Kulla v. E.F. Hutton & Co., Inc.

• Decision Date: 25 January 1983
• Docket Number: No. 82-433,82-433
• Citation: 426 So.2d 1055
• Court: Florida District Court of Appeals
• Parties: Fed. Sec. L. Rep. P 99,080 Richard KULLA, Appellant, v. E.F. HUTTON & COMPANY, INC. and Herbert A. Wilson, Appellees.

Page 1055

426 So.2d 1055

Fed. Sec. L. Rep. P 99,080

Richard KULLA, Appellant, v. E.F. HUTTON & COMPANY, INC. and Herbert A. Wilson, Appellees.

No. 82-433.

District Court of Appeal of Florida,

Third District.

Jan. 25, 1983.

Rehearing Denied Feb. 28, 1983.

Howard W. Mazloff, Coral Gables, for appellant.

Walton, Lantaff, Schroeder & Carson and O'Bannon M. Cook, Miami, for appellees.

Before HENDRY, DANIEL S. PEARSON and JORGENSON, JJ.

DANIEL S. PEARSON, Judge.

Kulla brought suit alleging that E.F. Hutton (through its co-defendant, agent, employee and registered representative, Herbert Wilson) talked:

"Defendant WILSON, called Plaintiff and represented to him that he had received a tip from California concerning the stock of Pacific Coast Medical Enterprises.

"WILSON told Plaintiff that papers had been signed for a merger of Pacific Coast Medical Enterprises into another company and that the papers were at that moment sitting on the desk of the president of Pacific.

"At that time, the stock of Pacific was quoted at three and one-eighth and WILSON told Plaintiff that it would soon sell for six dollars per share.

"WILSON further represented that this was a 'sure thing; and that he was not permitted to do this but that he wanted to tell Plaintiff about it so that Plaintiff could buy the stock.

"WILSON further represented that the merger announcement would be announced in The Wall Street Journal that Friday." (Paragraph 8.a. through e. of the complaint).

and Kulla listened:

"In reliance upon the foregoing, Plaintiff purchased 5,000 shares of Pacific Coast Medical Enterprises on February 9, 1981 at three and one-eighth dollars per share and 5,000 shares of Pacific at a price of three and one-eighth on February 10, 1981. In paying for these shares and the applicable commission, Plaintiff paid to Defendant, HUTTON, the sum of $32,440.00 on or about February 17, 1981." (Paragraph 9 of the complaint).

Hopefully, the eavesdroppers in the well-known E.F. Hutton advertisement were not listening, because, according to Kulla:

"Thereafter, the merger did not occur and when Plaintiff questioned Defendant, WILSON, about this, WILSON, represented to Plaintiff that Plaintiff should not worry that the stock would come back in price. The stock is currently selling at approximately $1.00 per share today. Defendant, WILSON, has now admitted to Plaintiff that there was no merger." (Paragraph 10 of the complaint).

Kulla asked for rescission of the transaction and compensatory and punitive damages. Again, E.F. Hutton talked, and this time the trial court listened. Kulla's complaint was dismissed with prejudice on the ground that the facts alleged showed that Kulla actively participated in the alleged scheme to defraud employed by the defendants, and therefore acted in pari delicto with the defendants, barring recovery. Kulla appeals, and it is our turn to listen.

It is a well-settled principle of law requiring little discussion that one who himself engages in a fraudulent scheme, that is, acts in pari delicto, may forfeit his right to any legal remedy against a co-perpetrator. Goldring v. Johnson, 65 Fla. 381, 62 So. 212 (1913); Horjales v. Loeb, 291 So.2d 92 (Fla. 3d DCA 1974); Frye v. Taylor, 263 So.2d 835 (Fla. 4th DCA 1972). The rationale underlying this principle, in its most distilled form, is that the "law will not lend its support to a claim founded on its own violation," Robert G. Lassiter & Co. v. Taylor, 99 Fla. 819, 832, 128 So. 14, 19 (1930). See also Citizens' Bank & Trust Co. v. Mabry, 102 Fla. 1084, 136 So. 714 (1931); Schaal v. Race, 135 So.2d 252 (Fla. 2d DCA 1961). It is, however, obvious that merely acting on a tip does not, by itself, make the actor guilty of wrongdoing. As the parties readily acknowledge, Kulla can be said to have acted in delicto only if his acting on the tip under the circumstances described in the complaint was prohibited by law. ¹

The defendants assert that Kulla's actions were in violation of the antifraud provision of the Securities Exchange Act of 1934. Section 10(b) of the Act, 15 U.S.C. § 78j, prohibits the use "in connection with the purchase or sale of any security ... [of] any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [Securities and Exchange] Commission may prescribe." Rule 10b-5, promulgated by the Securities and Exchange Commission, makes it unlawful for any person to "employ any device, scheme or artifice to defraud," or 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."

The Act has been construed to apply to a person receiving a tip only when the information received comes from an "insider," that is, one with a relationship to the affected corporation giving him access to information which should be used "only for a corporate purpose and not for the personal benefit of anyone." In re Cady, Roberts & Co., 40 S.E.C. 907, 912 (1961). When such inside information is received from an "insider," the recipient who has acted thereon can be deemed to have engaged in an act which operates as a fraud or deceit in connection with the purchase or sale of a security in violation of Section 10(b) of the Act. The tippee's liability under the law is predicated on the fact that he has knowledge or reason to know

"that the material non-public information became available to [him] in breach of a duty owed to the corporation not to disclose or use the information for non-corporate purposes. Such knowledge, in effect, renders the tippee a participant in the breach of duty when he acts on the basis of the information received." In re Investors Management Co., Inc., 44 S.E.C. 633, 650 (1971) (Smith, Comm., concurring).

Thus, a tippee is subjected to the same liability as an insider-tippor by virtue of the tippee's participation after the fact in the insider's breach of fiduciary duty owed to the corporation. Shapiro v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 495 F.2d 228 (2d Cir.1974). If the tippee knows or has substantial reason to know that the information given to him by an "insider" was received from within the corporation and was material and non-public, the tippee has a duty not to profit from the use of this information, and if he does so, is in violation of the Act. See Chiarella v. United States, 445 U.S. 222, 231 n. 12, 100 S.Ct. 1108, 1116 n. 12, 63 L.Ed.2d 348, 358 n. 12 (1980).

It is apparent from the allegations of Kulla's complaint that, if the defendants were to be believed, Kulla had substantial reason to know that the information given to him came from within Pacific Coast Medical Enterprises and was material and non-public. However, there is nothing in Kulla's complaint to show that either E.F. Hutton & Company or Wilson were "insiders" of Pacific Coast Medical Enterprises, so as to make the defendants liable under the Act for divulging the secret information and, in turn, subject Kulla, as the recipient of the information, to liability.

As we have noted, an "insider" is someone with a special relationship to the corporation affected.

"As the law was originally conceived, with an emphasis on the prevention of abuse by top management and controlling shareholders, the term 'insider' was limited to officers, directors, and holders of 10 percent or more of the stock. However, under rule 10b-5 the concept has been broadened to include not only the previously mentioned top-rung corporate personnel and owners but also all persons 'in special relationship with a company and privy to its internal affairs ...' Cady, Roberts & Co., 40 S.E.C. 907, 912 (1961)." Herman, Equity Funding, Inside Information And The Regulators, 21 U.C.L.A.L.Rev. 1, 7 (1973).

In Chiarella, supra, the court made clear that the mere possession of superior undisclosed information does not make one an insider. As one commentator has put it, "[m]ost important, a duty to disclose--something more than an ad hoc conclusion that fairness requires disclosure in a particular case--will have to be identified before liability can be imposed." Langevoort, Insider Trading And The Fiduciary Principle: A Post-Chiarella Restatement, 70 Cal.L.Rev. 1, 17 (1982). See also Polinsky v. MCA, Inc., 680 F.2d 1286 (9th Cir.1982); Feldman v. Simkins Industries, Inc., 679 F.2d 1299 (9th Cir.1982). Compare Shapiro v. Merrill Lynch, Pierce, Fenner & Smith, Inc., supra (insider status established where brokerage firm acting as prospective underwriter for corporation's debenture issue ). Apart from identifying the defendants as brokers in apparent possession of confidential information, Kulla's complaint is barren of any allegation that these defendants occupied a special relationship to Pacific Coast Medical Enterprises, a necessary predicate to a finding that the defendants were insiders and that, derivatively, Kulla acted in pari delicto. Thus, we agree with the conclusion reached in Xaphes v. Shearson, 508 F.Supp. 882 (S.D.Fla.1981):

"In the absence of any facts establishing defendant's status as a corporate 'insider,' it is impossible to characterize the plaintiff as a 'tippee.' As demonstrated, the status of 'tippee' is directly related to that of his informant since a 'tippee' must obtain his tip from a corporate 'insider.'

....

"To uphold the defense of in pari delicto as a matter of law in the present case would be to hold that a duty to disclose under Section 10(b) arises from mere possession of nonpublic information, a result forbidden by the Supreme Court in Chiarella, the legislative history of the Act, and the Congressional plan for regulation of the securities markets." Id. at 885-86.

We have not overlooked the possibility that the defendants could be deemed insiders under Section 517.301(1), Florida Statutes (1981), ² rendering Kulla, as their tippee, in delicto under the Florida Securities Act. We believe, however, that...