Nathanson v. Weis, Voisin, Cannon, Inc., 70 Civil 215.

CourtUnited States District Courts. 2nd Circuit. United States District Courts. 2nd Circuit. Southern District of New York
Citation325 F. Supp. 50
Docket NumberNo. 70 Civil 215.,70 Civil 215.
PartiesHerman S. NATHANSON and Gladys Nathanson, Plaintiffs, v. WEIS, VOISIN, CANNON, INC., Defendant.
Decision Date09 April 1971

Battle, Fowler, Stokes & Kheel, New York City, for plaintiffs; Raymond F. Gregory, Joel M. Walker, Robert S. Bernstein, New York City, of counsel.

London, Buttenwieser & Chalif, New York City, for defendant; Ephraim S. London, New York City, of counsel.

EDWARD WEINFELD, District Judge.

This is a motion by the defendant, Weis, Voisin, Cannon, Inc., engaged in the business of securities brokerage and securities underwriting, and a member of national stock exchanges, for summary judgment pursuant to Rule 56 of the Federal Rules of Civil Procedure. The action was commenced by plaintiffs, husband and wife, to recover damages for losses sustained by them in the purchase of securities of TST Industries, Inc. (TST). It is not disputed, for the purposes of this motion, that the defendant was an "insider" with respect to TST and also Elgin National Watch Company (Elgin). At the time of the purchases, the defendant owned a controlling percentage of TST stock, and TST owned a substantial number of the issued shares of Elgin.1 The defendant's President was Chairman of the Board of each corporation; other officers and directors of the defendant were also directors of each corporation; and eight of the eleven directors of Elgin were also directors of TST.

The complaint contains two counts, the first charging violations of sections 12 and 17 of the Securities Act of 19332 and section 10(b) of the Securities Exchange Act of 19343 and Rule 10b-5 promulgated thereunder,4 and the second charging common law fraud. Plaintiffs, in addition to recovery of the losses allegedly sustained by them in the purchase of TST stock, also seek punitive damages.

In substance, the claim is that plaintiffs received material "inside information" from the defendant's officers and agents that TST and Elgin were about to merge; that the defendant's agents and representatives made false and misleading statements to plaintiffs that the merger would be on the basis of one share of TST stock for one share of Elgin stock; that they were assured if they purchased TST securities the exchange ratio at the time of merger would be on a one to one basis; that in reliance upon such representations plaintiffs were induced to purchase TST common stock, warrants and convertible debentures; that the defendant knew that the exchange ratio would not be as stated, but that each share of Elgin stock would be exchanged for at least two shares of TST stock; that when the alleged false and misleading statements were made, the market value of Elgin stock was approximately $17 a share and the market value of TST approximately $8 a share; that plaintiffs had no knowledge of the alleged falsity of the statements until several months after they had purchased TST securities.

What all this adds up to is that plaintiffs assert they received in advance of a merger material "inside" information from the defendant—in effect they were tipped off to buy $8 stock, which upon the merger's consummation would be exchanged for stock priced at double on the market, all of which turned out not to be so.5 When the merger was consummated, the actual exchange ratio was 2½ shares of TST for each share of Elgin.

The defendant understandably brands plaintiffs' claim "absurd on its face," but accepts, only for the purposes of this motion, the allegations of the complaint as to the representations, their materiality, their falsity, plaintiffs' reliance thereon and damages, and upon that premise urges it is entitled to summary judgment dismissing plaintiffs' complaint. Defendant's position is that plaintiffs are barred from recovery under the doctrine of in pari delicto, since they themselves violated the antifraud provisions of the securities laws by purchasing TST stock on the open market without making available to the sellers of the stock all information relevant to the transactions, including the proposed exchange basis.6

The precise issue has not been decided by our Court of Appeals. However, two cases upon somewhat analagous facts lend support to the defendant's position. In one, Kuehnert v. Texstar Corp.,7 by a divided court the Fifth Circuit held that the defense of in pari delicto was sufficient to bar plaintiffs' recovery.8 The other ruling, Wohl v. Blair & Co.,9 permitted the defense to stand as against a motion to strike, but to await final determination upon a trial, since the question was "not free from doubt," and raised "serious and substantial legal issues which should be more fully explored before being finally resolved."

The issue, as both courts have noted, is a close one. The basic question, as this court views it, centers not about the claims asserted by plaintiffs against the defendant or the defense advanced in resistance to those claims, but rather about third parties not involved in the litigation—the investing public and what policy with respect to the allowance or disallowance of the defense would best serve to carry out the prime purpose of the securities laws to protect the investing public.10 So viewed, I have concluded that the defense of in pari delicto, or its broader equitable counterpart, the doctrine of unclean hands,11 must yield to overriding public policy considerations in order to secure effective enforcement of the anti-fraud provisions of the securities acts by discouraging insiders, brokers and others with superior market information from disclosing such information to a favored group before it is made available to the public.12

The starting point for discussion is whether the unavailability of the in pari delicto defense will further the purposes behind the statutes and the regulations.13 It is unnecessary to set forth at length the basic purposes of the securities acts which have been considered in many decisions since their enactment and are the subject of a host of articles and textbooks. The dominant congressional policy underlying the Securities Exchange Act of 1934 was recently articulated in SEC v. Texas Gulf Sulphur Co.,14 as designed "to prevent inequitable and unfair practices and to insure fairness in securities transactions generally, whether conducted face-to-face, over the counter, or on exchanges."15 The court further observed that implementing Rule 10b-5 "is based in policy on the justifiable expectation of the securities marketplace that all investors * * * have relatively equal access to material information * * *."16 And the court held that the essence of the Rule required inside directors or management officers who had access to information intended to be available only for a corporate purpose either to disclose it to the investing public before taking personal advantage of it or to abstain from trading in or recommending securities of the issuer as long as the information remained undisclosed.17 The proscription of the Rule, moreover, was also held to be "applicable to one possessing the information who may not be strictly termed an `insider' within the meaning of Section 16(b) of the Act," thus bringing within its sweep "tippees."18

These broad policy purposes must be considered in conjunction with the means of their enforcement. While no private right of action is expressly provided under section 10(b), such a right has been judicially implied thereunder,19 and also under other sections of the Exchange Act,20 since "private actions by market investors are a highly effective means of protecting the economy as a whole from violations by brokers and dealers."21 Thus, such private suits under the securities acts may be considered to parallel actions by aggrieved parties under the antitrust laws with their treble damage provisions as a means not only of redressing a private wrong, but also of protecting the public interest.22

In considering whether protection of the public interest and effective enforcement of the overall purposes of the securities acts justify overriding the particular equities which may exist between immediate private litigants, the fact, here urged by the plaintiffs, that the inside information received by them was false and hence did not constitute a fraud upon the public investors whose shares were purchased is quite beside the point.23 The information was not disclosed to the holders of TST stock who sold to the plaintiffs.24 The tippees, the plaintiffs here, were engaged in a potential fraud against the sellers of the TST stock by buying their shares, as plaintiffs believed, at one-half their actual value. The information as to the exchange basis of the shares of the two corporations involved in the contemplated merger was material, and certainly it cannot be denied that had the sellers of the TST stock been apprised of the information possessed by the purchasing insiders, here the plaintiffs, their business judgment as to whether to buy, sell or hold on to their securities would have been affected.25 The selling investors, had they known of the alleged inside information, might not have sold the stock or they might have deemed it prudent to purchase additional shares of TST, since there was the potentiality of appreciated value upon the consummation of the merger. Of course, the tippee, when he acts on his inside information, believes it to be true. And in his transactions, whether purchases or sales, he is overreaching or attempting to overreach the public investor on the basis of his private knowledge. In sum, plaintiffs were engaged in transactions designed to take advantage of the unknowledgeable holders of TST stock. Their conduct with respect to the investing public was similar to that attributed by them to the defendant, and such conduct constituted a fraudulent practice.26

However, plaintiffs' own recreant conduct, while a factor to be considered on the issue of whether the defense of in pari...

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