Albert E. Kuehnert v. Texstar Corporation

412 F.2d 700

• Court: Court of Appeals for the Fifth Circuit
• Decided: July 2, 1969
• Docket: 26015
• Status: Published

Opinions

ALDRICH, Circuit Judge:

Plaintiff Kuehnert brought suit in the district court pursuant to section 10(b) of the Securities and Exchange Act, 15 U.S.C. § 78j(b), and more particularly the Commission’s Rule 10b-5,¹ against W. T. Rhame, a former president of Texstar Corporation, a Texas corporation, sometimes hereinafter the company, and against Texstar itself. After interrogatories had been answered and depositions had been taken, both defendants were granted summary judgments of dismissal on the merits. 286 F.Supp. 340. On this appeal no issue is raised as to Rhame’s statements, their materiality or falsity, or Kuehnert’s reliance and damage. Rhame says that Kuehnert is barred from recovery by his own conduct. The company raises as a separate defense —a matter not reached by the district court — that Rhame’s actions were his own personal affair and were not authorized by it.

The facts are unusual, but relatively simple. In January 1965 Texstar was negotiating a merger agreement with Coronet Petroleum Company. The Coronet' stockholders were to be paid in Tex-star stock, the exchange ratio being fixed by a contract signed in March 1965, and based on an independent appraisal of Coronet’s assets.² Texstar stock in January was selling at around $4.25 a share. Rhame told Kuehnert of the acquisition plans and that Texstar had made some secret discoveries on a very favorable “farmout,” as a result of which dividends of $3.00 a year could be expected, and an enormous increase in the value of the stock. Rhame stated that as president, he was having trouble with some of the other directors and stockholders, and that it was to his advantage to keep this information secret while he, and hopefully his friend Kuehnert, bought up enough stock to acquire at least a working control. As a result of this Kuehnert bought on margin a substantial amount of company stock and, because the “farm-out” representations were not true, lost it all.

Texstar’s stock was listed on the American Stock Exchange. Kuehnert’s purchases were on the open market, through brokers, and without personal knowledge of the identity of the sellers. Kuehnert concedes that even though he was not, strictly, an “insider,” one who buys on the basis of inside information is what one court has termed a “tippee,” Ross v. Licht, S.D.N.Y., 1967, 263 F.Supp. 395, 410, and is, by virtue of Rule 10b-5, obliged to make disclosure to the seller. In re Cady, Roberts & Co., 1961, 40 S.E.C. 907; SEC v. Texas Gulf Sulphur Co., 2 Cir., 1968, 401 F.2d 833, cert. denied, Coates v. S.E.C., 394 U.S. 976, 89 S.Ct. 1454, 22 L.Ed.2d 756 (1969). Concededly he made no such disclosure. The district court held that having himself violated Rule 10b-5, Kuehnert could not invoke it in seeking recovery from the defendants.³

Our agreement with the district court on this point renders it unnecessary to discuss certain other obstacles that Kueh-nert might face, but lest it be thought that we consider it irrelevant we mention a matter not referred to by the parties, the possible necessity of privity, or what has been described as a “semblance of privity between the vendor and purchaser of the security.” ⁴ If privity is needed, an extensive examination of the facts would be required, involving many ramifications, unexplored in the briefs or by the court below. We do not, however, pursue this matter.

We will also not pause over the fact that with respect to the shares Kuehnert bought between January and March with knowledge that the Coronet merger was to take place, the information he posessed and failed to disclose as to the merger was true and, we would think, material. See List v. Fashion Park, Inc., 2 Cir., 1965, 340 F.2d 457, 462, 22 A.L.R.3d 782, cert. denied 382 U.S. 811, 86 S.Ct. 23, 15 L.Ed.2d 60. The precise nicety of Kuehnert’s case relates only to purchases made after the proxy material announcing the merger, when all he concealed was the information he had received about the successful drilling and its anticipated financial consequences. Since this information was untrue, we will assume that his then purchases occasioned no harm to anyone but himself.⁵ At the same time, the case cannot be as simple as Kuehnert would have it when he argues that it is wrong to circulate false information and therefore he was under a duty not to repeat what Rhame had told him.

What we have is a person in fact a dupe, but who believes he is a tippee with a duty to disclose, and who endeavors to take wrongful advantage of his tip. The question must be put at two levels. Is recovery in private Rule 10b-5 actions barred by unclean hands, or by being in pari delicto? If so, is an impure heart an equivalent?

We have small doubt but that actual illegal conduct should bar recovery. It is true that in certain areas exceptions may exist, as for example, antitrust.⁶ See, e. g., Perma Life Mufflers, Inc. v. International Parts Corp., 1968, 392 U.S. 134, 88 S.Ct. 1981, 20 L.Ed.2d 982; Kiefer-Stewart Co. v. Joseph E. Seagram & Sons, 1951, 340 U.S. 211, 71 S.Ct. 259, 95 L.Ed. 219; cf. Union Leader Corp. v. Newspapers of New England, Inc., 1 Cir., 1960, 284 F.2d 582, 586-587, cert. denied 365 U.S. 833, 81 S.Ct. 747, 5 L.Ed.2d 744. The guiding princi ple is one of policy. In private SEC violates the degree of public interest is not comparable to that made apparent by the triple damage provision; we see no sufficient public interest when the only question is one of accounting between joint conspirators. This view is supported by the availability of an unclean hands defense in actions involving SEC proxy requirements. Gaudiosi v. Mellon, 3 Cir., 1959, 269 F.2d 873, cert. denied 361 U.S. 902, 80 S.Ct. 211, 4 L.Ed.2d 157; Studebaker Corp. v. Allied Prods. Corp., W.D.Mich., 1966, 256 F.Supp. 173, 192; cf. Union Pac. RR. v. Chicago & N. W. Ry., N.D.Ill., 1964, 226 F.Supp. 400. See also 2 L. Loss, Securities Regulation 955-56 (2d ed. 1961). But cf. Stockwell v. Reynolds & Co., S.D.N.Y., 1965, 252 F.Supp. 215. It has been suggested that a true co-conspirator may be deprived of recovery even under the Sherman Act. See Perma Life Mufflers, Inc. v. International Parts Corp., 1968, 392 U.S. 134, 146, 147, 149, 153, 88 S.Ct. 1981, cf. Pennsylvania Water & Power Co. v. Consolidated Gas Elec. Light & Power Co., 4 Cir., 1953, 209 F.2d 131, cert. denied 347 U.S. 960, 74 S.Ct. 709, 98 L.Ed. 1104; see Note, In Pari Delicto and Consent as Defenses in Private Antitrust Suits, 78 Harv.L.Rev. 1241, 1244-45 (1965).

We would also have no doubt but that Kuehnert would have been in pari delicto had he in fact concealed material information from his vendors. It is irrelevant that Rhame originated the scheme. Rhame, on the assumption that what he told Kuehnert was true, would have violated his duty to the stockholders, and Kuehnert, willingly acquiescing in what seemed a mutually profitable plan, would have taken advantage of precisely that breach and made it effective against the very persons to whom protection was owed. This is not a case of mere knowledge of another party’s wrongdoing, without active participation. Can-Am Petroleum Co. v. Beck, 10 Cir., 1964, 331 F.2d 371, 373; Hooper v. Mountain States Sec. Corp., 5 Cir., 1960, 282 F.2d 195, 207-208, cert. denied 365 U.S. 814, 81 S.Ct. 695, 5 L.Ed.2d 693; In re Calton Crescent, Inc., 2 Cir., 1949, 173 F.2d 944, aff’d sub nom. Manufacturers Trust Co. v. Becker, 338 U.S. 304, 70 S.Ct. 127, 94 ; Rosenberg v. Hano, 3 Cir., 1941, 121 F.2d 818, 822. Kuehnert’s action being entirely voluntary, he could not even assert economic duress, such as may sometimes be an ameliorating factor in antitrust violations.

The only question admitting of real difficulty arises from the circumstance that in actuality, Kuehnert knowing nothing, concealed nothing, and hence did not defraud his vendors. Strictly speaking, he and Rhame cannot be seen as in pari delicto even as to intention, since, we will assume, Rhame’s only intent was to defraud Kuehnert, while Kuehnert’s was to defraud his vendors, a different group of persons. It does not follow, however, that Kuehnert escapes the obligations imposed on a tippee and thus should be permitted to recover.

In the first place, we are not convinced of any difference in substance between a successful fraud and an attempt. The statutory phrase “any manipulative or deceptive device,” 15 U.S.C. § 78j(b), seems broad enough to encompass conduct irrespective of its outcome. The Commission may act under sections 17(a) (1) and 17(a) (3) of the Securities Act of 1933, 15 U.S.C. §§ 77q(a) (1), (3), and under 10(b), involved here, to enjoin a potential fraud or prosecute a fraud that failed, without proof of actual loss to any victim. N. Sims Organ & Co. v. SEC, 2 Cir., 1961, 293 F.2d 78, 80 n. 3, cert. denied 368 U.S. 968, 82 S.Ct. 440, 7 L.Ed.2d 396; Hughes v. SEC, 1949, 85 U.S.App.D.C. 56, 174 F.2d 969; Trussell v. United Underwriters, Ltd., D. Colo., 1964, 228 F.Supp. 757, 767. The absence of actual harm to his vendors, as far as Kuehnert was concerned, was a pure fortuity. Kuehnert’s intention differed from Rhame’s, but it was no (more commendable. In determining whether a plaintiff’s hands were unclean equity has customarily looked to intent. Thus, when plaintiff and defendant had conspired together to cheat plaintiff’s creditors, and instead the defendant cheated the plaintiff, no relief was given. Ford v. Caspers, N.D.Ill., 1941, 42 F.Supp. 994, 997-998, aff’d, 7 Cir., 128 F.2d 884. Accord, Precision Instrument Mfg. Co. v. Automotive Maintenance Mach. Co., 1945, 324 U.S. 806, 814-815, 65 S.Ct. 993, 89 L.Ed. 1381; New York Football Giants, Inc. v. Los Angeles Chargers Football Club, Inc., 5 Cir., 1961, 291 F.2d 471; Shinsaku Nagano v. McGrath, 7 Cir., 1951, 187 F.2d 753, 758. Although Kuehnert is not seeking equitable relief the doctrine remains applicable, since it expresses a general principle equally suited to damage actions. Union Pac. R. R. v. Chicago & N. W. Ry., N.D.Ill., 1964, 226 F.Supp. 400, 410; cf. Maltz v. Sax, 7 Cir., 1943, 134 F.2d 2, 5, cert. denied 319 U.S. 772, 63 S.Ct. 1437, 87 L.Ed. 1720; 4 J. Pomeroy, Equity Jurisprudence 989 (5th ed. 1941). But cf. Straley v. Universal Uranium & Milling Corp., 9 Cir., 1961, 289 F.2d 370, 373. The tippee should be encouraged to disclose, before trading, what he believes on a reasonable basis to be true, because disclosure allows the free market to probe and evaluate his information, accepting what is true and discrediting what is false. Indeed, had Kuehnert fulfilled his statutory obligations here, it is likely that Rhame would have been immediately exposed and Kuehnert saved from any appreciable harm.

Although Kuehnert’s status as a tippee makes the defenses of unclean hands and in pari delicto available, their application rests with the discretion of the court. Precision Instrument Co. v. Automotive Maintenance Mach. Co., supra; Republic Molding Corp. v. B. W. Photo Util., 9 Cir., 1963, 319 F.2d 347, 350. The question must be one of policy: which decision will have the better consequences in promoting the objective of the securities laws by increasing the protection to be afforded the investing public. Peoples Sec. Co. v. SEC, 5 Cir., 1961, 289 F.2d 268, 271; List v. Fashion Park, Inc., supra. Common law technicalities are to be avoided, SEC v. Capital Gains Research Bureau, Inc., 1963, 375 U.S. 180, 195, 84 S.Ct. 275, 11 L.Ed.2d 237; A. T. Brod & Co. v. Perlow, 2 Cir., 1967, 375 F., not merely in judging the plaintiff’s claim but also in assessing defendant’s responses. It is true that if a tippee has no remedy against an insider’s private falsehoods, little deterrent against such conduct will exist; the insider may have free rein. But, as against this, there is another danger. If a tippee can sue he has, in effect, an enforceable warranty that secret information is true. It is then he that will have free rein. If what he is told is false, he can recover against his informer. If it is true, he will, of course, be liable to his vendors or vendees, but here he may well be protected by the difficulties of discovery.⁷ It may be relatively easy to trace insiders; tippees are another matter.

The growth of 10b-5 actions has not thus far been handicapped observably by the absence of suits by tippees against insiders. Nor do we believe that in pari delicto and unclean hands have limited the effectiveness of the proxy regulations. Therefore, in view of the substantial deterrent pressures already felt by the corporate insider, SEC v. Texas Gulf Sulphur Co., supra, we think it important that tippees, who present the same threat to the investing public as do insiders themselves, should be offered appropriate discouragement. We conclude that the better choice is to leave upon persons believing themselves tippees the restraint arising from the fear of irretrievable loss should they act upon a tip which proves to have been untrue. Hence the loss must lie where it falls.

Affirmed.

1 . Rule 10b-5, 17 CFR 240.10b-5, reads:

“It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails, or of any facility of any national securities exchange,

(1) to employ any device, scheme, or artifice to defraud,

(2) to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

(3) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,

in connection with the purchase or sale of any security.”

While this rule does not provide for private causes of action, ic now seems settled that such will lie, even for defrauded purchasers. Ellis v. Carter, 9 Cir., 1961, 291 F.2d 270; Fischman v. Raytheon Mfg. Co., 2 Cir., 1951, 188 F.2d 783; cf. J. I. Case Co. v. Borak, 1964, 377 U.S. 426, 84 S.Ct. 1555, 12 L.Ed.2d 423.

2 . The reorganization was designed to fall under section 368(a) (1) (C) of the Internal Revenue Code of 1954. Coronet would sell all its assets to Texstar for Texstar stock and then, within a year, distribute that stock to its shareholders and dissolve.

3 . Kuehnert has alleged no common law action for deceit.

4 . See Joseph v. Farnsworth Radio & Television Corp., S.D.N.Y., 1951, 99 F.Supp. 701, 706, aff’d., 2 Cir., 1952, 198 F.2d 883, Ruckle v. Roto American Corp., 2 Cir., 1964, 339 F.2d 24, 28 (dictum), Buchholtz v. Renard, S.D.N.Y., 1960, 188 F.Supp. 888; Donovan, Inc. v. Taylor, N.D.Cal., 1955, 136 F.Supp. 552, 553; but see Brennan v. Midwestern United Life Ins. Co., N.D.Ind., 1966, 259 F.Supp. 673; cf. Cochran v. Channing Corp., S.D.N.Y., 1962, 211 F.Supp. 239; Texas Continental Life Ins. Co. v. Bankers Bond Co., W.D.Ky., 1960, 187 F.Supp. 14, rev’d on other grounds sub nom. Texas Continental Life Ins. Co. v. Dunne, 6 Cir., 1962, 307 F.2d 242. For a discussion of the necessity of a “semblance of privity” when stock is bought on the open market see 3 L.Loss, Securities Regulation 1767-71 (2d ed. 1961).

5 . Strictly speaking, this may not have been so, but, again, we need not make the possibly complicated analysis. The assumption we have made is the most favorable to Kuehnert.

6 . For cases involving unclean hands in labor disputes see Florida E. C. Ry. v. Brotherhood of Locomotive Engineers, 5 Cir., 1966, 362 F.2d 482; NLRB v. Fickett-Brown Mfg. Co., 5 Cir., 1944, 140 F.2d 883; Sanders v. De Lucia, S.D.N.Y., 1967, 266 F.Supp. 852, 857, aff’d, 2 Cir., 379 F.2d 550.

7 . If the tippee here should be held liable to an innocent third party the most he could obtain from Ms insider friend would be contribution. 15 U.S.C. §§ 77k (f), 78i(e); 3 L.Loss, Securities Regulation 1737-40 (2d ed. 1961); Douglas & Bates, The Federal Securities Act of 1933, 43 Yale L.J. 171, 178-81 (1933) (suggesting contribution should be on a purely pro rata basis); see deHaas v. Empire Pet. Co., D.Colo. 1968, 286 F.Supp. 809, 815-816. There is no right to indemnity between those in pari delicto. See Handel-Maatschappij H. Albert De Bary & Co. v. Faradyne Electronics Corp., S.D.N.Y., 1964, 37 F.R.D. 357; cf. Behar v. Savard, S.D.N.Y., 1958, 21 F.R.D. 367, 369-370; see generally, 3 L.Loss, Securities Regulation 1829-36 (2d ed. 1961).