Marx & Co., Inc. v. Diners' Club Inc.

• Decision Date: 25 February 1977
• Docket Number: 177,D,Nos. 159,s. 159
• Citation: 550 F.2d 505
• Parties: Fed. Sec. L. Rep. P 95,892, 1 Fed. R. Evid. Serv. 661 MARX & CO., INC., et al., Plaintiffs-Cross-Appellants, v. The DINERS' CLUB, INC., et al., Defendants-Cross-Appellees. The DINERS' CLUB, INC., and Diners/Fugazy Travel, Inc., Defendants-Appellants, v. William D. FUGAZY et al., Plaintiffs-Appellees. ockets 76-7050, 76-7069.
• Court: U.S. Court of Appeals — Second Circuit

Page 505

550 F.2d 505

Fed. Sec. L. Rep. P 95,892, 1 Fed. R. Evid. Serv. 661

MARX & CO., INC., et al., Plaintiffs-Cross-Appellants, v. The DINERS' CLUB, INC., et al., Defendants-Cross-Appellees.

The DINERS' CLUB, INC., and Diners/Fugazy Travel, Inc., Defendants-Appellants, v. William D. FUGAZY et al., Plaintiffs-Appellees.

Nos. 159, 177, Dockets 76-7050, 76-7069.

United States Court of Appeals,

Second Circuit.

Argued Oct. 18, 1976.

Decided Feb. 25, 1977.

Joseph J. Santora, New York City (Hardee Barovick Konecky & Braun, New York City, of counsel), for defendants-appellants and cross-appellees; Robert B. Kay, Robert B. McKay, Stephen Ross and Salvatore A. Raniere, New York City, on the brief.

James E. Tolan, New York City (Bruce E. Pindyck, Michael E. Twomey, Olwine, Connelly, Chase, O'Donnel & Weyher, New York City, and Barry I. Fredericks, Harris, Fredericks & Korobkin, New York City, of counsel), for plaintiffs-appellees and cross-appellants.

Before HAYS, ANDERSON and GURFEIN, Circuit Judges. ^*

GURFEIN, Circuit Judge:

This appeal by the Diners' Club, Inc. and Diners/Fugazy Travel, Inc. (collectively "Diners") arises out of a series of transactions whereby the Fugazys sold the assets of their company, Fugazy Travel Bureau, Inc. ¹ ("Fugazy Travel") to Diners Club in return for unregistered stock in the latter company. The Fugazys, plaintiffs below, allege that the defendants fraudulently induced the sale, in violation of § 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, by representing that defendant Continental Corporation was about to "take over" Diners and that the failure of Diners to use its best efforts to make effective a registration of plaintiffs' shares was part of a manipulative device to induce the plaintiffs not to offer their shares for sale from October 10, 1967 to February 6, 1970. ² The court ultimately submitted to the jury whether Diners breached its contractual obligation to use its best efforts to register the plaintiffs' stock.

The defendants filed various counterclaims alleging, inter alia, that they were fraudulently induced by misrepresentations of plaintiffs to purchase Fugazy Travel.

Jurisdiction was based solely on Section 27 of the Securities Exchange Act of 1934. While diversity jurisdiction was not alleged, there was a properly pleaded claim arising under Section 10(b) and Rule 10b-5 under the 1934 Act. During the trial the plaintiffs, without formal amendment, pressed a breach of contract claim based on a failure of Diners to use its best efforts to register the stock, which we shall treat as a pendent claim. ³

The case was tried to a jury in the Southern District of New York before Honorable Robert J. Ward. The court directed a verdict for the defendants on the 10(b) claim and the plaintiffs appeal. The court entered judgment for the plaintiffs on a jury verdict holding Diners liable on a breach of contract claim in the amount of $533,000, plus pre-verdict interest, and finding for the plaintiffs on Diners' counterclaims and Diners appeals.

We affirm the dismissal of plaintiffs' § 10(b) claim as well as the dismissal of defendant's counterclaims. We reverse the judgment in favor of the plaintiffs for breach of contract, and remand for a new trial.

I

Under an agreement dated October 10, 1967, Diners acquired the assets of Fugazy Travel in return for unregistered Diners stock and other consideration. Paragraph 10.2(b) of the acquisition agreement provided that, upon receipt of notification from plaintiffs that they desired registration, Diners would promptly file a registration statement for the unregistered Diners stock held by plaintiffs and would use its best efforts to cause the registration statement to become effective. ⁴ Plaintiffs requested Diners to file such a registration statement in April 1969. Preparation of the registration statement did not begin until July 1969, however, and it was not filed until August 28, 1969. This registration statement never became effective; it was ultimately withdrawn, over the protest of plaintiff Marx, early in 1970. ⁵

The issues of fact tendered were whether Diners had filed a registration statement promptly upon request and whether it had used its best efforts to make it effective. Plaintiffs contended that Diners should have filed on or about June 20, 1969 when its audited financials for the fiscal year ending March 31, 1969 were available and that preparatory work should have been begun immediately upon receipt of the request. ⁶ Diners contended that it was under no duty to file immediately because of plaintiffs' failure and refusal to fulfill certain conditions precedent to such registration rights, such as tendering one-half of the costs of registration, together with an indemnity agreement which the plaintiffs allegedly refused to give until August 24, just four days before the actual filing. ⁷ Diners also contended that, after the plaintiffs had formally requested the registration on April 16, 1969, the plaintiffs, during the next six to eight weeks were advancing certain alternative proposals to avoid the necessity for filing a registration statement, and that this may have resulted in a delay in commencement of the preparation of the registration statement. ⁸ Diners also pointed out that it had the right, which it exercised, to include in its registration statement other securities and hence, it had to obtain information regarding the other security holders which may have resulted in a delay in filing.

With regard to whether Diners used its best efforts to make the registration effective, Diners contended that within two weeks of receipt of the SEC's comments on the registration, which was received about two months after filing, it wrote two letters in response and attended a conference with the Commission staff to resolve these comments. It also noted that William D. Fugazy himself testified that there were "monumental problems" in causing the registration statement to become effective.

The jury found against Diners on these contentions. We agree with Judge Ward that there was sufficient evidence to support the verdict. Marx & Co., Inc. v. Diners Club, Inc., 400 F.Supp. 581 (S.D.N.Y.1975). The crucial issue, sufficiently posed by objection below, is whether, notwithstanding the general discretion allowed to trial judges respecting expert testimony, see Sanchez v. Safeway Stores, Inc., 451 F.2d 998 (10th Cir. 1971); Casey v. Seas Shipping Co., 178 F.2d 360 (2d Cir. 1949), the admission of the testimony of a securities law expert, Stanley Friedman, was, in the circumstances, an error of law and highly prejudicial. His testimony construed the contract, as a matter of law, and includes his opinion that the defenses of Diners were unacceptable as a matter of law. In his denial of defendant's motion for a directed verdict at the close of the evidence, the judge indicated that the plaintiffs had made a prima facie case through Friedman.

We hold that the District Court erred in permitting Friedman, an expert witness called by plaintiffs, to give his opinion as to the legal obligations of the parties under the contract. Mr. Friedman, a lawyer and a witness not named in the pretrial order, was called as a rebuttal witness on the last day of a three-week trial. ⁹ Friedman was qualified as an expert in securities regulation, and therefore was competent to explain to the jury the step-by-step practices ordinarily followed by lawyers and corporations in shepherding a registration statement through the SEC. Indeed, Friedman had done so as an expert witness on previous occasions. In Republic Technology Fund, Inc. v. Lionel Corp., 483 F.2d 540, 552 (2d Cir. 1973), this Circuit reversed the dismissal of a breach of contract claim that the defendant had failed to cause a registration statement to become effective within a reasonable time. 483 F.2d at 552. The issue there was whether a delay of one year before the S-1 became effective was a result of an originally misleading interim statement accompanying the S-1, in which event, "the delay may well have been unreasonable." Id. Mr. Friedman gave expert testimony that six to eight weeks was all that should have been necessary to effectuate a registration statement because "much of the work going into it had already been done" in the preparation of a proxy solicitation filed by the surviving corporation in a merger. This testimony concerned the practices of lawyers and others engaged in the securities business. ¹⁰ Testimony concerning the ordinary practices of those engaged in the securities business is admissible under the same theory as testimony concerning the ordinary practices of physicians or concerning other trade customs: to enable the jury to evaluate the conduct of the parties against the standards of ordinary practice in the industry. See VII Wigmore on Evidence § 1949, at 66 (3d ed. 1940). ¹¹

In the case at bar, however, witness Friedman's objectionable testimony did not concern only the customary practices of a trade or business. Rather, he gave his opinion as to the legal standards which he believed to be derived from the contract and which should have governed Diners' conduct. He testified not so much as to common practice as to what was necessary "to fulfill the covenant" (of the contract). For example, over the objection of defense counsel, he said that:

"I construe 'best efforts' in the context of a covenant to register shares as the assumption on the part of the person who gives the covenant an absolute, unconditional responsibility, to set to work promptly and diligently to do everything that would have to be done to make the registration statement effective. . . ." (emphasis added)

Counsel made timely objection "that's a legal conclusion." Similarly, the witness opined that "the best efforts obligations requires you to pursue the registration statement unless there is cause beyond your control." ¹² This testimony did not concern...