Tolan v. Computervision Corp.

• Decision Date: 12 October 1988
• Docket Number: Civ. A. No. 85-1396-H.
• Citation: 696 F. Supp. 771
• Parties: Elliott TOLAN, et al., Plaintiffs, v. COMPUTERVISION CORPORATION, Martin Allen, James R. Berrett, Richard I. Krieger and Philip L. Read, Defendants.
• Court: U.S. District Court — District of Massachusetts

696 F. Supp. 771

Elliott TOLAN, et al., Plaintiffs, v. COMPUTERVISION CORPORATION, Martin Allen, James R. Berrett, Richard I. Krieger and Philip L. Read, Defendants.

Civ. A. No. 85-1396-H.

United States District Court, D. Massachusetts.

October 12, 1988.

Glen DeValerio, Berman, DeVerio & Pease, Boston, Mass., Bernard M. Gross, Jay S. Cohen, Cohen, Milstein & Hausfeld, Washington, D.C., Eugene A. Spector, John F. Innelli, Philadelphia, Pa., Thomas Shapiro, Shapiro & Grace, Boston, Mass., for plaintiffs.

Thomas J. Dougherty, Skadden, Arps, Slate, Meagher and Flom, Boston, Mass., Allan R. Campbell, Bedford, Mass., for defendants.

MEMORANDUM AND ORDER

HARRINGTON, District Judge.

Plaintiffs object to, and this Court therefore makes a de novo determination of, Magistrate Lawrence Cohen's Report and Recommendation on: Defendants' Motion to Dismiss pursuant to Fed.R.Civ.P. 12(b)(6); Defendants' Motion for Summary Judgment pursuant to Fed.R.Civ.P. 56; and Plaintiffs' Motion for Certification of a Class pursuant to Fed.R.Civ.P. 23.¹

Plaintiffs Elliott Tolan, Stephen Rosen and Arthur Kalter allege that defendants Computervision Corporation ("Computervision"), Martin Allen, James Berrett, Richard Krieger and Philip Read ("Individual Defendants") engaged in a scheme artificially to inflate the price of Computervision securities by issuing a series of public statements which both misrepresented and omitted material facts. The alleged misrepresentations and omissions concerned Computervision's operations, anticipated operations, earnings, projected earnings, and its ability to maintain growth levels.² The plaintiffs seek redress of their alleged consequent injuries and those of a class of traders in Computervision's stock and stock options.

Liability is asserted under Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) ("1934 Act"), and Rule 10b-5 promulgated thereunder. See 17 C.F.R. § 240.10b-5 (1987). Liability is also asserted under Massachusetts' common law of fraud, deceit, and negligent misrepresentation.³

For the reasons stated below, the Court makes the following rulings:

(1) The motion to dismiss the pendent state law claims is denied at this time. Plaintiffs will be required to show actual reliance at trial in order to avoid entry of a directed verdict for defendants. Economy and efficiency are not served, however, by dismissing the claims at this early stage, only to encounter delay while the complaint is amended or additional putative plaintiffs are located. These common law claims, moreover, will not significantly expand the scope of discovery.

(2) Defendants' motion to dismiss the claims brought under Section 10(b) and Rule 10b-5 of the 1934 Act is denied.

(3) The motion for class certification is granted as to each of the plaintiffs Tolan, Rosen, and Kalter.

I. The Rule 10b-5 Count

Defendants move to dismiss the Rule 10b-5 claims on the ground that plaintiffs have failed to allege the essential element of reliance. In the alternative, defendants move to dismiss Tolan's and Kalter's Rule 10b-5 claim because they lack standing as options traders to sue under Rule 10b-5. In the alternative, defendants move for summary judgment against Rosen on the ground that he allegedly made a profit on his transactions. The Court considers each argument in turn.

A. Reliance

Reliance is an essential element of a Rule 10b-5 cause of action. Basic, Inc. v. Levinson, ___ U.S. ___, 108 S.Ct. 978, 989, 99 L.Ed.2d 194 (1988) (citing Ernst & Ernst v. Hochfelder, 425 U.S. 185, 206, 96 S.Ct. 1375, 1387, 47 L.Ed.2d 668 (1976) (quoting Senate Report)). The reliance requirement ensures that only injuries which result from defendants' material misrepresentation or non-disclosure are compensated. Id. (citing Wilson v. Comtech Telecommunications Corp., 648 F.2d 88, 92 (2d Cir.1981); List v. Fashion Park, Inc., 340 F.2d 457, 462 (2d Cir.), cert. denied sub nom. List v. Lerner, 382 U.S. 811, 86 S.Ct. 23, 15 L.Ed.2d 60 (1965)).

Magistrate Cohen's Report and Recommendation issued on December 8, 1987. As of that date, neither the United States Court of Appeals for the First Circuit nor the United States Supreme Court had accepted the fraud on the market theory. The Magistrate, however, chose to treat the theory as valid and applied it to the motions before him. Three months later, the Supreme Court validated the fraud on the market theory by ruling that "reliance on any public material misrepresentations.... may be presumed." Basic, 108 S.Ct. at 992. The court reasoned that:

The fraud on the market theory is based on the hypothesis that, in an open and developed securities market, the price of a company's stock is determined by the available material information regarding the company and its business ... Misleading statements will therefore defraud purchasers of stock even if the purchasers do not directly rely on the misstatements ... The causal connection between the defendants' fraud and the plaintiffs' purchase of stock in such a case is no less significant than in a case of direct reliance on misrepresentations.

Id. 108 S.Ct. at 988-89 (quoting Peil v. Speiser, 806 F.2d 1154, 1160-61 (3d Cir. 1986)); see also Blackie v. Barrack, 524 F.2d 891, 908 (9th Cir.1975), cert. denied, 429 U.S. 816, 97 S.Ct. 57, 50 L.Ed.2d 75 (1976).

Most investors are unable to compile and evaluate all available material information, but they act under the assumption that this information is reflected in the market price of the corporation's stock and stock options. Thus, the investor who relies on the integrity of a stock's market price shows the necessary causal connection between the misrepresentation and his injury when false or incomplete information have colored the market's perception of the corporation's worth. This approach to the reliance requirement relieves Rule 10b-5 plaintiffs, who have traded on impersonal markets, from the unrealistic evidentiary burden of showing how they would have acted had material misrepresentations not been made or had the omitted material information been disclosed. See Basic, 108 S.Ct. at 990, and cases cited therein.

This causal connection is severed, however, if the investor did not trade in reliance on the integrity of the market price or if the market price remained unaffected by the misrepresentations. The presumption of reliance may, therefore, be rebutted by a showing that misrepresentation did not affect market price, or that plaintiffs did not trade in reliance on the integrity of the market price. Id. 108 S.Ct. at 992; see also Cohen v. Laiti, 98 F.R.D. 581, 583 (E.D.N.Y.1983). Absent this severance of the causal connection, reliance is presumed.

None of the plaintiffs herein claim that they transacted in direct or actual reliance on defendants' public disclosures. Instead, plaintiffs rely on the fraud on the market theory to satisfy the reliance element of their cause of action. Under this theory, plaintiffs need not have read or relied on the defendants' allegedly material misrepresentations. Invocation of the presumption of reliance is sufficient.

Magistrate Cohen found that, assuming validity of the fraud on the market theory, dispute remains as to whether the plaintiffs relied "in fact" upon the integrity of the market. This Court's de novo determination is that the plaintiffs have sufficiently pled the element of reliance by invoking the doctrine of fraud on the market. Defendants may attempt to rebut the presumption of reliance at trial.

B. Standing

Defendants contend that put and call options traders lack standing to sue under federal securities laws in the absence of allegations that the defendants themselves engaged in options trading. Magistrate Cohen agreed and limited standing to purchasers of common stock. The Magistrate relied primarily on federal district court decisions in Starkman v. Warner Communications, Inc., 671 F.Supp. 297 (S.D.N.Y.1987), and Deutschman v. Beneficial Corp., 668 F.Supp. 358 (D.Del.1985); this latter decision, however, was reversed three months after the Magistrate's Report and Recommendation issued. See Deutschman v. Beneficial Corp., 841 F.2d 502 (3d Cir.1988), petition for cert. filed.

Although the 1934 Act defines the term "securities" as including options, see 15 U.S.C. § 78c(a)(10), it is unclear whether options traders satisfy the requirement that the fraud be "in connection with the purchase or sale of any security." 15 U.S. C. § 78j(b); 17 C.F.R. § 240.10b-5. Defendants interpret this language as requiring that plaintiffs be purchasers or sellers of the defendants' securities. Since none of the named defendants actually transacted with any of the named plaintiffs, defendants argue, the requisite "connection with the purchase or sale of any security" does not exist.

The holder of an option contract has paid a premium for the right, but not the obligation, to buy ("call") or sell ("put") a fixed number of shares of a particular stock at a specified price (called the "exercise" or "striking" price) at any time before the option's expiration date. See generally, Rubenstein, An Economic Evaluation of Organized Option Markets, 2 J.Comp. Corp.L.Sec.Reg. 49 (1979), cited in Deutschman v. Beneficial Corp., 841 F.2d at 504. Factors to be considered in determining whether Congress intended that option holders have standing under section 10(b) include: the social utility of options trading; the degree to which options trading affects and is affected by the underlying securities on which the options were written; and, most importantly, the extent to which options traders rely on the integrity of the market; or, stated differently, whether the price of an option reflects the judgment of an informed, unmanipulated market. This Court's de novo determination is that the 1934 Act, as initially drafted and later amended, reflects Congress' intent to grant standing to options traders under section 10(b).

Defendants argue that options...