STEVENS, Circuit Judge.
Plaintiffs are shareholders of a corporation which purchased a car leasing business from one of the defendants. In connection with the transaction, the corporate purchaser issued 7,000 shares of its stock to the seller, and the plaintiffs individually guaranteed certain liabilities assumed by the purchaser. Plaintiffs accuse both defendants of fraud and seek relief under § 10(b) of the Securities Exchange Act of 1934,
48 Stat. 891, 15 USC § 78j(b), and Securities and Exchange Commission Rule 10b-5.
The question presented is whether their claim is foreclosed by the so-called
“Bimbauw,
rule” which limits private relief for a violation of Rule 10b-5 to persons who were either purchasers or sellers of a security.
“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,
“(a) To employ any device, scheme, of artifice to defraud,
“(b) 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
“(c) 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.” 17 CFR § 240.10b-5.
The appeal is from an order dismissing plaintiffs’ third amended complaint and denying leave to file a fourth. The essential facts are quite simple. Prior to October 31, 1969, one of the defendants (Dave Waite Pontiac, Inc.) operated a Pontiac dealership and also an automobile leasing division. Purchases of cars for the leasing business were financed by General Motors Acceptance Corporation, the Second defendant. Bank Service Corporation, a company in which the plaintiffs owned stock, entered into an agreement to purchase the leasing business. As consideration for the business, Bank Service issued 7,000 shares of its stock to Waite and assumed the liabilities of the leasing business, including notes payable to GMAC, and the individual plaintiffs delivered a guarantee of those notes, as well as a guarantee of future liabilities, to GMAC.
The leasing business failed; Bank Service became insolvent and defaulted on the notes.
GMAC then brought suit in a state court to recover on the guarantees. Plaintiffs countered with this federal action, accusing both defendants of fraud and seeking rescission of the guarantees.
Plaintiffs seek to avoid
Bimbaum’s
purchaser-seller limitation on private relief under Rule 10b-5 in various ways. They contend that their guarantees were securities which they sold to GMAC; that the underlying notes are securities which they are being forced to purchase ; that they were indirect sellers of the 7,000 shares of corporate stock; and, in all events, that the
Birnbaum
limitation should be disavowed in this circuit. Since it would not be necessary to consider stretching the definitions of “purchasers,” “sellers,” and “securities” if there were no
Birnbaum
rule, we think it appropriate to examine the viability of that rule first. For purposes of decision, therefore, we assume that the only purchase or sale of a security involved in the transaction was the transfer of 7,000 shares of stock from Bank Service to Waite, and we reject the suggestion that plaintiffs should be characterized as “sellers” of that stock. The question which is thus presented is whether, notwithstanding the fact that they were neither purchasers nor sellers of a security, plaintiffs may obtain relief under Rule 10b-5. In answering that question, we first note that a violation of Rule 10b-5 has been alleged and then consider whether any remedy is available to these plaintiffs.
I.
For present purposes it is conceded that material misstatements and omissions attributable to both GMAC and Waite have been adequately alleged. The 7,000 shares of Bank Service stock were unquestionably “securities” within the meaning of Rule 10b-5. It is also settled that the issuance and delivery of such shares constituted a “sale,”
and further, that even though the alleged fraud related to the value of the assets acquired, rather than the value of the security delivered, the deception was “in connection with” the sale of a security.
Finally, “the fact that the transaction [was] not conducted through a securities exchange or an organized over-the-counter market is irrelevant to the coverage of § 10(b).” Superintendent of Insurance v. Bankers Life & Casualty Co., 404 U.S. 6, 10, 92 S.Ct. 165, 168, 30 L.Ed.2d 128. In short, defendants do not challenge the conclusion that a violation of Rule 10b-5 has been alleged. Nor would they dispute a federal court’s jurisdiction to entertain an appropriate claim by the corporation, Bank Service.
The disputed question is whether plaintiffs, as individual shareholders of Bank Service and guarantors of its indebtedness to GMAC, may assert a Rule 10b-5 claim.
II.
The question of plaintiffs’ right to relief has three aspects: (a) whether they have “standing,” (b) whether they are protected by the rule, and (e) whether overriding considerations of policy should defeat their claim.
A.
Neither the statute nor Rule 10b-5 expressly authorizes a private remedy. Nevertheless, in a 1946 decision which is now universally followed, Judge Kirkpatrick held that a civil action could be maintained by a member of the class “for whose special benefit the statute was enacted.”
The
Birnbaum
case, decided six years later,
has been read as holding that only the purchaser or the seller of a security may maintain such an action; this purchaser-seller limitation has been frequently described as a “standing requirement.”
This “standing requirement” may be interpreted in two quite different ways. On the one hand, it may signify that only purchasers or sellers of securities have legal rights that are protected by Rule 10b-5. In this sense, the analysis of the plaintiff’s status — that is to say, his relationship to defendant’s violation of Rule 10b-5 — really determines whether the plaintiff is a person who has suffered a legal wrong.
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STEVENS, Circuit Judge.
Plaintiffs are shareholders of a corporation which purchased a car leasing business from one of the defendants. In connection with the transaction, the corporate purchaser issued 7,000 shares of its stock to the seller, and the plaintiffs individually guaranteed certain liabilities assumed by the purchaser. Plaintiffs accuse both defendants of fraud and seek relief under § 10(b) of the Securities Exchange Act of 1934,
48 Stat. 891, 15 USC § 78j(b), and Securities and Exchange Commission Rule 10b-5.
The question presented is whether their claim is foreclosed by the so-called
“Bimbauw,
rule” which limits private relief for a violation of Rule 10b-5 to persons who were either purchasers or sellers of a security.
“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,
“(a) To employ any device, scheme, of artifice to defraud,
“(b) 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
“(c) 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.” 17 CFR § 240.10b-5.
The appeal is from an order dismissing plaintiffs’ third amended complaint and denying leave to file a fourth. The essential facts are quite simple. Prior to October 31, 1969, one of the defendants (Dave Waite Pontiac, Inc.) operated a Pontiac dealership and also an automobile leasing division. Purchases of cars for the leasing business were financed by General Motors Acceptance Corporation, the Second defendant. Bank Service Corporation, a company in which the plaintiffs owned stock, entered into an agreement to purchase the leasing business. As consideration for the business, Bank Service issued 7,000 shares of its stock to Waite and assumed the liabilities of the leasing business, including notes payable to GMAC, and the individual plaintiffs delivered a guarantee of those notes, as well as a guarantee of future liabilities, to GMAC.
The leasing business failed; Bank Service became insolvent and defaulted on the notes.
GMAC then brought suit in a state court to recover on the guarantees. Plaintiffs countered with this federal action, accusing both defendants of fraud and seeking rescission of the guarantees.
Plaintiffs seek to avoid
Bimbaum’s
purchaser-seller limitation on private relief under Rule 10b-5 in various ways. They contend that their guarantees were securities which they sold to GMAC; that the underlying notes are securities which they are being forced to purchase ; that they were indirect sellers of the 7,000 shares of corporate stock; and, in all events, that the
Birnbaum
limitation should be disavowed in this circuit. Since it would not be necessary to consider stretching the definitions of “purchasers,” “sellers,” and “securities” if there were no
Birnbaum
rule, we think it appropriate to examine the viability of that rule first. For purposes of decision, therefore, we assume that the only purchase or sale of a security involved in the transaction was the transfer of 7,000 shares of stock from Bank Service to Waite, and we reject the suggestion that plaintiffs should be characterized as “sellers” of that stock. The question which is thus presented is whether, notwithstanding the fact that they were neither purchasers nor sellers of a security, plaintiffs may obtain relief under Rule 10b-5. In answering that question, we first note that a violation of Rule 10b-5 has been alleged and then consider whether any remedy is available to these plaintiffs.
I.
For present purposes it is conceded that material misstatements and omissions attributable to both GMAC and Waite have been adequately alleged. The 7,000 shares of Bank Service stock were unquestionably “securities” within the meaning of Rule 10b-5. It is also settled that the issuance and delivery of such shares constituted a “sale,”
and further, that even though the alleged fraud related to the value of the assets acquired, rather than the value of the security delivered, the deception was “in connection with” the sale of a security.
Finally, “the fact that the transaction [was] not conducted through a securities exchange or an organized over-the-counter market is irrelevant to the coverage of § 10(b).” Superintendent of Insurance v. Bankers Life & Casualty Co., 404 U.S. 6, 10, 92 S.Ct. 165, 168, 30 L.Ed.2d 128. In short, defendants do not challenge the conclusion that a violation of Rule 10b-5 has been alleged. Nor would they dispute a federal court’s jurisdiction to entertain an appropriate claim by the corporation, Bank Service.
The disputed question is whether plaintiffs, as individual shareholders of Bank Service and guarantors of its indebtedness to GMAC, may assert a Rule 10b-5 claim.
II.
The question of plaintiffs’ right to relief has three aspects: (a) whether they have “standing,” (b) whether they are protected by the rule, and (e) whether overriding considerations of policy should defeat their claim.
A.
Neither the statute nor Rule 10b-5 expressly authorizes a private remedy. Nevertheless, in a 1946 decision which is now universally followed, Judge Kirkpatrick held that a civil action could be maintained by a member of the class “for whose special benefit the statute was enacted.”
The
Birnbaum
case, decided six years later,
has been read as holding that only the purchaser or the seller of a security may maintain such an action; this purchaser-seller limitation has been frequently described as a “standing requirement.”
This “standing requirement” may be interpreted in two quite different ways. On the one hand, it may signify that only purchasers or sellers of securities have legal rights that are protected by Rule 10b-5. In this sense, the analysis of the plaintiff’s status — that is to say, his relationship to defendant’s violation of Rule 10b-5 — really determines whether the plaintiff is a person who has suffered a legal wrong.
On the other hand, as the term “standing” is more properly used, it assumes that the plaintiff is a member of the class protected by the rule at issue, 'and addresses the question whether he has a sufficient interest in a real controversy with the defendant to entitle him to invoke the jurisdiction of a federal court. Thus, for example, although a taxpayer, in common with the rest of the citizenry, may be protected by the rule he invokes, he may lack standing to litigate an issue because of the “case” or “controversy” limitation on the exercise of federal judicial power. Frothingham v. Mellon, 262 U.S. 447, 43 S.Ct. 597, 67 L.Ed. 1078. In this sense, the requirement that the plaintiff must have “standing” raises a jurisdictional question under Article III of the United States Constitution.
The
Birnbaum
rule has been interpreted as a standing requirement in this constitutional and jurisdictional sense.
We are satisfied that such an interpretation of
Birnbaum
is unwarranted and we have no doubt that the plaintiffs’ interest in the controversy before us is sufficient to satisfy the requirements of Article III. Indeed, the parties with a vital stake in the outcome of the dispute are the individual plaintiffs on the one hand and GMAC on the other. One or the other will suffer a loss of approximately $300,000 — the balance allegedly due on the loans made by GMAC to which plaintiffs’ guarantees apply. This dispute may certainly be regarded as a “case” or “controversy” between these parties within the meaning of Article III.
In the
Bimbaum
case itself Judge Hand made no reference to the Constitution and did not mention the word “standing.” The decision in that case turned on the court’s evaluation of the kind of conduct which was forbidden by Rule 10b-5. The court concluded that the rule was “directed solely at that type of [manipulative] or fraudulent practice usually associated with the sale or purchase of securities . . . ” 193 F.2d at 464. Since the rule at that time was thought to relate only to public sales of securities, the prohibition of that type of activity was quite reasonably understood as intended to afford “protection only to the defrauded purchaser or seller.”
Ibid.
As conceived by its author, the purchaser-seller limitation was thus a description of the court’s understanding of the class of persons protected by Rule 10b-5.
Instead of stating the issue in terms of standing, we think it is more useful to ask whether the plaintiffs were members of the class for whose special benefit Rule 10b-5 was adopted. This is the inquiry which is suggested in Judge Kirkpatrick’s opinion which originally articulated the basis for finding an implied private remedy under Rule 10b-5.
B.
Judge Hand’s formulation of the
“Bimbaum
rule” in 1952 was an identification of the persons to whom Rule 10b-5 “extended protection.” Protection against the type of fraudulent practice usually associated with the sale or purchase of securities appropriately extended “only to the defrauded purchaser or seller.” In the last two decades, however, the rule has been interpreted to encompass additional types of misconduct and to extend protection to a variety of persons not included within the traditional definition of either purchaser or seller. Thus, issuers,
trust beneficiaries,
merging corporations,
minority shareholders in short form mergers,
parties to incomplete transactions,
offerees,
and others
have been treated as though they were sellers and thereby accorded the protection of the rule. The course of judicial decision since 1952, when
Birnbaum
was decided, has actually recognized that the class of protected persons is broader than merely purchasers and sellers.
The language of Rule 10b-5 itself describes any act or practice which operates as a fraud or deceit “upon any person in connection with the purchase or sale of a security.” The Supreme Court has repeatedly stated that this language should be given a broad and flexible construction.
Construing the words “any person” to include a purchaser or a seller but no one else is not consistent with that admonition. Nor does the so-called rule really have integrity when the words “purchaser” and “seller” are construed as flexibly as has been necessary in order both to decide 10b-5 cases properly and also to continue to pay homage to the
Birnbaum
rule. Moreover, a formal purchaser-seller limitation is not consistent with the overriding requirement that, in construing the 1934 Act, “form should be disregarded for substance and the emphasis should be on economic reality.” Tcherepnin v. Knight, 389 U.S. 332, 336, 88 S.Ct. 548, 553, 19 L.Ed.2d 564.
Congress, the Supreme Court, and the Commission have all used the term “investors” to describe the class of persons protected by Rule 10b-5. Thus, the statutory authorization for the rule refers to the prohibition of deceptive devices “for the protection of investors.”
And speaking for a unanimous court in Superintendent of Insurance v. Bankers Life & Casualty Co., Justice Douglas stated that the crux of the case was the fact that “Manhattan suffered injury as a result of deceptive practices touching its sale of securities
as an investor.”
404 U.S. 6, 12-13, 92 S.Ct. 165, 169, 30 L.Ed.2d 128 (emphasis added).
In its brief as amicus curiae in that case, the Securities and Exchange Commission also stressed the statutory purpose, implemented by Rule 10b-5, to protect investors from all forms of securities fraud.
Instead of attaching significance to the fact that Manhattan was the seller of the government securities, the Commission stated: “Manhattan not only suffered an injury as a result of the fraudulent dealings in its government securities, it suffered that injury in its capacity as an investor.”
Although no Supreme Court holding is inconsistent with the view that only purchasers or sellers of securities are protected by Rule 1 Ob-5, we think the Court’s opinions fairly imply that the rule was intended to protect a broader class of persons. The emphasis on the injured party’s status as an investor indicates that the protection of the rule extends to persons who, in their capacity as investors, suffer significant injury as a direct consequence of fraud in connection with a securities transaction, even though their participation in the transaction did not involve either the purchase or the sale of a security.
The plaintiffs in this case were certainly “investors” in the transaction which is allegedly tainted by fraud. Their interest as stockholders of Bank Service Corporation was apparently sufficient to induce them to execute substantial personal guarantees. As individual guarantors they were direct parties to the transaction in dispute. If, as plaintiffs have alleged, the transaction was consummated in violation of Rule 10b-5, we believe the plaintiffs, as investors and as principals in the trans
action, suffered a legal injury which may be redressed by a federal court.
C.
In addition to suggesting that the
Birnbaum
rule is constitutionally compelled, it has been argued that the purchaser-seller limitation should be retained to forestall an unmanageable flood of federal litigation,
and to preserve national consistency in the interpretation of federal securities legislation.
We find neither of these arguments persuasive.
The volume of 10b-5 litigation has already expanded dramatically and will no doubt continue to do so whether or not the purchaser-seller limitation is rejected.
The extent to which a refusal to adhere to
Birnbaum
will affect that volume is really a matter of speculation.
The fact that the purchaser-seller limitation is unacceptable does not mean that there will be no limit of any kind of the availability of private relief.
For in each case the plaintiff will have to demonstrate membership in the “special class” protected by Rule 10b-5 and inj ury as a direct consequence of the alleged violation. The number of parties who may invoke Rule 10b-5 without the purchaser-seller limitation may not differ materially from the number who would recover by persuading a court to interpret the purchaser-seller concept flexibly.
Assuming, however, that a complete abandonment of
Birnbaum
will significantly increase our workload, we may not for that reason reject what we believe to be a correct interpretation of the statute or the rule. Indeed, the vol
ume of future litigation that was more clearly predictable as a consequence of the Supreme Court’s holding in the
Bankers Life
case was not even mentioned in the Court’s opinion as a possible objection to its broadened interpretation of Rule 10b-5 as encompassing the misuse of proceeds of sale. The fear that the volume of 10b-5 litigation may actually impair the effective operation of organized securities markets, see Her-pich v. Wallace,
supra,
430 F.2d at 804, is not, in our opinion, well founded; but if we are wrong, the Securities and Exchange Commission has both the power and the expertise to adopt appropriate amendments to the rule. As the Commission has repeatedly stated, it is now of the view that the purchaser-seller limitation is an artificial restriction inconsistent with the intent of the underlying statute. That view merits our respect.
Nor do we believe that
Birnbaum,
should be followed simply to preserve national consistency in the interpretation of federal securities legislation. We are inclined to think that the extent of the consistency in applying
Birnbaum
is overstated
and is less important than an independent appraisal of an important issue arising in an area of the law which, despite the age of the statute, is still in an embryonic stage of development. See Dasho v. Susquehanna Corp.,
supra,
461 F.2d 11, 23 at n. 26. In all events, the only sure way to achieve consistency throughout the federal judiciary on a question of this character is for the Supreme Court to resolve such conflict among the circuits as does exist.
As Judge Sprecher demonstrated in Jannes v. Microwave Communications, Inc., 461 F.2d 525, 528-530 (7th Cir. 1972), the basic holding of
Birnbaum
was repudiated by a unanimous Supreme Court in the
Bankers Life
case. We are convinced that the purchaser-seller limitation is nothing more than an appendage to that holding without independent justification. We hold that it is not part of the law of this circuit.
The judgment is reversed and the case is remanded for further proceedings.