Shapiro v. Merrill Lynch, Pierce, Fenner & Smith Inc.

• Decision Date: 26 December 1972
• Docket Number: No. 70 Civ. 3653.,70 Civ. 3653.
• Citation: 353 F. Supp. 264
• Parties: Maurice SHAPIRO et al., Plaintiffs, v. MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED, et al., Defendants.
• Court: U.S. District Court — Southern District of New York

353 F. Supp. 264

Maurice SHAPIRO et al., Plaintiffs, v. MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED, et al., Defendants.

No. 70 Civ. 3653.

United States District Court, S. D. New York.

December 26, 1972.

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Wolf, Popper, Ross, Wolf & Jones, New York City, for plaintiffs; Howard L. Jacobs, New York City, of counsel.

Brown, Wood, Fuller, Caldwell & Ivey, New York City, for defendant Merrill Lynch and the individual defendants.

Shearman & Sterling, New York City, for defendants Investors Management Co., Inc., City Associates and Fairfield Partners.

Coudert Brothers, New York City, for defendants J. M. Hartwell & Co., J. M. Hartwell & Co., Inc., Hartwell and Associates, and Park Westlake Associates.

Milbank, Tweed, Hadley & McCloy, New York City, for defendant Van Strum & Towne, Inc..

Seward & Kissel, New York City, for defendants A. W. Jones & Co., and A. W. Jones Associates.

Debevoise, Plimpton, Lyon & Gates, New York City, for defendants Burden Investors Services, Inc. and William A. M. Burden & Co.

Oliver C. Biddle, Philadelphia, Pa., for defendant Madison Fund, Inc.; Baker, Nelson, Williams & Mitchell, New York City, of counsel.

OPINION

TENNEY, District Judge.

This is a civil action for money damages arising out of defendants' alleged violations of §§ 10(b) and 15(c) (1) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b), 78o(c)(1) (1970), Rules 10b-5 and 15c1-2 promulgated thereunder by the Securities and Exchange Commission, and § 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q (1970). Plaintiffs have moved this court, pursuant to Fed.R.Civ.P. 23(c), for an order declaring that this action be maintained as a class action. Defendants, in turn, have moved the court for a judgment on the pleadings on the grounds that plaintiffs have failed to state a claim upon which relief can be granted. For the reasons set out below, both plaintiffs' and defendants' motions are denied in all respects.¹

DEFENDANTS' MOTION

Ordinarily, the defense of failure to state a claim upon which relief can be granted is asserted either in a responsive pleading or by motion prior to a responsive pleading. Fed.R.Civ.P. 12(b). When defendant fails to avail himself of either of these procedures, Rule 12(h)(2) permits the defense to be raised in a motion for judgment on the pleadings pursuant to Rule 12(c). However, even though the 12(b)(6) defense is asserted through the procedural device of a 12(c) motion, the standards employed in determining the motion will be the same as if the defense had been raised prior to the closing of the pleadings. 5 Wright and Miller, Fed.Prac. and Proc.: Civil § 1367, at 688-89 (1969). Consequently, the well-pleaded material facts as alleged in plaintiffs' complaint will be taken as admitted for the purposes of defendants' motion. 2A J. Moore, Fed.Prac. ¶ 12.08 (2d ed. 1968).

Facts

The allegedly fraudulent transactions upon which plaintiffs base their complaint involved trading of Douglas Aircraft Company (hereinafter "Douglas") common stock on the New York Stock Exchange (hereinafter "NYSE"). (Subsequent to the relevant time period, Douglas merged with the McDonnell Company to form the McDonnell-Douglas Corporation, which has not been named as a party to this action.)

From about April 1966 through July 1966 defendant Merrill Lynch, Pierce, Fenner & Smith, Inc. (hereinafter "Merrill Lynch") had been engaged as the prospective managing underwriter of a proposed Douglas offering of $75,000,000 in convertible subordinated debentures. When the registration statement for the offering was approved on July 12, 1966, Merrill Lynch became the acting managing underwriter.

On or about June 7, 1966, Douglas released an earnings report for the first five months of its 1966 fiscal year. This report indicated that Douglas had earned 85 cents per share of common stock for that period. The complaint alleges that sometime during the period of June 17 through June 22, 1966, defendant Merrill Lynch and its then employees Lenz, Sedlmayer, Martin, Shinn, Catapano, McMillen, Woodman, Heindel, Bilbao, and Idelman (hereinafter collectively referred to as the "individual defendants"), came into possession of certain nonpublic and material information that was the exclusive property of Douglas; that such information was given to Merrill Lynch solely as a result of its position as prospective underwriter for the Douglas bond issue; that both Merrill Lynch and the individual defendants knew, or should have known, that the information was confidential and the sole property of Douglas, and that it was not to be used for any purposes of their own. This confidential information consisted of the following:

(a) that Douglas would report sharply lower earnings for the first six months of its fiscal year 1966 than it had for the first five months of that year;

(b) that Douglas had sharply reduced its estimate of earnings for the 1966 fiscal year and that it now expected to have little or no profit for that year; and

(c) that Douglas had substantially reduced its projection of earnings for its 1967 fiscal year.

The complaint further alleges that from about June 20 through June 24, 1966, defendant Merrill Lynch and the individual defendants divulged this information to the following parties, all of whom were customers of Merrill Lynch: Investors Management Company, Inc. (a wholly-owned subsidiary of Anchor Corporation), Madison Fund, Inc., J. M. Hartwell & Co. (whose business has been succeeded to by J. M. Hartwell & Co., Inc.), Hartwell Associates, Park Westlake Associates, Van Strum & Towne, Inc., Fleschner Becker Associates, A. W. Jones & Co., A. W. Jones Associates, City Associates, Fairfield Partners, Burden Associates, and William A. Burden & Co. (hereinafter referred to collectively as the "selling defendants"). Plaintiffs claim that all of the selling defendants knew, or should have known, that this information was confidential and the sole property of Douglas.

During the period of June 20 through June 23, 1966, the selling defendants either sold from existing positions or effected short sales of more than 165,000 shares of Douglas common stock on the New York Stock Exchange. These sales were made prior to public disclosure of the revised earnings information by Douglas on June 24, 1966, and without disclosure of the information to plaintiffs and other purchasers of Douglas stock during that period of time. As a result of these sales, both the individual defendants and Merrill Lynch received commissions from the execution of the selling defendants' orders and also received compensation in the form of customer directed "give-ups" (i. e., division of commissions earned by other brokers executing orders for the selling defendants).

On June 23, 1966, plaintiff Gibson purchased an unspecified number of shares of Douglas common stock on the NYSE. On June 24, 1966, Douglas issued a report containing the revised earnings information. On the same morning, plaintiffs M. Shapiro, I. Shapiro, Naigles, and Saxe purchased an unspecified number of shares of Douglas common stock on the NYSE. All of these plaintiffs claim that defendants have defrauded them by withholding material inside information; that had they known of the information which defendants possessed they would not have purchased Douglas stock; that as a result of these acts plaintiffs have sustained substantial losses.

The following is a table of prices of Douglas common stock on the NYSE for all relevant dates.

                                                                  Closing
                Date      Volume        High       Low            Price
                June 21   66,200        90         86             86¼
                June 22   66,500        90½      87½          87½
                June 23   261,500       88¾      77 5/8          78¾
                June 24   211,100       77         74½          76
                June 25                      S A T U R D A Y
                June 26                        S U N D A Y
                June 27   121,300       74 3/8       69             69
                June 28   135,300       70          66¼          68½
                June 29   102,200       69 7/8       64 1/8          64 3/8
                June 30   180,900       65¼       61             63 1/8
                July 1    100,400       64 7/8       61             61¾
                

Since a determination of whether plaintiffs are entitled to an order declaring a valid class action will not be necessary if plaintiffs have not stated a cause of action, defendants' motion to dismiss will be considered first.

THE 10b-5 CLAIM

Plaintiffs' claim, in essence, is (1) that the selling defendants, by trading in Douglas common stock without disclosing the material inside information divulged to them by Merrill Lynch and the individual defendants, have violated § 10(b) and Rule 10b-5 and thus are liable in damages to plaintiffs (and to the members of their proposed class), and (2) that defendant Merrill Lynch and the individual defendants, by divulging this material inside information to the selling defendants for the purpose of protecting their investments in Douglas stock, have violated § 10(b) and Rule 10b-5 and thus are liable in damages to plaintiffs (and to the members of their proposed class).

There is considerable disagreement among both the courts and the commentators as to what the requisite elements of a 10b-5 cause of action are.² Those elements which have most often been determined as necessary are: misrepresentation or nondisclosure, materiality, scienter, privity, reliance and causation. 2 A. Bromberg, Securities Law: Fraud, SEC Rule 10b-5 § 8.1 (1971).

Standing to Sue

Before proceeding, however, to examine the various elements in detail, plaintiffs must first establish their standing to sue under the "purchaser-seller" doctrine first enunciated in this Circuit in Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2d Cir.), cert. denied, 343 U. S. 956, 72 S.Ct. 1051, 96 L.Ed. 1356 (1952). There, plaintiff, a minority shareholder of defendant Newport Steel Corp., claimed that he was...