Marbury Management, Inc. v. Kohn

• Decision Date: 21 April 1980
• Docket Number: Nos. 129,130,D,s. 129
• Citation: 629 F.2d 705
• Parties: Fed. Sec. L. Rep. P 97,357 MARBURY MANAGEMENT, INC., and Harry Bader, Plaintiffs-Appellants-Appellees, v. Alfred KOHN, Defendant-Appellant, and Wood, Walker & Co., Defendant-Appellee. ockets 79-7364, 7380.
• Court: U.S. Court of Appeals — Second Circuit

Page 705

629 F.2d 705

Fed. Sec. L. Rep. P 97,357

MARBURY MANAGEMENT, INC., and Harry Bader, Plaintiffs-Appellants-Appellees, v. Alfred KOHN, Defendant-Appellant, and Wood, Walker & Co., Defendant-Appellee.

Nos. 129, 130, Dockets 79-7364, 7380.

United States Court of Appeals, Second Circuit.

Argued Oct. 29, 1979.

Decided April 21, 1980.

George Berkowitz, New York City, for plaintiffs-appellants-appellees.

Jay H. Fischer, New York City (Fischer & Klein, New York City, of counsel), for defendant-appellant Kohn.

Charles A. Crocco, Jr., New York City (Lunney & Crocco, New York City, of counsel), for appellee Wood, Walker & Co.

Before MESKILL and KEARSE, Circuit Judges, and DOOLING, ^* District Judge.

DOOLING, District Judge:

Marbury Management, Inc., ("Marbury") and Harry Bader sued Alfred Kohn and Wood, Walker & Co., the brokerage house that employed Kohn, for losses incurred on securities purchased through Wood, Walker allegedly on the faith of Kohn's representations that he was a "lawfully licensed registered representative," authorized to transact buy and sell orders on behalf of Wood, Walker. ¹ After a non-jury trial before the Honorable Lee P. Gagliardi, District Judge, the court found that Kohn was employed by Wood, Walker as a trainee and that his repeated statements that he was a stock broker and his use of a business card stating that he was a "portfolio management specialist" were undeniably false; the court found further that Kohn made the statements with intent to deceive, manipulate or defraud in making them, and that his misstatements were material. The court found that Kohn's misrepresentations about his employment status caused Marbury and Bader to purchase securities from Kohn between summer 1967 and April 1969. The district court also found that the predictive statements Kohn made about various securities were not fraudulently made, and that there was no evidence that they were made without a firm basis.

Judge Gagliardi reasoned: a trainee at a brokerage firm can accept buy or sell orders by phone only under the supervision of a broker and cannot recommend the purchase of a security outside the brokerage office; moreover, the qualifications and expertise of a security salesman are particularly significant criteria in evaluating any information as inherently speculative as future earnings predictions; and a reasonable investor would consider the total mix of information that he received significantly altered if he learned that the investment advice was being furnished to him by a trainee in the field rather than by a specialist. Judge Gagliardi concluded that the important circumstance was that the terms "broker" and "specialist" themselves connote a level of competence to the reasonable investor. Thus, he held Kohn liable to plaintiffs under § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b). Inferentially Judge Gagliardi found that Kohn's misstatements of his status not only induced the purchase of the securities involved but their retention as investments as well, until it became evident that Kohn was not, as his business card asserted, a "security analyst" and "portfolio management specialist" associated with Wood, Walker, but simply a trainee. Since both plaintiffs learned the true facts about Kohn's status on about January 28, 1970, Judge Gagliardi computed the damage award to each plaintiff by taking the difference between the price each plaintiff paid for the securities and either the selling price of the securities, if sold before January 28, 1970, or the value within a reasonable time after that date, if the securities were still held on that date.

Judge Gagliardi dismissed the plaintiffs' claims against Wood, Walker on the ground of plaintiffs' failure to prove that Wood, Walker participated in the fraudulent manipulation or intended to deceive plaintiffs; treating plaintiffs as basing their claims against Wood, Walker solely on the theory that the firm aided and abetted Kohn's fraud, the court found that the evidence supported neither a finding of conscious wrongful participation by the firm nor a legally equivalent recklessness but at best a finding of negligence in supervision.

Judge Gagliardi's findings of fact are not clearly erroneous. The cross-appeals of defendant-appellant Kohn from the judgment against him and of plaintiffs-appellants from the judgment exonerating Wood, Walker from liability raise questions of law that are hardly novel but are not free from difficulty in application. It is concluded that the judgment against appellant Kohn must be affirmed and that in favor of Wood, Walker reversed.

1. The substantial question that the appeal of defendant-appellant Kohn raises is whether Kohn's misrepresentation was the legal cause of the loss for which Marbury and Bader have been allowed recovery. The securities bought did not lose value because Kohn was not a registered representative with Wood, Walker, and this case, accordingly, is not one in which a material misrepresentation of an element of value intrinsic to the worth of the security is shown to be false, and in which it is shown that disclosure of the falsity of the representation results in a collapse of the value of the security on the market. In such cases one induced to buy the security on the faith of the misrepresentation of the value element is obviously damaged, and the chain of causation is clear.

Here the claim and finding are that Kohn's statements by their nature induced both the purchase and the retention of the securities, the expertise implicit in Kohn's supposed status overcoming plaintiffs' misgivings prompted by the market behavior of the securities. ² Plaintiffs' recovery of their whole loss measured by the decline in value of the securities to the date when they learned the truth certainly does not fit the familiar rubric, for example, of Section 11(e) of the Securities Act of 1933, 15 U.S.C. § 77k(e) limiting recovery on account of a false or misleading registration statement to the depreciation in value of the security resulting from the untruthfulness of the statement made about it. Cf. Restatement (Second) of Torts § 548A (Comment b, Illustration 1) (1977) (security bought on faith of untrue representation that issuer had received full consideration for it; later full consideration received by issuer, but a court invalidated the security on other grounds; buyer not allowed to recover his loss because it was not considered a proximate consequence of the untrue representation). But plaintiffs in such a case as this, whether or not their claims fall under the more familiar rubric, are, nevertheless, entitled to recover the damages that they suffered as a proximate result of the allegedly misleading statements, Globus v. Law Research Service, Inc., 418 F.2d 1276, 1291 (2d Cir. 1969), cert. denied, 397 U.S. 913, 90 S.Ct. 913, 25 L.Ed.2d 93 (1970).

As Judge Weinfeld observed in Miller v. Schweickart, 413 F.Supp. 1062, 1067 (S.D.N.Y.1970):

Proximate cause, of course, is a concept borrowed from the law of torts, and generally requires that one's wrongful conduct play a "substantial" or "essential" part in bringing about the damage sustained by another.

The generalization is that only the loss that might reasonably be expected to result from action or inaction in reliance on a fraudulent misrepresentation is legally, that is, proximately, caused by the misrepresentation. Restatement (Second) of Torts § 548A (1977). See Levine v. Seilon, 439 F.2d 328, 333-34 (2d Cir. 1971). Oleck v. Fischer, Fed.Sec.L.Rep. (CCH) P 96,898, at 95,702-03 (S.D.N.Y.1979), aff'd (2d Cir. 1980), in effect requires that the damage complained of be one of the foreseeable consequences of the misrepresentation. The case for Marbury and Bader is that, since the misrepresentation was such as to induce both their purchases and their holding of the securities, their holding and its duration determined the extent of their losses. As in Schlick v. Penn-Dixie Cement Corp., 507 F.2d 374, 380-81 (2d Cir. 1974), cert. denied, 421 U.S. 976, 95 S.Ct. 1976, 44 L.Ed.2d 467 (1975), the claim is that the misrepresentation was the agency both of transaction causation and of loss causation.

Liability for representations having the effects of Kohn's representation was familiar in the law even before the Securities Act of 1933 and the Securities Exchange Act of 1934 were enacted. For example, in Rothmiller v. Stein, 143 N.Y. 581, 38 N.E. 718 (1894), the defendant officers of a small corporation told plaintiff that the company was prospering and would pay at least a 10% dividend, and they recommended that plaintiff reject an offer of $80 a share for his stock and accept an offer at $50 a share plus a deferred payment of $50 a share if there were an interim dividend of 10% on the stock. Plaintiff acted on the advice, relying on the defendants' fraudulent statements about the company's affairs. In holding defendants liable, the court said that defendants

. . . cannot in such case shelter themselves under the statement that they did not make the representations, i. e., commit the fraud with the motive or for the purpose of inducing the plaintiff to sell his stock. They intended to deceive the plaintiff and they were induced thereto by other causes, yet the natural, proximate and direct result of such deception they knew or had reasonable ground for believing would be this sale, although its accomplishment was not the particular purpose of their fraud. In such case their liability would seem to be plain.

Id. at 588, 38 N.E. at 719. So in David v. Belmont, 291 Mass. 450, 197 N.E. 83 (1935), plaintiff had retained stock of a certain company and bought additional shares of the same stock in reliance on certain representations made by defendant which were false. The court said:

Presumably (plaintiff) continued to hold the stock after the purchase in reliance on the representations. The fraud was therefore continuing in...