Fratt v. Robinson (203 F.2d 627, 1953)

STEPHENS, Circuit Judge.

It is alleged in the complaint which was filed in the United States District Court, that the defendants-appellees acquired corporate stock from the plaintiff-appellant through fraudulent representations by the use of the United States mails, the telephone, and other means and instrumental-ities of interstate commerce; thus violating Securities Exchange Commission’s Rule X-10B-5 which implements § 10 of the Securities Exchange Act of 1934, 48 Stat. 881, 891, 15 U.S.C.A. § 78j. Of specific application here is § 10(b), subdivision (b) of § 78j, 15 U.S.C.A. Hereinafter we shall refer to the implemented section of the Act as § 10. The stock was not handled on or through any securities exchange, or any stock-dealing organization, nor by any person connected with any business sometimes referred to as “over-the-counter markets” or businesses. The stock was not listed with or upon or put for sale with any stock or security-exchange or sales business.

The defendants made motions to dismiss the action upon several grounds, and the court granted the motion. to dismiss specifically upon the one ground only, to-wit, that § 10 of the Act does not embrace transactions in stock- which have no relation to security exchanges or over-the-counter houses or businesses. The court denied the other motions to dismiss which were based upon the claims: that the -allegations as to the use of the United States mails or an instrumentality of interstate commerce were not sufficient; that the act of 1934 does not provide a civil right of action as alleged in the complaint; and that the statute of limitations had run against the action when the complaint was filed. We are concerned in this appeal with the issues raised in the denied motions as well as with the issues in the granted motion. The order dismissing the action also included rulings on motions to strike, and to make more definite and certain, but we are not concerned therewith in this appeal. The plaintiff has appealed to this court.

The court used the following language in its order:

“ * * * [T]he same [motion to dismiss] is hereby granted upon the sole ground that the transactions complained of do not involve a security traded . in or upon a securities exchange or upon an ‘over-the-counter’ market and are therefore not within the purview of the Securities Exchange Act of 1934 * * *"

Are the Alleged Facts Outside the Purview of the Act?

The first issue posed is: Does § 10 embrace stock transactions (in interstate commerce or through the United States mails) in which no phase of a stock exchange or stock handling business is involved ?

But we think it will be helpful to first get well in mind the preamble or foreward to the applicable Act, 48 Stat. 881; 15 U.S.C. A. § 78b, entitled “Necessity for regulation”. It is in part as follows (we quote the full preamble in the margin) :

“For the reasons hereinafter enumerated, transactions in securities as commonly conducted upon securities exchanges and over-the-counter markets are affected with a national public interest which makes it necessary to provide for regulation and control of such transactions and of practices, and matters related thereto, * *

Section 10(b), 15 U.S.C.A. § 78j (b) is AS follows:

“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) * * *

“(b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.” [Emphasis ours.]

The implementing Rule X-10B-5 is as follows :

“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, or 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 C.F.R. § 240.10b-5.

Thus it is seen that if § 10 stood alone, its provisions together with the implementing rule would be applicable to “any person” and would not be limited to persons having to do with transactions in securities through organized or established “stock exchanges” or “over-the-counter markets” But the section does not stand alone; instead it stands as a part of a single legislative Act designed to be administered as a whole in the abolition 'of extensive inimical practices. And its scope should be construed in the interests of such purpose.

The parties to the instant litigation do not agree as to the manner in which the section is intended to aid in the grand purpose. Appellees, in observing the expression “over-the-counter markets”, conclude that the expression alludes to established businesses or brokers who handle security transfers off the regular stock exchanges, not including the transfer of securities made without the aid of any such intermediaries. They argue, from such premise, that to come under the Act at all a stock‘transaction must be through one or another of the established businesses. Therefore, they conclude, the deal in suit is outside the Act and the questioned section of the Act does not touch it.

Appellant and the Commission, as Ami-cus Curiae, advance the theory that “over-the-counter” embraces every security not traded through a regular stock, exchange-Therefore, since in the preamble both expressions “stock exchange” and “over-the-counter markets” are used, the two expressions embrace every security transaction. And, if the mails or an instrumentality of interstate commerce has been connected with it, the section covers it, and, a fortiori, the instant alleged deal.

The application of § 10 has been treated by several courts, and in each case until the instant one the section has been held to cover transactions entirely outside any established securities-transfer business,, when the mail or any instrumentality of interstate commerce has been used.' Thus, each case, save the instant one, rejects the conclusion of appellees but not always their reasoning, and embraces the conclusion of appellant but not always her or the Commission’s reasoning.

By what may seem to be a paradox we-agree with the conclusion reached by appellant and the Commission while, in general, disagreeing with their premise; and. we disagree with the conclusions reached by appellees while, in general, agreeing; with their assigned premise.

We think the whole tenor of the-Act indicates that its operative procedure-is by regulation of security-transfer businesses and persons who function in or-through them. That “stock exchange” and; “over-the-counter markets” mean, in the-Act, any security-transfer business where— in the business of marketing securities is conducted. We think the authors of the Act realized that the remedy of the abuses sought to be applied by the Act would be more or less completely effective in the proportion of security-trading done on or through the established businesses. To this end § 10 was enacted in order that those who desire to promote crooked deals would see little advantage in using devious methods to by-pass the security-dealing business houses under regulation. And, further, that prospective crooked deals would be under a powerful deterrent by reason of the fact that perpetrators of fraud in security exchanges would be in violation of federal laws and, as we shall see in our discussion under the next point to be considered herein, would be answerable in damages in federal courts to those they have injured.

We are in substantial agreement with Judge Clark’s dissenting opinion in the case of Baird v. Franklin, 2 Cir., 1944, 141 F.2d 238, 244, certiorari denied 1944, 323 U.S. 737, 65 S.Ct. 38, 89 L.Ed. 591, as to which we shall have more to say presently, wherein he construed § 6(b) of the same Act upon the point under consideration as we construe § 10 and, as we see it, such construction conforms to the intent of Congress as expressed in the Act’s preamble, that is, to make the control of security transactions “reasonably complete and effective.” Without going into' the details of the legislatiye history, and we have made some examination thereof, we believe our construction is in harmony therewith. We will not lengthen this opinion with extracts from or specific citation of the applicable legislative history. Very full citation and quotations may be found in Appendix A and Appendix B of the Commission’s brief and in the body of appellees’ brief.

The decisions on the point, save the one in the case we are now reviewing, are in accord with our conclusion, but the reasoning of the several courts varies. Some of the courts take the straight road, that no matter about the rest of the Act, the wording of the section is too plain to admit of extraneous matter in explanation of its meaning. Some say, as does the Commission, that over-the-counter security transfers include all security transactions not made through “stock exchanges” and therefore all transfers covered by § 10 are included in the preamble and sections of the Act following it. The terms “stop-gap”, “plugging a loop-hole” and “catch-all” have been applied to § 10. Each expression has been used in argument to support the theory that the questioned section was placed in the Act to more perfectly effectuate the primary purposes of the Act. There appears to be logic in all of these roads to the common destination. There is one phase common to the reasoning of all the cases: § 10 is in aid of the end sought by the Act, to-wit, the lessening of fraudulent and sharp practices in the securities market. We hold that the district court erred" in holding that the facts as alleged in the complaint are outside the purview of the Act, and that it was error to dismiss the action.

Has the District Court Jurisdiction of a Private Civil Cause of Action for Damages Under Section 10(b) of the Act?

One of the grounds upon which the motions to dismiss were based, was that there is no provision in the Securities Exchange Act of 1934 for a civil cause of action for damages in the United States District Court under § 10. That there is no such express provision is admitted. While the district court specifically denied the motion to dismiss on this ground, appellees here claim that the dismissal should be affirmed for lack of jurisdiction, and the point was briefed and orally argued by the parties.

It is argued by appellees that Congress intended to confine any enforcement of benefits secured to private' parties by the section, to action by the Securities and Exchange Commission by way of injunction or criminal prosecution. It is true that there are several sections of the Securities Exchange Act specifically making á civil cause of action available, and it is argued by application of the rule “expfessio unius est exclusio alterius” that no civil remedy exists where not expressly provided for.

However, the weight of authority and the best reasoning, as we see it, bring us to the conclusion that a civil cause of action may be brought to enforce § 10 as implemented by Securities Exchange Commission Regulation X-10B—5, C.F.R. Section 240.10b-5. As heretofore mentioned, the second circuit had a similar point before it in' Baird v. Franklin, 2 Cir., 1944, 141 F. 2d 238, and the point ,was discussed in an opinion written by Judge Clark which is termed a dissent. In the majority opinion the court-assumed the jurisdictional power of the district-court, to entertain the action, but reversed the judgment, on the merits. Judge Clark dissents as to,, the majority view -of the facts, but since the majority did not treat the jurisdictional question at length, he proceeded to-do so. :