and restrictive approach to the issue. See generally Touche Ross, 442 U.S. at 578, 99 S.Ct. at 2490 ("in a series of cases since Borak we have adhered to a stricter standard for the implication of private causes of action, and we follow that stricter standard today").

In Cort, supra, the Court considered whether a private right of action could be implied under 18 U.S.C. § 610, a criminal statute prohibiting corporations from contributing to certain political campaigns. Four factors were identified as "relevant" to the determination of whether a private right of action is implicit in a statute: (1) does the statute create a federal right in plaintiff's favor; (2) does the legislative history of the statute indicate that Congress explicitly or implicitly intended to create such a remedy; (3) is such a remedy consistent with the underlying purposes of the legislative scheme; and (4) is the cause of action one traditionally relegated to state law, such that it would be "inappropriate" to create such an action as a matter of federal law. Cort, supra, 422 U.S. at 78, 95 S.Ct. at 2088. After analyzing 18 U.S.C. § 610 under these factors, the Court held that no private remedy had been intended by Congress when it enacted the statute.⁶

Subsequent cases have explored how these factors should be applied, particularly in the context of the federal securities laws. The Supreme Court was asked to imply a private damages remedy for violations of § 17(a) of the 1934 Act in Touche Ross, supra. There, the Court noted that in Cort it "did not decide that each of the four factors is entitled to equal weight. The central inquiry remains whether Congress intended to create, either expressly or by implication, a private cause of action." 442 U.S. at 575, 99 S.Ct. at 2489 (emphasis added). The fact that a federal statute has been violated and a person harmed does not of necessity create a federal cause of action in the injured's favor. Id. citing Cannon v. University of Chicago, 441 U.S. 677, 688, 99 S.Ct. 1946, 1953, 60 L.Ed.2d 560 (1979); see also Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11, 100 S.Ct. 242, 62 L.Ed.2d 146 (1979) (mere fact that statute protects the interests of an identifiable group does not mean that it also implicitly creates a private cause of action in that group, id. at 24, 100 S.Ct. at 249). The application of these factors in Transamerica Mortgage well illustrates the Supreme Court's methodology.

The Transamerica Mortgage Court considered whether a client could sue his investment adviser for violating §§ 206 and 215 of the Investment Advisers Act of 1940 (15 U.S.C. § 80b-1 et seq.). Section 206 of that Act proscribes fraudulent conduct with a client (15 U.S.C. § 80b-6), and § 215 provides that contracts made in violation of the Act are void. 15 U.S.C. § 80b-15. The Court agreed with the plaintiff that these sections established a "federal fiduciary standard" governing the conduct of investment advisers and was intended to benefit the advisers' clients. Transamerica Mortgage, supra, 444 U.S. at 17, 100 S.Ct. at 246. The Act and its legislative history, however, shed no light on the...