Docutel/Olivetti Corporation v. Finkel Respondent's Brief in Opposition to Petition for a Writ of Certiorari to the US Court of Appeals for the Fifth Circuit

    No. 87-303

In The

Supreme Court of the United States
October Term, 1987

----------------o---------------

DOCUTEL/OLIVETTI CORPORATION, ING. C. OLI­
VETTI & C., S.p.A., CARLO DE BENEDETTI, EM­
METT R. DeMOSS, JR., SIMONE FUBINI, B. J. 
MEREDITH and ELSERINO M. PIOL,

Petitioners, 
v.

HANNAH FINKEL,
Respondent.

----- — -— o------ ------ -—■

RESPONDENT’S BRIEF IN OPPOSITION 
TO PETITION FOR A WRIT OF CERTIORARI 

TO THE UNITED STATES COURT OF APPEALS 
FOR THE FIFTH CIRCUIT

----------------o----------------
O f Counsel:

JULES BRODY 
STULL, STULL & BRODY 
6 East 45th Street 
New York, New York 10017 
(212) 687-7230

W . D. MASTERSON 
THEODORE C. ANDERSON 
KILGORE & KILGORE 
2900 First RepublicBank Plaza 
901 Main Street, LB-180 
Dallas, Texas 75202 
(214) 741-6781

Attorneys fo r Respondent

COCKLE LAW BRIEF PRINTING CO., (800) 225-6964 
or call collect (402) 342-2831

ROGER F. CLAXTON
Counsel of Record
2900 First RepublicBank Plaza
901 Main Street, LB-180
Dallas, Texas 75202
(214) 741-6781



1

QUESTION PRESENTED

Is a plaintiff class of investors which purchases se­
curities in an established market at a price artificially 
inflated by a scheme to defraud or course of business that 
operates as a fraud on investors, entitled to a presump­
tion of reliance in order to recover for securities fraud 
under Section 10(b) of the 1934 Act and Rule 10b-5(l) 
and (3) thereunder?



11

QUESTION PRESENTED ...........................................  i
TABLE OF AUTHORITIES ...............................    ill
STATEMENT OF THE C A S E .....................................  2
STATEMENT OF F A C T S............................................. 3
REASONS FOR DENYING THE PETITION ........... 5

T. RESPONDENTS WERE ENTITLED TO A 
REBUTTABLE PRESUMPTION OF RE­
LIANCE UNDER THE FRAUD ON THE 
MARKET DOCTRINE ...................................  5

II. THE FRAUD ON THE MARKET DOC­
TRINE FURTHERS THE CLEAR IN­
TENT OF CONGRESS...................................  8

III. THIS COURT HAS PREVIOUSLY CON­
SIDERED THE INDIVIDUAL RELIANCE 
ISSUE IN THE SECURITIES FRAUD 
CONTEXT ........................................................  16

IV. PETITIONERS DO NOT HAVE STAND­
ING TO ASSERT THE CONFLICT WITH­
IN THE CIRCUITS AS A REASON FOR 
THIS COURT TO GRANT CERTIORARI... 18

V. THIS CASE DIFFERS FROM BASIC VS. 
LEVINSON WHICH IS CURRENTLY BE­
FORE THIS COURT ......    20

CONCLUSION .................................................................  22

TABLE OF CONTENTS
Page



I l l

Cases

TABLE OF AUTHORITIES
Page

Affiliated Ute Citizens v. United States,
406 U.S. 128 (1972) ....................................... 16,17,18

Bateman. Eichler, Hill Richards, Inc. v.
Berner, 472 U.S. 299 (1985) ...............................  12

Blackie v. Barrack, 524 F.2d 891 (9th Cir.
1975), cert, denied, 429 U.S. 816 (1976) ...6,10,11,19

Blue Chip Stamps v. Manor Drug Stores,
421 U.S. 723 (1975) ............................................... 10

Chemetron Corp. v. Business Funds. Inc.,
718 F.2d 725 (5th Cir. 1983) ........ ....................... 16

Dorfman v. First Boston Corp., 62 F.R.D.
466 (E.D.Pa. 1974) ............. .................................  18

Dupuy v. Dupmj, 551 F.2d 1005 (5th Cir.
1977), cert, denied, 434 U.S. 911 (1977) ...............  6

Finkel v. Do cut el/ Olivetti, 817 F.2d 356 (5th
Cir. 1987) ............................................................ 6,7,8

Green v. Occidental, 541 F.2d 1335 (9th Cir. 1976) 15
Harris v. Union Electric Co., 787 F.2d 355 (8th 

Cir. 1986), cert, denied, No. 85-2036 (Oct.
6, 1986) ...................................................................  6

Herman do MacLean v. Huddleston, 459 U.S.
375 (1983) ..............................................................  15

In re LTV Securities Liliaation, 88 F.R.D. 134
(N.D. Texas 1980) .... 1.....................................7,13,15

Kardon v. National Gypsum, 69 F.Supp. 512
(E.D.Penn. 1946) ..................................................  9

Levinson v. Basic, 786 F.2d 741 (6th Cir. 1986), 
cert, granted, 107 S. Ct. 1284 (Feb. 23, 1987)
(No. 86-279) ...............................................6,12,20,21



IV

Lipton v. Documation, Inc., 734 F.2d 740 (11th
Cir. 1984), cert, denied, 469 U.S. 1132 (1985) 6,10,19

Mills v. Electric Auto-Lite Co., 396 U.S. 375
(1970) .............................................. ......................16,17

Pansirer v. Wolf, 663 F.2d 365 (2d Cir. 1981), 
vacated as moot after cert, granted, 459
U.S. 1027 (1982) ..................................................  6

Peil v. Speiser, 806 F.2d 1154 (3d Cir. 1986) .......6,19

T.J. Raney d  Sons, Inc. v. Fort Cobb, Okla­
homa Irrigation Fuel Authority, 717 F.2d 
1330 (10th Cir. 1983), cert, denied, 465 U.S.
1026 (1984) ............................................................  6

Rifhin v. Crow, 574 F.2d 256 (5th Cir. 1978) ....... 18

Ross v. A.H. Robins Co., 607 F.2d 545 (2d Cir.
1979), cert, denied, 446 U.S. 946 (1980) ...........6,16

Schlanger v. Four-Phase Systems, Inc., 555 
F.Supp. 535 (S.D.N.Y. 1982) .............................. 11

SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 
(2d Cir. 1968) (en banc), cert, denied, 394 
U.S. 976 (1969) ....................................................  10

Shores v. Sklar, 647 F.2d 462 (5th Cir. 1981)
(en banc), cert, denied, 459 U.S. 1102 (1983) ...2,3,6

Valley Forge College v. Americans United,
454 U.S. 464 (1982) .............................................  19

Vervaecke v. Chiles, Heider & Co., 578 F.2d 
713 (8th Cir. 1978) ............................................... 18

TABLE OF AUTHORITIES—Continued
Page



S tatutes and  R ules

Section 10(b) of the Securities Exchange
Act of 1934, 15 U.S.C. § 7Sj(b) ...2, 8, 9,10,15,16,17

Section 14(a) of the Securities Exchange 
Act of 1934, 15 U.S.C. § 78 (n) (1976) .................  17

Section 18(a) of the Securities Exchange
Act of 1934, 15 U.S.C. § 78(r) ............ ............. 15, 16

Section 20 of the Securities Exchange Act of 
1934, 15 U.S.C. §78 (t) .........................................  2

Securities and Exchange Commission Rule 
10b-5, 17 C.F.R. § 240.1013-5 ..................... ....passim

Rule 12(b)(6) Fed. F. Civ. P. ................................ 20
Rule 23(a) and (b) (3) Fed. R. Civ. P . .............2,12, 20

A rticles

Black, Fraud on the Market: A Criticism of 
Dispensing with Reliance Requirements in 
Certain Open Market Transactions, 62 
X.C.L. Rev. 435 (1984) ............................................  9

A. Bromberg & L. Lowenfels, 1 Securities 
Fraud and Commodities Fraud, 2.2(110) at 
2:13 (1986) .......................................................  10

Easterbrook and Fischel, Mandatory Disclos­
ure and the Protection of Investors, 70 Ya.
L.Rev. 669 (1984) ..................................................  12

Note, The Efficient Capital Market Hypoth­
esis, Economic Theory and the Regulation 
of the Securities Industry, 29 Stan. L. Rev.
1031 (1977) ......................................   7

TABLE OF AUTHORITIES—Continued
Page



VI

Fama, Efficient Capital Markets: A Review 
of Theory and Empirical Work, 25 J.Fin.
383 (1970) ..............................................................  7

Fiscliel, TJse of Modern Finance Theory in Se­
curities Fraud Cases Involving Actively 
Traded Securities, 38 Bus.L. 1 (1982) ...............7,14

Note, Fraud on the Market: An Emerging 
Theory of Recovery Under SEC Rule 10b-5,
50 Geo. Wash. L. Rev. 627 (1982) ......................  9

Note, Fraud-on-the-Market Theory, 95 Harv.
L.Rev. 1143 (1982) .............................................7, 9,13

H. Kripke, The SEC and Corporate Disclos­
ure at 14 (1979) ..................................................  7

Rapp, Rule 10b-5 and “ Fraud-on-the-Market”
—Heavy Seas Meet Tranquil Shores, 39 
Wash. & Lee L.Rev. 861 (1982) .......................... 9

M iscellaneous

Testimony of Thomas G. Corcoran, Hearing 
on HR 7852 and HR 8720 before the House 
Committee on Interstate and Foreign Com­
merce, 73d Congress, 2d Sess., 115 (1934) .......  10

Wall Street Journal, April 2, 1984 ........................5,15

TABLE OF AUTHORITIES—Continued
Page



No. 87-303

---------------- o— _— .—----

In The
Supreme Court ©f the United States

October Term, 1987

—------------ o----------------

DOCUTEL/OLIVETTI CORPORATION, ING. C. OLI­
VETTI & C., S.p.A., CARLO DE BENEDETTI, EM­
METT R. DeMOSS, JR., SIMONE FUBINI, B. J. 
MEREDITH and ELSERINQ M. PIOL,

v.
Petitioners,

HANNAH FINKEL,
Respondent.

■o-------------

RESPONDENT’S BRIEF IN OPPOSITION 
TO PETITION FOR A WRIT OF CERTIORARI 

TO THE UNITED STATES COURT OF APPEALS 
FOR THE FIFTH CIRCUIT

------------— o---------------

Respondent Hannah Finkel respectfully requests that 
the Court deny the Petition for Certiorari to the United 
States Court of Appeals for the Fifth Circuit (“ Petition” ) 
submitted by Docutel/Olivetti Corporation (“ Docutel” ) 
and several individuals (collectively the “ Defendants” ) to 
review a final judgment of the United States Court of

1



2

Appeals for the Fifth Circuit. The judgment appealed 
from (i) reversed the District Court’s Order granting 
Defendants/Petitioners’ Motion to Dismiss dismissing 
Plaintiff’s claims under 10b-5(l) and (3) of the Securities 
and Exchange Commission, and (ii) affirmed the District 
Court’s Order granting Defendants’ Motion to Dismiss 
Plaintiff’s claims under Rule 10b-5(2) of the Securities 
and Exchange Commission.

--------------------o— -—■— -—-— ••

STATEMENT OF THE CASE

Course of Proceedings and Disposition Below
Plaintiff’s complaint arises under Sections 10(b) and 

20 of the Securities and Exchange Act of 1934, 15 U.S.C. 
§ 78(a), et seq. (the “ Exchange Act” ) and Securities and 
Exchange Rule 10b-5 promulgated thereunder. Plaintiff 
brought this action as a class action pursuant to Rules 23 
(a) and (b)(3) F.R.C.P.

Defendants filed a Motion to Dismiss. The Motion to 
Dismiss alleged that the Complaint is fatally defective for 
failure to allege individual reliance upon misrepresenta­
tions of Defendants.

Discovery and class certification were deferred pur­
suant to agreed orders pending a ruling by the District 
Court on Defendants’ Motion to Dismiss.

On August 20, 1986, the District Court dismissed the 
Plaintiff’s Complaint without prejudice based upon an in­
terpretation of Shores vs. Sklar, 647 F.2d 462 (5th Cir. 
1981) (en banc), cert, denied, 459 TT.S. 1102 (1983), to the



3

effect that a plaintiff in the Fifth Circuit who purchases 
securities in an established market cannot rely upon the 
integrity of the market pursuant to the fraud on the market 
doctrine, but must plead and prove individual reliance upon 
specific misrepresentations.

On May 27, 1986, the Fifth Circuit reversed and re­
manded, holding that to the extent that Plaintiff’s Com­
plaint alleged a scheme to defraud or course of business 
operating as a fraud, Plaintiff had properly pled causes 
of action under 10b-5(l) and (3). Plaintiff did not have 
to plead specific reliance upon alleged misrepresentations. 
The Fifth Circuit affirmed the District Court’s dismissal 
of Plaintiff’s Complaint with respect to claims under 10b- 
5(2), holding that under Shores, any fraud on the market 
claim under section (2) is barred by Plaintiff’s failure to 
allege that she read and relied on any of the documents 
now claimed to have misrepresented the financial condi­
tion of Docutel.

On August 29, 1987, the District Court stayed this 
action pending this Court’s ruling on Petitioner’s petition 
for a writ of certiorari.

--------------- o--------------- .

STATEMENT OF FACTS

Defendant Docutel/Olivetti Corporation (“ Docutel” ) 
is a Delaware corporation with executive offices in Irving, 
Texas. On October 1, 1983, Docutel had issued and out­
standing 6,800,000 shares of common stock owned by more 
than 3,200 shareholders. Docutel’s shares were traded in



4

the over-the-counter market. Defendant Ing. C. Olivetti 
and C., S.p.A. (“ Olivetti” ) is an Italian corporation with 
its executive offices located in Italy. Olivetti acquired 
practical control of Docutel by means of a merger between 
a subsidiary of Olivetti and Docutel, and the issuance of 
a warrant by Docutel to the Olivetti subsidiary. Defen­
dants B. J. Meredith and Emmett R. DeMoss were, re­
spectively, the chief executive officer and executive vice 
president and chief financial officer of Docutel.

Defendants Carlo DeBenedetti and Simone Fubini 
were respectively the chief executive officer and chief 
operating officer of Olivetti. Defendant Elserino M. Piol 
was a representative of Olivetti who acted as a director 
of Docutel.

On December 5, 1983, Plaintiff purchased 300 shares 
of Docutel on the public market at $14-5/8 per share, for 
a total price of $4,474.75.

Plaintiff alleged that the quarterly earnings of Docutel 
reported through 1983 were substantially overstated, and 
losses were understated, by reason of the failure of Docu­
tel, and Olivetti as its controlling shareholder, and the re­
spective officers, to charge off worthless inventories ac­
quired from Olivetti and its subsidiary. Docutel was made 
to buy inventory from Olivetti which was unsalable, giving- 
rise to the write-downs complained of by Plaintiff in this 
action.

Plaintiff relied upon the integrity of the public market 
for Docutel shares in making her purchases and thereby 
incurred losses by paying the artificially inflated public 
market prices resulting from the fraudulently overstated 
earnings.



5

Oil February 16, 1984, Docutel announced a projected 
net loss for tbe year ended December 31, 1983, in the 
amount of $14,000,000. On April 2, 1984, the Wall Street 
Journal reported that Docutel said its previously projected 
net loss for 1983 of $14,000,000 would be significantly 
wider. In its 10-K for 1983 Docutel reported an after tax 
loss of $18,263,000 for 1983. The loss included $10,900,000 
of inventory write-downs, approximately $10,100,000 of 
which was recorded in the fourth quarter. Significantly, 
Docutel made the following admission in its 1983 Form 
10-K:

In 1983, the Company’s record keeping procedures and 
accounting staff were strained due to the significant 
growth in transaction volume resulting from the 
merger with Olivetti Corporation, attrition of per­
sonnel, and the transfer in the second half of 1983 
of OPD accounting function from Tarrytown, New 
York, to the Company’s headquarters in Irving, Texas.

Docutel’s stock plummeted from a high of $38-7/8 in 
1983 to a closing bid price on April 6, 1984 of $7-1/4, caus­
ing public investors to take large losses.

--------------- o----------------

REASONS FOR DENYING THE PETITION

I. RESPONDENTS WERE ENTITLED TO A REBUT­
TABLE PRESUMPTION OF RELIANCE UNDER 
THE FRAUD ON THE MARKET THEORY

The Fifth Circuit Court of Appeals in this case cor­
rectly held that since Respondent had alleged a scheme to 
defraud or course of business operating as a fraud in viola­



6

tion of Rule 10b-5(l) and (3), Respondent was entitled to a 
rebuttable presumption of reliance upon proof of material­
ity of the alleged conduct.

Reliance is generally a requirement to a claim stated 
under Rule 10b-5. Proof of reliance establishes that the 
damaged party was induced to act by the defendant’s con­
duct ; it defines the causal link between defendant’s miscon­
duct and the plaintiff’s decision to buy or sell securities. 
Dupuy v. Dupuy, 551 F.2d 1005, at 1016 (5th Cir. 1977), 
cert, denied, 434 U.S. 911 (1977); FinJcel v. Docutel/Oli- 
vetti, 817 F.2d 356 at 359 (5th Cir. 1987). The fraud on 
the market doctrine, adopted by every Circuit Court of 
Appeals to consider it1 permits a plaintiff to rely upon 
the integrity of an established market to set a price 
untainted by fraud, without pleading individual reli­
ance upon specific misrepresentations. Most courts have 
held that a plaintiff is entitled only to a presumption of re­
liance, which may be rebutted by defendants. In this case, 
the Court of Appeals held that Defendants may rebut the 
presumption of reliance in two ways: 1) by showing that 
the nondisclosures did not affect the market price for the

^ e e  Pei I v. Speiser, 806 F.2d 1154 (3d Cir. 1986); Levinson 
v. Basic, 786 F.2d 741 (6th Cir. 1986), cert, granted, 107 S. Ct. 
1284 (Feb. 23, 1987); Harris v. Union Electric Co., 787 F.2d 355 
(8th Cir. 1986), cert, denied, No. 85-2036 (Oct. 6, 1986); Upton  
v. Documentation, Inc., 734 F.2d 740 (11th Cir. 1984), cert, de­
nied, 469 U.S. 1132 (1985); T.J. Raney & Sons, Inc. v. Fort Cobb, 
Oklahoma Irrigation Fuel Authority, 717 F.2d 1330 (10th Cir. 
1983), cert, denied, 465 U.S. 1026 (1984); Shores v. Sklar, 647 
F,2d 462 (5th Cir. 1981), cert, denied, 459 U.S. 1102 (1983); 
Panzirer v. W o lf, 663 F.2d 365 (2d Cir. 1981), vacated as moot 
after cert, granted, 459 U.S. 1027 (1982); Ross v. A.H. Robins 
Co., 607 F.2d 545, 553 (2d Cir. 1979), cert, denied, 446 U.S. 946 
(1980); Blackie v. Barrack, 524 F.2d 891 (9th Cir. 1975), cert. 
denied, 429 U.S. 816 (1976).



security; or 2) that plaintiff would have purchased the 
stock at the same price even if she had known the informa­
tion that was not disclosed. Docutel, 817 F.2d at 364-365.

The fraud on the market doctrine is premised upon the 
theory that the market price for a security, in an open and 
developed market, accurately reflects the value of that se­
curity if all relevant information has been disclosed in the 
marketplace.2 When one fails to disclose or misrepresents 
material information about a security, the market’s effic­
ient pricing mechanism is skewed and the price of the secur­
ity is distorted. Docutel, 817 F.2d at 360. The fraud on the 
market doctrine recognizes the fact that most investors do 
not carefully examine all available information about a 
security because there is too much, and much of it is too 
technical.3 Instead the typical investor relies upon the in-

7-

2This is a conclusion of the efficient market theory. The 
theory states that the market price reflects all representations 
concerning the stock. The market price of securities is a func­
tion of the information the market possesses, both positive and 
negative, assuming all information is disclosed. In re LTV  Se­
curities Litigation, 88 F.R.D. 134, 144 (N.D.Texas 1980). See LTV  
for citations to the economic theories and leading works which 
support the doctrine. See also, Fischel, Use of Modern Finance 
Theory in Securities Fraud Cases Involving Actively Traded Se­
curities, 38 Bus.L 1 (1982); Fama, Efficient Capital Markets: A 
Review of Theory and Empirical W ork, 25 j.Fin. 383 (1970); 
Note, Fraud-on-the-Market Theory, 95 Harv.L.Rev. 1143 (1982); 
Note, The Efficient Capital Market Hypothesis, Economic Theory  
and the Regulation of the Securities Industry, 29 Stan. L. Rev. 
1031 (1977).

35ee, Fischel, 38 Bus. Law, 1, 2 -5 ; Docutel, 817 F.2d at 360 
n. 9 ("[R jecent scholarship suggests that the dissenters' vision of 
individual investors reading and relying upon information re­
quired to be disclosed in registration statements and the like is 
suspect. Most SEC disclosure documents not only go unread by 
their intended recipients but in fact 'can only be used effectively 
by market professionals.'")  (quoting Note, The Fraud-on-the- 
Market Theory, 95 Harv.L.Rev. 1143, 1159 (1982) and H. Kripke, 
The SEC and Corporate Disclosure at 14 (1979)).



8

tegrity of the market to be free from deception and to value 
accurately a security in light of all the material information 
about the security. The market becomes the theoretical 
agent of the investor. Consequently, a purchaser or seller 
who relies on the market to value the security accurately 
suffers damages if the market does not have all the infor­
mation or if some of the information is false.

The ability of an investor to rely upon the market price 
for securities as reflecting an individual issuer’s prospects 
is critical to liquidity in the nation’s capital markets. Most 
investors rely upon the integrity of the public market when 
they invest. The typical investor has insufficient time to 
review all of the data available with respect to individual 
securities considered for purchase. Thus, there are im­
portant economic bases, as well as legal bases, for the fraud 
on the market doctrine. It is for these reasons that the 
fraud on the market doctrine has been adopted in every cir­
cuit to consider it. See note 1 above.

II. THE FRAUD ON THE MARKET DOCTRINE FUR­
THERS THE CLEAR INTENT OF CONGRESS.

Petitioners wrongly contend that in adopting Section 
10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. 
§78j(b), Congress intended to incorporate the basic ele­
ments of common law fraud. Petitioners mischaracterize 
Congress’ intent in an attempt to overturn the fraud on the 
market doctrine against the great weight of judicial, scho­
lastic and administrative authority that supports it.4 The

4See supra note 1 and accompanying text; Docutel, 817 F.2d 
at 361 (“ The Securities and Exchange Commission accepts the 
efficient market hypothesis, which underlies the fraud on the

(Continued on next page)



9

creation of the many new rules contained in the ’33 and ’34 
Acts constitutes Congressional recognition of the inability 
of state common law principles to deal with securities 
fraud. Nowhere in the text of Section 10(b), or Rule 10b-5 
promulgated thereunder, are the alleged elements of com­
mon law fraud required.5 Section 10(b) was deliberately 
couched in broad terms and intended to be a catch-all to 
prevent manipulative devices that theretofore ran ram­
pant.6

(Continued from previous page)

market theory.") (footnote omitted); see also Black, Fraud on 
the Market: A Criticism of Dispensing w ith Reliance Require­
ments in Certain Open Market Transactions, 62 N.C.L.Rev. 435 
(1984); Rapp, Rule 10b-5 and "Fraud-on-the-Market"— Heavy 
Seas Meet Tranquil Shores, 39 Wash.& Lee L.Rev. 861 (1982); 
Note, Fraud on the Market: An Emerging Theory of Recovery 
Under SEC Rule 10b-5, 50 Geo. Wash. L. Rev. 627 (1982); Note, 
Fraud-on-the-Market Theory, 95 Harv. L. Rev. 1143 (1982).

5At the outset, Petitioners cite Kardon v. National Gypsum, 
69 F.Supp. 512 (E.D.Penn. 1946) for the proposition that the 
cause of action under Rule 10b-5 has always incorporated the 
basic elements of the common law deceit action. This is simply 
not correct. In National Gypsum the plaintiffs made claims 
based upon both common law fraud and Rule 10b-5. The court 
held that plaintiff's allegations sustained both claims. Nowhere 
did the court require the allegations of a common law fraud 
claim as a prerequisite to a claim under Rule 10b~5. The court 
simply held that the allegations as they were made sufficed to 
uphold claims under both 10b-5 and common law fraud.

6ln summing up Section 9(c) before the House Committee, 
which without significant alteration became Section 10(b) of 
the Act, one of the principal drafters said the following:

"Subsection (c) says, 'Thou shalt not devise any other cun­
ning devices.' . . .  O f course subsection . . .  (c) is a catch­
all clause to prevent manipulative devices!.] I do not 
think there is any objection to that kind of a clause. The 
Commission should have authority to deal with new manip­
ulative devices."

(Continued on next page)



10

The fraud on the market theory actually embraces 
Congress’ intent. The fraud on the market theory adheres 
to legislative intent by fostering public confidence in the 
markets, by deterring fraud and by promoting judical ef­
ficiency through the class action vehicle.

Restoring investor confidence in the securities mar­
kets was a primary reason for adopting the federal securi­
ties laws. See 1 A. Bromberg & L. Lowenfels, Securities 
Fraud and Commodities Fraud, Section 2.2(110) at 2:13 
(1986) (“  [Statutory antifraud provisions] were part of the 
initial New Deal response to the financial debacle of the 
1920’s, investigations of which revealed widespread fraud, 
manipulation and victimization of public investors by con­
cealment of relevant information” ). With respect to Sec­
tion 10 and Rule 10b-5, courts have held that “ [t]he 
statute and rule are designed to foster an expectation that 
securities markets are free from fraud—an expectation on 
which purchasers should be able to rely.”  Blackie v. Bar­
rack, 524 F.2d at 907; see also, Lipton v. Documation, 
734 F.2d at 748. The ability of an investor to rely upon 
the honesty and integrity of the market is critical to liquidi­
ty in the nation’s capital markets. As one court has noted, 
“ it is hard to imagine that there ever is a buyer or seller 
who does not rely on market integrity. Who would know­

continued from previous page)

Testimony of Thomas G. Corcoran, Hearing on HR 7852 and 
HR 8720 before the House Committee on Interstate and Foreign 
Commerce, 73d Congress, 2d Sess., 115 (1934). The courts have 
quoted this comment in giving broad interpretation to Section 
10(b). See, e.g., Blue Chip Stamps v. Manor Drug Stores, 421 
U.S. 723, 766 (1975) (dissent of Blackmun J.); SEC v. Texas Gulf 
Sulphur Co., 401 F.2d 833, 859 (2d Cir. 1968) (en banc), cert, 
denied, 394 U.S. 976 (1969).



11

ingly roll the dice in a crooked crap game?”  Schlanger 
v. Four-Phase Systems, Inc., 555 F.Supp. 535, 538 (S.D. 
N.Y. 1982).

The fraud on the market doctrine recognizes the fact 
that the legislative policy designed to foster investor ex­
pectations of honesty in the securities markets has become 
reality. Investors rely upon the integrity of the market 
when they invest. They purchase upon the assumption that 
the market price is free from any unsuspected manipula­
tion that could inflate the market price. The fraud on the 
market doctrine simply furthers the goals of the securities 
laws by protecting those that rely on the integrity of the 
market when they invest. Blackie v. Barrack, 524 F.2d at 
907. Such investors may recover from corporate wrong­
doers without proving individual reliance on specific mis­
representations, but by showing that they relied upon the 
integrity of the market when they purchased the security 
—an expectation on which purchasers should be able to 
rely. Requiring direct proof from each purchaser that he 
relied on a particular representation when purchasing 
would defeat recovery by those whose reliance was indirect 
or on the integrity of the public market place. The securi­
ties laws would operate to protect only those investors 
with enough time and sophistication to digest all informa­
tion disseminated into the public market, despite the fact 
that all investors who rely on the honesty of the market 
suffer the damage of purchasing a security at a price in­
flated by material misrepresentations. To leave such open 
market purchasers unprotected is not consistent with the 
policies under the federal securities laws. Investors should 
and do rely upon the integrity of the public market when 
they invest.



12

To the extent that private securities fraud actions may 
be prosecuted more efficiently by adoption of the fraud 
on the market theory, the enforcement of the securities 
laws, and the underlying goal of honest markets, are fur­
thered. Brief for the Securities and Exchange Commission 
as Amicus Curiae at 26, Basic v. Levinson, No. 86-279 
(U.S. filed April 1987). There is no doubt that implied pri­
vate actions under 10b-5 effectively enforce the securities 
laws. Id. (The Securities and Exchange Commission noted 
that the Supreme Court has “ repeatedly . . . emphasized 
. . . that implied private actions [under Rule 10b-5] pro­
vide ‘ a most effective weapon in the enforcement’ of the 
securities laws and are ‘ a necessary supplement to Com­
mission action.’ ”  (quoting Bateman Eichler, Rill Rich­
ards, Inc. v. Berner, 472 U.S. 299, 310 (1985)).

Federal securities laws were also adopted for the pur­
pose of efficiency in enforcing in one case all claims that 
arise out of a single transaction. As commentators have 
written,

The securities laws create nationwide service of pro­
cess and have a liberal venue rule that permits litiga­
tion to consolidate all defendants and all claims in a 
single forum. The class action device created by Rule 
23 of the Rules of Civil Procedure makes it easy to 
bring all plaintiffs together.

Easterbrook and Fisehel, Mandatory Disclosure and the 
Protection of Investors, 70 Ya.L.Rev. 669, at 680 (1984). 
The fraud on the market doctrine has special and obvious 
appeal in class actions because the need to prove a per­
sonalized reliance by each class member is avoided. The 
question of reliance usually arises in the context of whether



13

or not to certify a class.7 If a plaintiff in a securities 
fraud action must plead and prove individual reliance, then 
class certification is probably improper, because issues of 
individual reliance will predominate. If the class action 
procedural device can no longer be used to handle major 
securities cases, then defendants will gain some measure 
of relief because not all defrauded investors will sue. As 
one commentator pointed out:

The only person whose behavior is likely to be changed 
are would-be defrauders, because the fraud-on-the- 
market theory, by eliminating issues of individual re­
liance, facilitates class action recovery of claims that 
would otherwise be too small to be litigated individual­
ly. And here, possibly, lies an unstated rationale for 
the fraud-on-the-market decisions, almost all of which 
involved class actions: only if courts allow class ac­
tions to proceed will under-inclusive recoveries and 
hence a failure to deter fraud at its inception be 
avoided.

(footnote omitted) Note, Fraud-on-the-Market Theory, 95 
Harv.L.Rev. 1143, at 1159 (1982). Moreover, there will no 
doubt be many separate suits filed by investors who are 
in a position to plead and prove individual reliance. The 
cost to the judicial system in litigating each of such suits 
separately will likely be unacceptable.

Petitioners argue that the fraud on the market doctrine 
is inconsistent with the full disclosure policy of the se­

7For example, in In re LTV  Securities Litigation, 88 F.R.D. 
134 (N.D.Tex. 1980), the question of whether to apply the fraud 
on the market doctrine arose in the context of a motion to cer­
tify a class of more than 100,000 members who traded nine (9) 
different types of securities over a period of three and a half 
years. Id. at 140.



14

curities laws. Such is not correct. In fact, it is obvious 
that the fraud on the market doctrine could not exist with­
out the full disclosure contemplated by the securities laws. 
The doctrine assumes that the markets have assimilated 
all available information. However, liquidity in the mar­
kets requires that investors who have not had an opportuni­
ty  to read every disclosure made by a company, or who 
may not be sophisticated enough to understand all the dis­
closures, may nevertheless invest at the market price upon 
the assumption that such price represents the consensus 
price established by interested and informed investors. 
“ Various market professionals still have an incentive to 
secure information until a marginal dollar invested in pro­
cessing information equals the profits to be made from 
trading on superior forecasting.” 8

Petitioners’ argument that the fraud, on the market 
doctrine establishes a policy of “ investor’s insurance”  im­
plies that each investor can collect his full damages in the 
event he loses money as a result of securities fraud. This 
contention is totally unfounded. Even if individual re­
liance is presumed until defendants have an opportunity 
to rebut the presumption, it remains necessary for de­
frauded investors to prove fraud. What Petitioners seek

8Fischel, Use of Modern Finance Theory in Securities Fraud 
Cases Involving Actively Traded Securities, 38 Bus.L. 1, at 4 
(1982). Professor Fischel explains it, "Markets may be analyzed 
as having two classes of participants. One class will have a 
comparative advantage, actors in this class have an incentive 
to invest in gathering and analyzing information and to take 
actions to affect the market. The other class, however, lacking 
a comparative advantage, has no incentive to invest in process­
ing information because it cannot profit thereby. The first group 
will earn a superior return commensurate with their greater in­
vestment skill." Id.



15

is practical immunity from prosecution for corporate 
wrongdoers. Even if a defrauded investor can prove lia­
bility, the plaintiff still recovers only his out-of-pocket dam­
ages. The out-of-pocket damage rule established in Green 
v. Occidental, 541 F.2d 1335, 1341 (9th Cir. 1976) (Sneed, 
J., concurring); see, e.g., In re LT V Securities Litigation, 
88 F.RJD. 134 (NJD.Tex. 1980), permits an investor to re­
cover only that portion of his total loss which is due to 
defendants’ fraud. While most class actions are indeed 
settled, the settlements frequently result in a recovery of 
only pennies on the dollar to defrauded investors. This 
is scarcely a plan for “ investor insurance,”  but is an ef­
fective plan for keeping corporate management as honest 
as possible.

Petitioners’ argument that upholding fraud on the 
market claims under Rule 10b-5 constitutes the effective 
repeal of Section 18(a) is similarly unfounded. Petition­
ers ignore the fact that in this case Plaintiff alleges a 
scheme to defraud the market by disseminating fraudulent 
information not only in the SEC filings, but also in pub­
licly disseminated reports appearing in The Wall Street 
Journal. Section 18(a) limits its remedy to fraudulent 
SEC filings. Furthermore, this Court has already re­
jected an interpretation of the securities laws that dis­
places an action under Section 10(b) merely because of 
the availability of express remedies under other sections. 
In Herman d  MacLean v. Huddleston, 459 U.S. 375, 384- 
387 (1983) this court said, “ In savings clauses included 
in the 1933 and 1934 Acts, Congress rejected the notion 
that the express remedies of the securities laws would 
preempt all other rights of action . . . We therefore reject 
an interpretation of the securities laws that displaces an



16

action under Section 10(b).”  (footnotes omitted). A cu­
mulative construction of the securities laws furthers the 
broad remedial purposes of the securities laws and fur­
thers Congress’ intent in enacting the 1934 Act, “ to im­
pose requirements necessary to make [securities] regula­
tion and control reasonably complete and effective.”  Id. 
(quoting 15 USC Section 78b [15 USCS Section 78b]).

Courts have similarly rejected the notion that there 
must be additional and differing elements contained in a 
Section 10(b) claim to justify a civil remedy under 10(b) 
when other remedies were available under other sections 
of the Securities Acts. See, e.g., Chemetron Corp. v. Bus­
iness Funds, Inc., 718 F.2d 725 (5th Cir. 1983). None­
theless, plaintiffs face a more difficult task in stating a 
claim under section 10(b) where plaintiff must allege 
scienter, as opposed to stating a claim under Section 18 
where an allegation of scienter is not a requirement. Ross 
v. A.II.Robins Co., 607 F.2d 545, 556 (2d Cir. 1979), cert, 
denied, 446 U.S. 949 (1980).

III. THIS COURT HAS PREVIOUSLY CONSIDERED 
THE INDIVIDUAL RELIANCE ISSUE IN THE 
SECURITIES FRAUD CONTEXT

Two decisions by this Court, Mills v. Electric Auto- 
Lite Co., 396 U.S. 375 (1970) and Affiliated TJte Citizens 
v. United Slates, 406 U.S. 128 (1972), demonstrate this 
Court’s recognition that under certain circumstances, 
causation in a securities fraud suit is adequately estab­
lished by proof of materiality, without direct proof of in­
dividual reliance.

In Mills this court expressly noted the judicial utility 
in substituting materiality for direct proof of reliance in



17

large securities fraud cases. In Mills, minority share­
holders alleged, under Section 14(a) of the Exchange Act, 
15 U.S.C. Section 78n(a) (1976), that shareholder approval 
of a merger had been obtained via a misleading proxy 
statement. This Court acknowledged that “ reliance by 
thousands of individuals . . . can scarcely be inquired 
into.'’ Id. at 380 (citation omitted). As an alternative, 
this Court stated,

There is no need to supplement this [materiality] re­
quirement . . . with a requirement of proof of wheth­
er the defect actually had a decisive effect on the vot­
ing. Where there has been a finding of materiality, 
a shareholder has made a sufficient showing of causal 
relationship between the violation and the injury . . .

Id. at 384-85. The Mills case is also informative because 
this Court found liability without proof of individual re­
liance, even though Mills involved an implied remedy un­
der Section 14(a). Like Section 10(b) of the Exchange 
Act, the remedy under Section 14(a) is a judicially implied 
remedy.

In Affiliated Ute, a Rule lQb-5 case, this Court dis­
pensed with the need of plaintiffs to establish reliance in 
nondisclosure cases involving open market transactions. 
Like the Court of Appeals in this case, this Court noted 
the distinction between paragraph (2) of rule 10b-5 and 
paragraphs (1) and (3), saying that the former is re­
stricted to “ the making of an untrue statement of a ma­
terial fact and the omission to state a material fact.”  Id. 
at 152-153. Nevertheless, this Court continued, the first 
and third paragraphs are not so restricted, they deal with 
a course of business or a device, scheme, or artifice that 
operated as a fraud. Id. Thus, this Court held,



1 8

Under the . circumstances of this case, involving pri­
marily a failure to disclose, positive proof of reliance 
is not a prerequisite to recovery. All that is necessary 
is that the facts withheld he material in the sense that 
a reasonable investor might have considered them im­
portant in the making of this decision . . . .  This ob­
ligation to disclose and this withholding of a material 
fact establish the requisite element of causation in 
fact.

Id. 153-154. Affiliated Ute has been widely interpreted as 
eliminating plaintiff’s need to establish reliance in non­
disclosure cases involving open market transactions. E.g., 
Vervaecke v. Chiles, Heider & Co., 578 F.2d 713, 717 (8th 
Cir. 1978); Rifkin v. Crow, 574 F.2d 262-63; Dorfman v. 
First Boston Corp., 62 F.R.D. 466, 471 (E.D.Pa. 1974).

The decision by the Court of Appeals below hardly 
conflicts with decisions by this Court. To the contrary, 
the decision below embraces policies long recognized by 
this Court that in certain securities fraud suits, material­
ity oftentimes sufficiently establishes causation in fact. 
Where through a scheme to defraud or course of business 
a defendant disseminates misrepresentations that artifici­
ally inflate the market price for a security, plaintiffs 
should be entitled to a presumption of reliance upon prov­
ing materiality.

IV. PETITIONERS DO NOT HAVE STANDING TO 
ASSERT THE CONFLICT WITHIN THE CIR­
CUITS AS A REASON FOR THIS COURT TO 
GRANT CERTIORARI.

Article III of the constitution limits the judicial power 
of the United States to resolution Of “ cases”  and “ contro­
versies.”  As an incident to this requirement, this Court



19

has always required that a litigant have “ standing.”  To 
have “ standing”  a litigant must show that he personally 
has some actual or threatened injury. Valley Forge Col­
lege v. Americans United, 454 U.S. 464, 471-473, 70 L.Ed. 
2d 700, 102 S.Ct. 752 (1982).

On page fifteen of their brief, Petitioners urge this 
Court to grant certiorari because of an alleged conflict 
within the Circuits. Petitioners contend that the Fifth 
Circuit’s decision in this case is in conflict with decisions 
in other Circuits. In this case the Fifth Circuit held that 
a plaintiff is permitted to assert a fraud on the market 
theory under 10b-5(l) and (3), but not under 10b-5(2). 
In 10b-5(2) cases, plaintiffs must still prove individual 
reliance upon specific misrepresentations. In their opin­
ion, the Fifth Circuit recognized that other Circuits permit 
the fraud on the market theory under 10b-5(2).9 Never­
theless, the Court declined to so hold and for this reason 
upheld the District Court’s dismissal of Respondent’s 
claim stated under 10b-5(2). The Fifth Circuit’s decision 
thus favored Petitioners. Due to the conflict, Petitioners 
need only defend themselves against claims stated under 
10b-5(l) and (3). Consequently, Petitioners cannot urge 
the conflict among Circuits as a basis for this Court to 
grant certiorari. Petitioners have suffered no injury. 
They have actually benefited from the conflict among Cir­
cuits.

It is Respondent who has suffered injury by virtue of 
the conflict among Circuit Courts. If Respondent could

9See, e.g., Peil v. Speiser, 806 F.2d 1162-63; Upton  v. Docu- 
mation, 734 F.2d 740; Blackie v. Barrack, 524 F.2d 891.



20

have brought this action in the Third or Eleventh Circuits, 
her claim under 10b-5(2) would not have been dismissed. 
Such is not the case, however, and Respondent has suf­
fered an injury in the dismissal of part of her case. Not­
withstanding the conflict among Circuit Courts, the injury 
is peculiar to Respondent, and Respondent alone may urge 
the conflict among the Circuits.

V. THIS CASE DIFFERS FROM BASIC V. LEVIN­
SON WHICH IS CURRENTLY BEFORE THIS 
COURT.

On page 19 of their brief Petitioners argue that this 
Court should consider this case as a companion to Levin­
son v. Basic, 786 F.2d 741 (6th Cir. 1986), cert, granted, 
107 S.Ct. 1284 (Feb. 23, 1987) (No. 86-279). These cases 
differ, however, and should not be considered as com­
panion cases. First, as admitted by Petitioners, Basic, 
Inc. raises the issue in the context of class certification 
under Fed.R.Civ.P. 23(b)(3). The standard of review is 
abuse of discretion. In this case, the issues arise under 
a Fed.R.Civ.P. 12(b)(6) motion to dismiss, presenting a 
pure question of law. Thus, these cases are to be re­
viewed under differing standards.

Second, Basic, Inc. does not distinguish between causes 
of action stated under 10b-5(l) and (3), and causes of 
action stated under 10b-5(2). Basic, Inc. considers ma­
terial misrepresentations in public statements relating to 
the existence of merger negotiations. There is no issue as 
to a scheme to defraud or course of business that operated 
as a fraud. Basic, Inc. is primarily a 10b-5(2) case. This 
case on the other hand hinges on a scheme to defraud or



21

course of business to defraud in violation of Rule 10b-5(l) 
and (3).

Further, Basic, Inc. presents questions of whether 
sellers may utilize the fraud on the market doctrine as 
well as purchasers. This issue is not presented on this 
appeal.

--------------- o------------— —



22

CONCLUSION

For the foregoing reasons, the Petition For A  Writ 
Of Certiorari to review the decision of the United States 
Court of Appeals for the Fifth Circuit should he denied.

Respectfully submitted,

R oger F. Claxton  
Bar Card No. 04329000
2900 First RepublicBank Plaza 
901 Main Street, LB-180 
Dallas, Texas 75202 
(214) 741-6781
Attorney for Respondent

W. D. M asterson 
T heodore C. A nderson 
K ilgore & K ilgore 
2900 First RepublicBank Plaza 
901 Main Street, LB-180 
Dallas, Texas 75202 
(214) 741-6781
J ules B rody
S t u l l , S tu ll  & B rody
6 East 45th Street
New York, New York 10017
(212) 687-7230
OF COUNSEL
September 1987.