Kirkland v. EF Hutton and Co., Inc.

• Decision Date: 04 March 1983
• Docket Number: Civ. A. No. 80-72737.
• Citation: 564 F. Supp. 427
• Parties: Otis KIRKLAND, Plaintiff, v. E.F. HUTTON AND COMPANY, INC., a Delaware corporation, William Phillips and Ronald Pruitt, Defendants.
• Court: U.S. District Court — Western District of Michigan

564 F. Supp. 427

Otis KIRKLAND, Plaintiff, v. E.F. HUTTON AND COMPANY, INC., a Delaware corporation, William Phillips and Ronald Pruitt, Defendants.

Civ. A. No. 80-72737.

United States District Court, E.D. Michigan, S.D.

March 4, 1983.

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Richard T. Fenton, Detroit, Mich., for plaintiff.

Gerald C. Davis, Livonia, Mich., for defendants.

OPINION AND ORDER GRANTING IN PART AND DENYING IN PART DEFENDANTS' MOTION FOR PARTIAL SUMMARY JUDGMENT

PATRICIA J. BOYLE, District Judge.

Before the court is defendants' motion for partial summary judgment. Plaintiff is the manager of the Detroit office of The Dictaphone Company and was approached by defendant William Phillips, an account executive (stockbroker) with defendant E.F. Hutton, to invest in securities through E.F. Hutton. Plaintiff did so invest, eventually selling through E.F. Hutton the Dictaphone stock he had acquired through his employment and, as a result of the investments made by Phillips and defendant Ronald Pruette, another account executive, lost an estimated Seventy-Five Thousand Dollars.

Plaintiff now sues both account executives and E.F. Hutton, seeking actual and exemplary damages. The complaint contains nine stated causes of action and seeks damages and attorneys fees from all three defendants jointly and severally. The counts (called "causes of action") include violations of various sections of the 1933 and 1934 federal securities acts; violations of the rules promulgated under those statutes; violations of the National Association of Securities Dealers (hereinafter "NASD") rules; violations of the New York Stock Exchange (hereinafter "NYSE") rules; violations of the securities statutes through violation of the NASD and NYSE rules; and violations of the Michigan blue sky laws regulating securities, common-law negligence, and common-law fraud.

In greater detail, plaintiff alleges that he agreed with defendant Phillips to invest several thousand dollars in securities to be brokered by E.F. Hutton and that subsequently Phillips bought for plaintiff 2000 calls (or options to purchase shares) in ConEdison stock. Plaintiff was not provided with an options prospectus and was not advised by Phillips or an E.F. Hutton agent of the risks of options trading, an omission plaintiff alleges to be a violation of NASD and NYSE rules.

Most significantly, plaintiff alleges that Phillips persuaded him to sell some of his Dictaphone (Pitney-Bowes) stock and purchase 1000 shares of Trans World Corporation (hereinafter "TWC"). Phillips allegedly told plaintiff he had "inside information" that Texas International (hereinafter "TI"), a Texas airline, was attempting a takeover of TWC stock outstanding which would cause the value of the TWC stock to rise.

When Phillips brokered the purchase of TWC stock for plaintiff, the stock was at Twenty-Seven and 00/100 Dollars ($27.00) per share. Two weeks later, allegedly, the price had dropped to Seventeen and 00/100 Dollars ($17.00). Phillips persuaded plaintiff to buy an additional 1000 shares of TWC stock. The value of TWC continued to fall, while the value of the Dictaphone stock plaintiff had sold (and continually sold to meet payments on the margin calls in connection with the financing of the purchase of TWC stock) remained stable.

Phillips finally sold for plaintiff the 2000 shares of TWC stock, getting $15 & 7/8 for 1000 shares and $15 & 3/8 for the second 1000 shares. Those sales were 3 and 4 months after Phillips had initially persuaded plaintiff to make the first buy of TWC stock.

At the heart of plaintiff's complaint are the allegations that Phillips did not tell plaintiff all the pertinent information known to Phillips, amounting to intentional omission of potentially discouraging information in an attempt to induce plaintiff to buy the TWC stock and that Phillips was "churning" plaintiff's account, by engaging in quick sales and purchases, without regard to the long-term return, in an attempt to generate large commissions for himself. Plaintiff invokes several statutory and common-law causes of action in order to recover for these basic injuries.

Each cause of action in the complaint is the subject of the instant motion, although several allegations within those separate counts are not addressed.

The allegations against E.F. Hutton rest on derivative liability, either through respondeat superior or through conspiracy/aiding and abetting or as a "control person" within the meaning of the federal securities laws. The allegations against Phillips and Pruette are those of principal liability and will be addressed separately in this opinion.

The allegations of Count I seek recovery for the omissions and misrepresentations of Phillips and Pruette in their brokering of plaintiff's investments, violating sections 10(b) and 15(c) of the 1934 Securities Exchange Act and section 17 of the 1933 Securities Act and the rules promulgated under those sections, rule 10b-5 and rule 15c-1 & -2.

Defendants contend that (1) sections 15 and 17 do not give rise to a private cause of action and thus do not constitute proper counts here, (2) sections 15 and 17 are aimed at the initial distribution of stock, rather than the trading and resale after distribution as was involved here, (3) plaintiff himself made use of any illegally given insider information from Phillips (by plaintiff's purchase upon hearing of the insider information) and thus is barred from suit by the doctrine of in pari delicto, (4) Phillips's exhortations to buy the TWC stock amounted to sales puffing, not actionable at law, and (5) the information about the Texas International takeover that plaintiff contends should have been told him was public and/or rumor and therefore created no duty to be told to plaintiff.

Since defendants' assertion of the in pari delicto defense, if successful, would bar plaintiff's cause of action under all three of the federal securities statutes, that defense will be addressed first.

Defendants argue that plaintiff himself was aware that the insider information furnished him by the broker was not information available to the public and that, by choosing to purchase the TWC stock based on that information, any violation of the federal securities laws was shared by plaintiff, and plaintiff is thus precluded from recovering against the broker.

Section 10(b) of the 1934 Securities Exchange Act prohibits the use of non-public information in trading securities. A corporate insider possessing confidential, material information undisclosed to the public at large is required either to disclose the information or to abstain from trading in the stock until the information is publicly disseminated. See SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir.1968) (en banc), cert. denied, 394 U.S. 976, 89 S.Ct. 1454, 22 L.Ed.2d 756 (1969). A "tipper" who advised another of inside information material to a certain transaction has violated section 10(b) and rule 10b-5, Shapiro v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 495 F.2d 228 (2d Cir.1974), and is liable to third parties who were damaged by having traded without the benefit of the confidential information passed by the "tipper" to only a select few ("tippees"¹). See Texas Gulf Sulphur Co., supra. Here, however, plaintiff is a "tippee" who wishes to hold the "tipper" liable, in the face of an asserted defense of in pari delicto.

The defense of "in pari delicto," which means "in equal fault," is a common-law defense applicable where "a plaintiff seeking damages or equitable relief is himself involved in some of the same sort of wrongdoing." Perma Life Mufflers, Inc. v. International Parts Corp., 392 U.S. 134, 138, 88 S.Ct. 1981, 1984, 20 L.Ed.2d 982 (1968). See also Tarasi v. Pittsburgh National Bank, 555 F.2d 1152, 1156-57 & n. 9 (3d Cir.), cert. denied, 434 U.S. 965, 98 S.Ct. 504, 54 L.Ed.2d 451 (1977). Its application in the realm of broad statutory schemes directed toward regulation through the mechanism of private civil actions is uncertain, however, particularly in light of the Supreme Court's criticism of wholesale importation of the defense into areas in which the private lawsuit serves as the "bulwark of ... enforcement." Perma Life Mufflers, supra, 392 U.S. at 139, 88 S.Ct. at 1984.

Neither the Supreme Court nor the Sixth Circuit Court of Appeals has decided the application of the in pari delicto defense to federal securities cases based on the antifraud provisions of the 1933 Act.² While the circuits are not in agreement on whether a "tippee" can successfully surmount the defense raised by a "tipper," the majority of courts deciding the issue have held the defense applicable in the proper circumstances. Compare Tarasi v. Pittsburgh National Bank, supra; Malamphy v. Real-Tex Enterprises, Inc., 527 F.2d 978 (4th Cir. 1975); Woolf v. S.D. Cohn & Co., 515 F.2d 591 (5th Cir.1975), vacated, 426 U.S. 944, 96 S.Ct. 3161, 49 L.Ed.2d 1181 (1976); James v. DuBreuil, 500 F.2d 155 (5th Cir.1974); Clement A. Evans & Co. v. McAlpine, 434 F.2d 100 (5th Cir.1970), cert. denied, 402 U.S. 988, 91 S.Ct. 1660, 29 L.Ed.2d 153 (1971); Kuehnert v. Texstar Corp., 412 F.2d 700 (5th Cir.1969); In re Haven Industries, Inc., 462 F.Supp. 172 (S.D.N.Y.1978); Weitzman v. Stein, 436 F.Supp. 895 (S.D.N. Y.1977); Hogan v. Teledyne, Inc., 328 F.Supp. 1043 (N.D.Ill.1971) (all allowing the defense), with Nathanson v. Weis, Voison, Cannon, Inc., 325 F.Supp. 50 (S.D.N.Y.1971) (barring the defense).³ Notwithstanding the number of decisions favoring the defense, however, the reasons given for rejecting the defense in the Nathanson decision are persuasive and bear careful consideration absent guidance from this circuit's appellate court on the question.

Those courts that have allowed the defense to be asserted by a "tipper" in a 10b-5 action brought by a "tippee" have done so on the rationale that by a "tipper" depriving a "tippee"...