(CITE AS: 506 F.2D 1080)
Irving GORDON,
Plaintiff-Appellant,
v.
Robert L. BURR and Elpac, Inc.,
Defendants-Appellees,
and
Arnold Lord and Philips, Appel & Walden, Inc. (sued herein
as Philips, Appel & Walden),
Defendants-Appellees-Appellants.
Nos. 179, 310 and 311, Dockets 74-1749, 74-1865 and 74-1840.
United States Court of Appeals, Second Circuit.
Argued Oct. 9, 1974.
Decided Nov. 20, 1974.
JOHN C. KLOTZ, New York City, (Leonard Loewinthan, New York City, of
counsel), for plaintiff-appellant Gordon.
Michael C. Devine, New York City, (Butowsky, Schwenke & Devine,
New York City), for defendant-appellee, cross-appellant Lord.
Steven H. Lipsitz, New York City, (Bressler, Meislin, Tauber &
Lipsitz, Neil M. Berson, New York City, of counsel), for defend
ant-appellee, cross-appellant Philips, Appel & Walden, Inc.
Harry Balterman, New York City, for defendant-appellee Elpac,
Inc.
Before KAUFMAN, Chief Judge, and SMITH and TIMBERS, Circuit
Judges.
J. JOSEPH SMITH, Circuit Judge.
Irving Gordon, a purchaser of securities issued by Elpac, Inc.,
sued for rescission of his purchase and restitution of his
$45,000 payment against: Robert L. Burr, as seller of the shares;
Arnold Lord, as the salesman; Philips, Appel & Walden, Inc.
(P.A.W.), as Lord's brokerage firm; and Elpac, Inc., as the
issuer. After a non-jury trial, Judge Arnold Bauman of the
Southern District of New York, in an opinion reported at 366
F.Supp. 156 (1973), accepted Gordon's claims that Burr and Lord
had violated '10(b) of the Securities Exchange Act of 1934, 15
U.S.C. '78j(b) , [FN1] by misrepresenting material facts in the
transaction with Gordon and that P.A.W. had violated '20(a) of
the Act, 15 U.S.C. '78t(a), [FN2] as a 'controlling person' of a
'10(b) violator, Lord. The court rejected Gordon's attempt to
implicate Elpac in the fraud as a controlling person of Burr,
Elpac's president during most of the negotiations preceding
Gordon's purchase and a director alone for the remainder of the
period relating to the transaction. Judge Bauman granted the
requested rescission relief against Burr but held that as a
matter of law such relief was inapplicable to persons not in
privity of contract with the defrauded purchaser. Thus, although
he went on to find that Lord and P.A.W. had violated the securi
ties laws, Judge Bauman deemed them immune from a rescission
remedy. He held that damages, if proven, would lie against Lord
and P.A.W., but that Gordon had made no effort to establish
damages, despite the indication in the complaint (later orally
disavowed) that he would and the court's invitation at trial to
do so. In light of this conscious by-passing of a damages theory
at trial, the court then rejected Gordon's post-trial motions
under Fed.R.Civ.P. 59(a), 60(b), to amend the judgment to reflect
Lord's and P.A.W.'s liability to Gordon in damages or, in the
alternative, to hold a new trial limited to the issue of damages
On appeal, Gordon contests the district court's understanding
of rescission as a remedy available only against the fraudulent
seller. Alternatively, he renews his request for an opportunity
to prove damages against those who fraudulently induced his
purchase. In addition, by challenging the court's conclusion
that Elpac was not guilty of securities fraud, Gordon seeks to
enlarge the group from which he might recover under either a
rescission or damages theory. Burr does not appeal from the
judgment against him; Elpac defends the finding in its favor; and
Lord and P.A.W. cross-appeal from the adjudication of their
violations, which would become relevant in the event that this
court either accepts the appellant's characterization of the
scope of rescission relief or orders a new trial on damages.
For the reasons detailed below, we disagree with the district
court's view of the remedy of rescission and find it applicable
against persons not in privity with the defrauded purchaser but
who are party to the fraud. Because we also differ with the
district court as to the liability of P.A.W., this reversal on
the issue of rescission adds only Lord to those from whom Gordon
may seek restitution of his purchase price. In all other re
spects, we affirm.
I. THE FACTS
Gordon became interested in purchasing Elpac stock as a result
of a fortuitous encounter in June, 1968, with Howard Mann, an old
acquaintance who had recently bought 5,000 shares of Elpac. Both
Mann and his companion at the time, Lord, spoke highly to Gordon
of Elpac stock. Shortly thereafter, Gordon received a telephone
call from Lord inviting him to a meeting of prospective purchas
ers of a new Elpac offering. Gordon attended the select gather
ing, which included two brokers from P.A.W. in addition to Lord;
all present, except Lord, were strangers to Gordon. At the
meeting, Burr, president of Elpac at the time, offered to sell
20,000 shares of his holdings in Elpac. He asserted, however,
that he would sell no shares to the group unless they agreed to
purchase all 20,000. By reference to subsequent events, the
district court found that this statement constituted a material
misrepresentation in violation of '10(b) of the 1934 Act. 366
F.Supp. at 164.
The group departed without any commitments made. Within two
weeks, however, Lord informed Gordon that the other offerees had
already completed documents to expedite their purchase and thus
that the ostensibly requisite block purchase awaited only Gor
don's completion of these documents for its speedy realization.
This statement, belied by later developments, became a basis for
Lord's '10(b) liability. 366 F.Supp. at 164.
Approximately one month after Gordon complied with this re
quest, Burr pressed completion of the transaction. On August 20,
he offered Gordon by telegram 4,500 shares at $10 per share.
After a brief delay, Gordon arranged for the funds to be wired to
Burr. On the 22nd, Gordon met with Lord and Burr, who both
explained that, despite delays in the arrival of documents ap
proving the sale as well as sundry other apparent irregularities,
there were no problems with either the Burr offering or Elpac's
business health in general. They specifically reassured Gordon
that the other offerees had already made payment for their
shares-- a material misrepresentation, in the court's view. 366
F.Supp. at 164.
Subsequently, Gordon fruitlessly sought to locate Lord in order
to inquire about the whereabouts of the documents of approval
and, now, his stock certificates as well. When he telephoned and
visited P.A.W.'s offices in search of Lord, the firm's employees
indicated only that Lord was not in-- not, as was in fact the
case, that Lord had left the firm in late 1968. Finally,
Gordon managed to reach Lord, who told him that the certificates
were at P.A.W. On this second trip to the firm's offices, Gordon
did not find his certificates. He did meet, however, one of the
offerees present at the June, 1968, meeting, and the latter
informed Gordon that neither he nor any of the others who attend
ed the meeting had purchased stock from Burr. The certificates
did arrive shortly after, but Gordon's attention had turned to
procuring a refund of the $45,000 which he had invested in the
stock-- already a losing venture. Unable to procure the refund
by persuasion alone, Gordon brought the instant suit for rescis
sion based on various alleged misrepresentations made to him by
Burr and Lord of facts material to his decision to purchase the
stock. The court found 'at least one determinative misstatement'
by each, 366 F.Supp. at 164, but as indicated above, held that
Lord's violation of the 1934 Act did not give rise to relief
against him or P.A.W., which he held qualified as a 'controlling
person' within '20(a) of the Act.
II. RESCISSION AGAINST PERSONS NOT IN PRIVITY
Although Judge Bauman concluded that Lord and P.A.W. had vio
lated '10(b) and '20(a) of the 1934 Act respectively, he found
them to be outside the scope of an action for rescission. The
court regarded rescission as a remedy available only against the
tortfeasor who is party to the contract with the victim of the
fraud; under this view, therefore, rescission relief would apply
only to Burr, the seller. Where an action for rescission is
based on a contract theory-- mistake, or breach of contract--
this circumscription of the class from whom restitution may be
sought is undoubtedly correct. See generally, 3 A. Corbin,
Contracts '613 (1960); 5 id. '1104. But where such a suit is
predicated instead on fraud, the authorities do not adhere to a
privity theory with the uniformity which the district court-- as
one infers from its essentially parenthetical disposition of the
issue [FN3] -- apparently assumed. See cases cited infra. As
indicated below, we believe that the district court took too
narrow a view of its powers as a court of equity and erred in
placing a violator of '10(b) or ' 20(a) beyond the reach of a
rescission remedy. Because we resolve this issue in the appel
lant's favor, we need not review his alternative claim that the
court abused its discretion in not granting his post-trial mo
tions regarding a damages award.
The majority view regarding the availability of rescission
against parties not in privity with the defrauded person favors a
broad conception of the scope of rescission relief where the
theory relied upon is fraud. Thus, the New York courts have long
held rescission applicable against a defrauder not in privity of
contract with the victim of the fraud. See, Keskal v. Modrakows
ki, 249 N.Y. 406, 164 N.E. 333 (1928); Kaufman v. Jaffee, 244
App.Div. 344, 279 N.Y.S. 392 (1st Dept. 1935). [FN4] Iowa's high
court was emphatic to similar effect:
Of course, if the principal makes restoration, there is an end.
But if he does not restore, why should not the agent be made to
return money that would never have reached the principal if the
agent had not, by fraud, induced the one he dealt with to part
with the money? Peterson v. McManus, 187 Iowa 522, 546, 172 N.W.
460, 469 (1919). See also, Cox v. National Coal & Oil Investment
Co., 61 W.Va. 291, 56 S.E. 494 (1907). In Johns Hopkins Univers
ity v. Hutton, 297 F.Supp. 1165 (D.Md.1968), aff'd in part, rev'd
in part & remanded, 422 F.2d 1124 (4th Cir. 1970), 343 F.Supp.
245 (D.Md.1972), aff'd in part, rev'd in part & remanded, 488
F.2d 912 (4th Cir. 1973), cert. denied, 416 U.S. 916, 94 S.Ct.
1622, 1623, 40 L.Ed.2d 118 (1974), the district court granted
rescission against the co-partners of W. E. Hutton & Co., a
brokerage firm, for misrepresentations made in arranging a sale
of oil and gas production payments from Trice Production Company
to the plaintiff university. Although the Fourth Circuit re
versed portions of both lower court orders, it plainly upheld the
lower court's conception of rescission as a remedy available
against persons not in privity of contract with the victim of a
fraud. Among the violations of the securities laws to which the
court had applied this expansive view of rescission was-- as in
the instant case-- a violation of '10(b) of the 1934 Act. The
First Circuit has also approved the application of rescission
against tortfeasors not in privity with the defrauded party.
Cady v. Murphy, 113 F.2d 988, 991 (1st Cir.), cert. denied, 311
U.S. 705, 61 S.Ct. 175, 85 L.Ed. 458 (1940) (dictum). Indeed,
the only federal or upper-level state court decision we have
found to the contrary is Huffman v. Bankers Automobile Insurance
Co., 112 Neb. 283, 200 N.W. 994 (1924), an opinion sharply criti
cized, 3 Neb.L.Bull. 436 (1925), shortly after its rendition.
[FN5] Moreover, this resolution of the problem is indicated by a
consideration of the basic equities of the situation.
As between two tortfeasors, one the seller and the other not a
privy to the transaction, it is desirable that the seller be the
person from whom the purchaser recover; otherwise, the seller
will benefit from his fraud to the extent of the purchase price.
The choice, then is between returning the seller to the status
quo prevailing prior to the fraud or forcing the defrauder not in
privity to a worse status than he occupied quo ante. To avoid
unjust enrichment, general equitable principles indicate the
preferability of the purchaser pursuing first the seller, rather
than his partner in the fraud. However, as between the innocent
purchaser and the wrongdoer who, though not a privy to the fraud
ulent contract, nonetheless induced the victim to make the pur
chase, equity requires the wrongdoer to restore the victim to the
status quo.
Since the district court erred in its ruling on rescission, we
reverse as to the availability of rescission against Lord and
P.A.W. insofar as they may be violators of the 1934 Act. Accord
ingly, their cross-appeals, disputing the court's finding that
they violated the Act, must now be considered.
III. THE CROSS-APPEALS
Judge Bauman held Lord in violation of '10(b) on the basis of
two misrepresentations: shortly after the June, 1968, meeting,
Lord advised Gordon that the other offerees had already indicated
their intention to purchase by completing certain documents; and
the day after Gordon wired Burr the funds, Lord (along with Burr)
reassured Gordon that the other offerees had also completed their
purchases. On appeal, Lord concedes that the court enunciated
the correct standard for determining the presence of a '10(b)
violation. He differs, though, with the court's application of
this standard. Specifically, Lord contends that the representa
tions which Judge Bauman singled out as violative of the 1934 Act
were neither false nor material within the meaning of '10(b) and,
in any event, could not have been a proximate cause of Gordon's
purchase of the Elpac stock.
We agree that the court below correctly stated the '10(b)
standard. See generally, List v. Fashion Park, Inc., 340 F.2d 457
(2d Cir.), cert. denied sub nom., List v. Lerner, 382 U.S. 811,
86 S.Ct. 23, 15 L.Ed.2d 60 (1965), and find substantial evidence
in the record to support its application of the standard to
Lord's two statements. The misrepresentations as to participa
tion of the others were clearly material to one in Gordon's
position contemplating a substantial investment in the venture
painted as it was as a simultaneous purchase by all the members
of the group. Accordingly, we uphold Lord's liability to Gordon
for violating '10(b) of the 1934 Act.
If P.A.W. is also liable to Gordon, it must be derivatively--
as a 'controlling person' of Lord, within the meaning of '20(a)
of the 1934 Act. In Lanza v. Drexel & Co., 479 F.2d 1277, 1299
(2d Cir. 1973) (en banc), we had occasion to comment on the scope
of the secondary liability established by '20(a):
The intent of Congress in adding this section . . . was obviously
to impose liability only on those directors who fall within its
definition of control and who are in some meaningful sense culpa
ble participants in the fraud perpetrated by controlled persons.
In light of the evidence marshalled by Judge Bauman relevant to
P.A.W.'s culpability as well as his remarks regarding the appli
cable standard, we are convinced that the court erred in applying
too stringent a test of liability to P.A.W. Significantly,
Gordon was not a regular customer of the firm and P.A.W. did not
manage the Burr transaction; its brokers at the June, 1968,
meeting were present in their private capacities, not as repre
sentatives of the firm. But the court minimized the importance of
'these facts . . . (for day) only tend to establish that P.A.W.
could not be held primarily liable under '10(b); the standard
under '20(a) is a far lower one.' 366 F.Supp. at 168. We fail
to find in the record support for a finding that P.A.W. had
knowledge of the fraudulent representations or in any meaningful
sense culpably participated in them. We conclude that the dis
trict court required P.A.W. to vindicate its good faith after a
lesser showing by Gordon of P.A.W.'s culpability than '20(a)
demands. See, Lanza v. Drexel & Co., supra; cf. Securities and
Exchange Commission v. Lum's Inc., 365 F.Supp. 1046, 1064-1065
(S.D.N.Y.1973). The court's conclusion that P.A.W. is liable to
Gordon for violating '20(a) of the 1934 Act must therefore be
reversed.
IV. LIABILITY OF ELPAC
Like P.A.W., Elpac stands to be adjudged liable to Gordon in
rescission only derivatively-- in this instance, for Burr's
violation of '10(b). The record however, is lacking in evidence
that Burr was acting for Elpac in his sale of his own shares or
his representations to Gordon.
Though in effect conceding his failure at trial to offer posi
tive proof of Elpac's culpability, Gordon seeks to predicate
'20(a) liability on the negative inference which the court might
have drawn from Elpac's failure to present certain evidence at
trial conceivably within its ability to produce. Plainly, this
inference is far less compulsory than Gordon would have it. Kirby
v. Tallmadge, 160 U.S. 379, 383, 16 S.Ct. 349, 40 L.Ed. 463
(1896), cited by Gordon as authority and quoted by him at length
in his brief, characterizes a failure to produce evidence within
one's control as no more than 'a proper subject of comment.'
Whatever inference the court below may have drawn from Elpac's
alleged non-production of evidence, [FN6] it was hardly error for
the court not to make this permissible inference. In any event,
it appears highly dubious that this inference from nonproduction
of evidence could supply sufficient evidence to hold Elpac liable
under '20(a). We reject Gordon's claim that Elpac violated
'20(a) of the 1934 Act.
Reversed as to availability of rescission against Lord and as
to liability of Philips, Appel & Walden, Inc., and remanded for
entry of appropriate judgment; otherwise affirmed.
FN1. '78j. Manipulative and deceptive devices
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 ofany facility of any national securities
exchange-- (b) To use or employ, i connection with the purchase
or sale of any security registered on a national securities ex
change 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 neces
sary or appropriate in the public interest or for the protection
of investors.
FN2. '78t. Liabilities of controlling persons
(a) Every person who, directly or indirectly, controls any person
liable under any provision of this chapter or of any rule or
regulation thereunder shall also be liable jointly and severally
with and to the same extent as such controlled person to any
person to whom such controlled person is liable, unless the
controlling person acted in good faith and did not directly or
indirectly induce the act or acts constituting the violation or
cause of action.
FN3. It should be noted at the outset that the discussion of the
liability of Lord, Elpac and P.A.W. is rendered wholly academic
by plaintiff's choice of the remedy of rescission . . . which is
available only against Burr, the seller of the securities. 366
F.Supp. at 164.
FN4. Although Gordon urges Mack v. Latta, 178 N.Y, 525, 71 N.E.
97 (1904), as authority for his position and the appellees disp
ute its applicability, we need not decide among their competing
interpretations of Mack. The appellees argue that Mack holds no
more than that a court sitting in equity will permit joinder of
an action for damages against tortfeasors not in privity with the
defrauded party, and a bill for rescission against the fraudulent
seller. Under their view, then, the case deals with a procedural
issue (joinder), not the substantive problem of the persons
against whom a bill in rescission may lie. This may well capture
what the Mack court meant. Subsequent to Mack, however, the New
York Court of Appeals has made clear that it reads that case
for-- or at least regards as Mack's ratio decidendi-- the propo
sition propounded by the appellant. See, Keskal v. Modrakowski,
supra. Whatever the court in Mack intended to say, then, is
rather beside the point, for the state's high court has since
elucidated in no uncertain terms that New York recognizes the
availability of rescission against tortfeasors not in privity
with the victim of the fraud.
FN5. Although Professor Loss seems in a passing reference to resolve
availability in the negative, 3 L. Loss, Securities Regulation 1627 (2d ed.
1961), he elsewhere clarifies his position on this issue along the lines
which we suggest, 3 id. 1713-15, 1769-70. The Second Restatement of
Agency (1958) also offers support for allowing rescission relief against
all persons party to a fraud:
'339. Other Party Rescinds for Cause Existing at Time of Trans
action; Principal Disclosed for Partially Disclosed An agent who
has received things from another for a disclosed or partially
disclosed principal in a transaction conducted by him has a duty
to return them or their proceeds if the other rescinds the trans
action for a cause existing at the time of their receipt, to the
extent that the agent has not, before notice of rescission and in
good faith, changed his position. (Comment:)
f. Change of position. A person who, as agent, receives things
from a third person for the principal is not thereby under a duty
to return what he has received if, before demand, he has in good
faith changed his position.
If the agent has notice that the other has rescinded or, if he
learns of facts from which he should realize that the other is
entitled to and will demand rescission, as where the agent or
principal was fraudulent in inducing the transaction, a subse
quent change of position does not relieve him from the duty of
returning what he has received . . ..
FN6. Even on its own terms, this claim of non-production of evidence is
unconvincing. For at least one piece of allegedly withheld evidence,
minutes of a meeting, was in fact proffered by Elpac. Transcript at 258.
