Simon v. Merrill Lynch, Pierce, Fenner and Smith, Inc.

• Decision Date: 30 October 1973
• Docket Number: No. 72-2905.,72-2905.
• Citation: 482 F.2d 880
• Parties: James SIMON, Individually and as representative of a Class, etc., Plaintiff-Appellant, v. MERRILL LYNCH, PIERCE, FENNER AND SMITH, INC., a Delaware corporation, Defendant-Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

482 F.2d 880 (1973)

James SIMON, Individually and as representative of a Class, etc., Plaintiff-Appellant, v. MERRILL LYNCH, PIERCE, FENNER AND SMITH, INC., a Delaware corporation, Defendant-Appellee.

No. 72-2905.

United States Court of Appeals, Fifth Circuit.

July 10, 1973.

Rehearing and Rehearing Denied October 30, 1973.

G. Lee Hart, Dallas, Tex., William H. Merrill, Detroit, Mich., A. Joe Fish, William A. McKenzie, Dallas, Tex., for plaintiff-appellant.

Frank Finn, Jr., Jerry L. Buchmeyer, Dallas, Tex., Brown, Wood, Fuller, Caldwell & Ivey, New York City, Erwin S. Simon, Detroit, Mich., Henry F. Minnerop, Richard Conway Casey, New York City, for defendant-appellee.

Before BELL, INGRAHAM and RONEY, Circuit Judges.

Rehearing and Rehearing En Banc Denied October 30, 1973.

RONEY, Circuit Judge:

James Simon appeals from a judgment for defendant Merrill Lynch, Pierce, Fenner and Smith, Inc., in a suit for damages resulting from alleged common law fraud and negligence and for non-disclosure violations of the Securities Exchange Act of 1934. 15 U.S.C.A. §§ 78j and 78o(c)(1), 17 C.F.R. § 240.10b-5. After a complicated procedural history, the District Court denied plaintiff's motions for joinder, intervention, and that the suit be maintained as a class action. At trial, the Court, sitting without a jury, concluded that Simon had failed to establish a claim against Merrill Lynch. We affirm.

The basis for Simon's individual suit and the purported class action is the purchase of common stock of Scientific Control Corporation (SCC), a Dallas computer firm, by Simon and some 6,000 others upon Merrill Lynch's alleged misrepresentations and omissions of material facts in its written and oral statements, advertisements, and acts. Plaintiff alleges that, in March 1969, Merrill Lynch was apprised of SCC's precarious financial condition, but the defendant continued recommending the stock, thereby creating an artificial market. In November, 1969, SCC filed a petition for reorganization under Chapter XI of the Bankruptcy Act, and the value of SCC common stock declined substantially.

Simon contends that his purchase of 1,900 shares of the stock during the period May through October, 1969, was based on these misrepresentations, and he claims to represent the class of individuals who also purchased the stock in reliance upon Merrill Lynch's misrepresentations. Although not argued in the trial court, he urges on appeal that Merrill Lynch was an "insider" of SCC and that Merrill Lynch made a market in SCC common stock without revealing that fact to all of its customers.

I. Class Action

The District Court's denial of Simon's motion for an order that this action be maintained as a class action, Rule 23(b)(1), F.R.Civ.P., rested on its views that "questions of fact and law common to the members of the class did not predominate over questions of fact and law affecting only individual members," and that the use of the class action device in this action would not preclude a multiplicity of suits based on a common wrong. These determinations were based on the Court's findings that Simon had "unique" access to information regarding SCC through that company's board chairman, his personal friend, that there was no showing that the oral representations made to Simon by a Merrill Lynch salesman had been similarly made to other members of the purported class, and that plaintiff could not supply the required proof for the entire class on the issues of misrepresentation and omission.

Rule 23 permits a class action only when the Court finds that "the questions of law or fact common to the members of the class predominate over any question affecting only individual members . . . ." Rule 23(b)(3), F.R. Civ.P.

If there is any material variation in the representations made or in the degrees of reliance thereupon, a fraud case may be unsuited for treatment as a class action. See Rule 23, Advisory Committee's Official Note, 39 F. R.D. 98, 107 (1966). Thus, courts usually hold that an action based substantially, as here, on oral rather than written misrepresentations cannot be maintained as a class action. See, e. g., Morris v. Burchard, 51 F.R.D. 530 (S. D.N.Y.1971); Moscarelli v. Stamm, 288 F.Supp. 453 (E.D.N.Y.1968); See also Comment, The Impact of Class Actions on Rule 10b-5, 38 U.Chi.L.Rev. 337, 342 (1971). Similarly, if the writings contain material variations, emanate from several sources, or do not actually reach the subject investors, they are no more valid a basis for a class action than dissimilar oral representations. Cf. Harris v. Palm Springs Alpine Estates, Inc., 329 F.2d 909 (9th Cir. 1964); Frankel v. Wyllie & Thornhill, Inc., 55 F.R.D. 330 (W.D.Va.1972); Dolgow v. Anderson, 43 F.R.D. 472 (E.D.N.Y.1968); Richland v. Cheatham, 272 F.Supp. 148 (S.D.N.Y.1967).

Although Simon alleges that Merrill Lynch's misrepresentations were both oral and written, his testimony premised his reliance on the oral touting of SCC stock by a Merrill Lynch account executive. Even if plaintiff had established that the alleged misrepresentations were primarily written, a class action would not be appropriate unless he could prove the similarity of the writings. His failure to prove any standardized representations by Merrill Lynch bars a class action whether it is based on Rule 10b-5 or the state common law. Furthermore, the geographical dispersion of the alleged representations would bring into issue various state common law standards. With no single law governing the entire class, common issues of law cannot be shown to warrant Rule 23 treatment.

We recognize that the Rule 23(b)(3) suit has been one of the principal weapons against fraud in securities transactions, see Green v. Wolf Corp., 406 F.2d 291, 295-296 (2d Cir. 1968), cert. denied, 395 U.S. 977, 89 S.Ct. 2131, 23 L. Ed.2d 766 (1969); and that the Securities Exchange Commission has advocated its use in such cases, see Dolgow v. Anderson, supra; accord, Wolfson v. Solomon, 54 F.R.D. 584 (S.D.N.Y.1972). But the record before us — indicating no standardized communications, plaintiff's primary reliance on oral statements made directly to him and his personal access to, if not information about, SCC's financial condition — demonstrates no "common course of conduct," see Richland v. Cheatham, supra; or "common scheme," see Dolgow v. Anderson, supra, on the part of Merrill Lynch which would insure Simon's adequate representation of the purported class.

Plaintiff, in alleging that he was not afforded sufficient opportunity to support his capacity to represent the class, has overlooked the elaborate two-year history of this suit. Our reading of the District Court's Order indicates that the Court's discussion of the reasonableness of Simon's reliance and his access to inside information was properly directed to the commonality of issues between him and the purported class.

II. Merits

The District Court found that Merrill Lynch's recommendations of SCC common stock were in no way "fraudulent or negligent or inaccurate in stating facts known by the brokerage firm about SCC," and that the evidence did not establish that Merrill Lynch was fraudulent or negligent in either its investigation of SCC or its representations about the Company. The Court specifically found that Simon "did not rely on Merrill Lynch's representations regarding these securities." The Court also found that Merrill Lynch did disclose to Simon, in the midst of his trading, its position as market maker in SCC common stock during the relevant period. Upon these findings, the Court held that Simon had failed to establish a claim against Merrill Lynch under the Securities Act or under common law fraud or negligence.

Simon has not met his burden under Rule 52(a), F.R.Civ.P., of establishing as "clearly erroneous" the trial court's findings. Nor has he convinced us of the merit of his contentions regarding (a) fraud or negligence, (b) defendant's disclosure of its role as a market maker in SCC common stock, and (c) Merrill Lynch's posture as an "insider."

A. Fraud or Negligence

Simon contends that the District Court's decision turned on inappropriate standards of reliance and proximate cause. He reasons that, since this is allegedly a case of nondisclosure by an insider, the Court's finding that plaintiff did not rely on Merrill Lynch's representations is not dispositive.

Simon would have us assert, consequently, that reliance need not be proved in nondisclosure cases. He relies primarily on the standard established by the United States Supreme Court in Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128, 92 S.Ct. 1456, 31 L.Ed.2d 741 (1972):

Under the circumstances of this case, involving primarily a failure to disclose, positive proof of reliance is not a prerequisite to recovery. All that is necessary is that the facts withheld be material in the sense that a reasonable investor might have considered them important in the making of this decision. . . . This obligation to disclose and this withholding of a material fact establish the requisite element of causation in fact. Chasins v. Smith, Barney and Co., 438 F.2d, at 1172.

406 U.S. at 153-154, 92 S.Ct. at 1472. The Courts, in other cases, have pointed out that reliance, "a particularly difficult matter to . . . prove" regarding the nondisclosure of a fact, Mills v. Electric Auto-Lite Co., 396 U.S. 375, 382, 90 S.Ct. 616, 24 L.Ed.2d 593 (1970) (n. 5), is "an element of causation which plays little role in nondisclosure cases." Crane Co. v. Westinghouse Air Brake Co., 419 F.2d 787, 797 (2d Cir. 1969), cert. denied, 400 U.S. 822, 91 S. Ct. 41, 27 L.Ed.2d 50 (1970). See Chasins v. Smith, Barney & Co., 438 F.2d 1167 (2d Cir. 1970); 6 L. Loss, Securities Regulation 3876-80 (1969 Supp.).

Simon argues that, under the Ute standard, he was not required to establish his individual reliance on Merrill Lynch's representations. All that need be shown is that the...