658 CASE PRINTOUTS TO ACCOMPANY BUSINESS LAW
Dr. Bellemore, the Texas Gulf defendants’ expert witness, has written: “The intelligent speculator assumes that facts are available
11. We are not, of course, bound by the trial court’s determination as to materiality unless we find it “clearly erroneous’ for that
standard of appellate review is applicable only to issues of basic fact and not to issues of ultimate fact. See Baranow v. Gibraltar
12. We do not suggest that material facts must be disclosed immediately; the timing of disclosure is a matter for the business
K-55-1 discovery. We do intend to convey, however, that where a corporate purpose is thus served by withholding the news of a
13. The April 16th article in The Northern Miner resulted from the reporter’s April 13th visit to the drill site where he interviewed
defendants Mollison, Holyk and Darke and looked at records of the drilling to that time. The text of the article was approved by
Mollison in Timmins on April 15th. The first five paragraphs read as follows:
Should Make Substantial Open Pit Operation TEXAS GULF SULPHUR COMES UP WITH A “MAJOR’ See Big Tonnages Of Base
9.7% Zinc and 2.4 ozs. silver. This was followed by continuous values of ore tenor– deeper down, a 100-ft. section runs 0.33%
14. The trial court found that defendant Murray “had no detailed knowledge as to the work’ on the Kidd-55 segment. There is no
evidence in the record suggesting that Murray purchased his stock on January 8, 1964, on the basis of material undisclosed
information, and the disposition below is undisturbed as to him.
1965).
16. Judges Waterman and Anderson, believing that there had been no definitive finding below as to whether Darke, expressly or
17. The effective protection of the public from insider exploitation of advance notice of material information requires that the time
that an insider places an order, rather than the time of its ultimate execution, be determinative for Rule 10b-5 purposes. Otherwise,
CHAPTER 42: CORPORATE SECURITIES LAW AND CORPORATE GOVERNANCE 659
or in the United States (10:00 A.M.) or whether Coates’s order was executed before or after the news appeared over the Merrill
Lynch (10:29 A.M.) or Dow Jones (10:54 A.M.) wires.
18. Although the only insider who acted after the news appeared over the Dow Jones broad tape is not an appellant and therefore
we need not discuss the necessity of considering the advisability of a “reasonable waiting period’ during which outsiders may
19. The record reveals that news usually appears on the Dow Jones broad tape 2-3 minutes after the reporter completes dictation.
Here, assuming that the Dow Jones reporter left the press confernce as early as possible, 10:10 A.M., the 10-15 minute release
20. The SEC seeks permanent injunctions restraining future proscribed activity by all the individual defendants and the corporation.
The Commission also seeks court orders upon certain of the individual defendants that are essentially remedies of a private, rather
than of a regulatory nature, court orders designed to have those individual defendants disgorge any profits they enjoyed from TGS
stock transactions they or their “tippees’ engaged in from November 12, 1963 to April 17, 1964.
21. Even at common law, the essentially private remedy of rescission which is sought here does not require more than a showing
1964), has been expanded from recklessness, see Prosser, Torts, 102, pp. 715-17 (3d ed. 1964), to include non-reckless negligent
misrepresentations or omissions, see Note, 63 Mich.L.Rev. 1070, 1079.
22. Liability under 12(2) of the Securities Act of 1933, 15 U.S.C. 77l(2), the language of which is strikingly similar to that of 10b–
5(2), attaches from the mere fact of misrepresentation or misleading omission unless defendant proves that “he did not know, and
in the exercise of reasonable care could not have known, of such untruth or omission.’ The provisions of Sections 17(a)(2) and (3)
of the Securities Act of 1933, 15 U.S.C. 77q(a)(2) and (3), which are virtually identical to the provisions of Rule 10b-5(2) and (3)
23. Coates’s violations encompass not only his own purchases but also the purchases by his son-in-law and the customers of his
son-in-law, to whom the material information was passed. See footnote 16, supra.
24. The options granted on February 20, 1964 to Mollison, Holyk, and Kline were ratified by the Texas Gulf directors on July 15,
1965 after there had been, of course, a full disclosure and after this action had been commenced. However, the ratification is
irrelevant here, for we would hold with the district court that a member of top management, as was Kline, is required, before
accepting a stock option, to disclose material inside information which, if disclosed, might affect the price of the stock during the
25. Rule 10b-5(2) provides in pertinent part:
660 CASE PRINTOUTS TO ACCOMPANY BUSINESS LAW
26. The prayer for relief reads:
WHEREFORE the plaintiff prays for:
(5) The issuance of a final judgment permanently enjoining the defendant Texas Gulf from directly or indirectly, by use of any
means or instrumentality of interstate commerce, or of the mails, or of any facility of any national securities exchange, in
27. See the discussion in footnotes 20, 21, and 22, supra, and in the accompanying text, dispensing with a fraudulent intent
requirement in actions based on clause (3) of Rule 10b-5.
28. Examined in retrospect, the situation in Timmins at the time the release was prepared seems to offer good reason for optimism.
The draftsmen of the release had full knowledge of the discoveries up to 7:00 P.M. on Friday, April 10. At that time approximately
2/3 of the ore ultimately found to exist by the time of the preparation of the April 16 “major strike’ release had been discovered by 5
holes placed so as to indicate continuity of mineralization within the large anomaly. As of that time SEC experts estimated ore
reserves of over 8 million tons at a gross assay value (excluding costs) of over $26 a ton. Accepting the conservative view of
Case 42.2
C.A.9,2010.
Gebhart v. S.E.C.
595 F.3d 1034, 10 Cal. Daily Op. Serv. 1987, 2010 Daily Journal D.A.R. 2437
United States Court of Appeals,
FN1. The NASD is now the Financial Industry Regulatory Authority (FINRA).
I. BACKGROUND
Alvin Gebhart has been in the securities industry since 1983.FN2 In 1994, he began working at Mutual of New York (MONY) in San
FN2. In May 1983, Gebhart registered with the NASD as an investment company products and variable contracts
representative (“IC representative”) with the Prudential Insurance Company of America. In January 1996, he became
associated with Mutual Service Corporation (MSC), a NASD member, as an IC representative. In December 1997, he
passed the Series 7 general securities representative qualifying examination and became associated with MSC as a
general securities representative.
In early 1996, Gebhart moved from MONY to another financial services firm, Mutual Service Corporation (MSC), a broker-dealer
and member of the NASD. His wife, Donna Gebhart, joined him at MSC and the two opened and operated a MSC branch in
Rancho Bernardo, California, where they sold insurance and annuities and provided financial planning services to clients. In
October 1996, Archer approached the Gebharts about selling MHP notes to their MSC clients. The Gebharts met with Archer for
about 40 minutes. Archer told them that the MHP program had been approved by the compliance officer at Archer’s firm, MONY.
had good cash flow and that would be a deal worth them doing.” Although the Gebharts believed that their clients’ loans would be
secured by second trust deeds, they did not inquire why they were not first trust deeds or who held the first trust deeds. In lieu of
an independent investigation, the Gebharts relied on Archer’s representations. As Alvin Gebhart explained:
Throughout our four-year relationship, Mr. Archer continually stressed the strength of this program. Even in February [2000]
when he spoke to Mr. Dave Mounier, the other principal [in MHP], he indicated that the parks were deep with equity. Donna and I
Between the Gebharts’ meeting with Archer in October 1996 and CSG’s collapse in 2000, the Gebharts sold nearly $2.4 million in
MHP promissory notes to 45 of their clients, earning about $105,000 in commission fees.FN3 The sales were based on several
statements by the Gebharts that, it later became clear, were false. The Gebharts told their clients that the MHP notes were a
proven investment that offered substantial returns and were secured by recorded deeds of trust. They said that in the worst case
scenario their clients would be part owners of the mobile home parks and would be able to recover their investments. In fact, the
FN3. The Gebharts also invested thousands of dollars of their own funds in the notes between 1996 and 1999.
CSG and MHP collapsed in the middle of 2000. In May, Scovie sent a letter to MHP noteholders explaining that an illness was
FN4. The Gebharts’ clients pursued a number of remedies, with the apparent support of the Gebharts, and were
eventually able to recover about 84 percent of their investments.
FN5. In addition to the fraud claims, the NASD complaint alleged that the Gebharts had offered and sold unregistered
securities, in violation of NASD Conduct Rule 2110, and engaged in private securities transactions, in violation of Conduct
Rules 2110 and 3040. The NASD found that the Gebharts had indeed violated these provisions and the SEC affirmed the
NASD’s findings. The Gebharts do not contest those findings in this appeal. Only the fraud charges are at issue here.
FN6. NASD Conduct Rule 2120 provides: “No member shall effect any transaction in, or induce the purchase or sale of,
any security by means of any manipulative, deceptive or other fraudulent device or contrivance.”
CHAPTER 42: CORPORATE SECURITIES LAW AND CORPORATE GOVERNANCE 663
The Gebharts petitioned for review of the SEC decision. We vacated and remanded in an unpublished decision,
Gebhart v. SEC,
FN7. “The Commission’s conclusions of law are to be set aside if arbitrary, capricious, or otherwise not in accordance with
law.”
Ponce v. SEC,
345 F.3d 722, 728 (9th Cir.2003) (quoting
Rutherford v. SEC,
842 F.2d 214, 215 (9th Cir.1988))
(internal quotation marks omitted).
Section 10(b) of the Securities Exchange Act of 1934 states, in relevant part:
Cir.1993) (discussing the elements the SEC must prove to establish a misrepresentation violating Rule 10b-5).FN8 “The plaintiffs
may establish scienter by proving either actual knowledge or recklessness.”
In re Software Toolworks Inc.,
50 F.3d 615, 626 (9th
Cir.1994);
see Ponce,
345 F.3d at 729 (“[S]cienter may be established by demonstrating that the defendant acted recklessly.”
(citing
Hollinger v. Titan Capital Corp.,
914 F.2d 1564, 1568-69 (9th Cir.1990) (en banc))).
FN8. The elements of a section 10(b) or Rule 10b-5 claim vary depending on the identities of the parties and the nature of
the relief sought. In a
private
securities fraud action, the plaintiff generally must prove five elements: (1) a material
misrepresentation or omission of fact; (2) scienter; (3) a connection with the purchase or sale of a security; (4) transaction
and loss causation; and (5) economic loss.
Zucco Partners, LLC v. Digimarc Corp.,
552 F.3d 981, 990 (9th Cir.2009). Our
FN9. In some circumstances not relevant here, the Private Securities Litigation Reform Act (PSLRA) requires a showing
664 CASE PRINTOUTS TO ACCOMPANY BUSINESS LAW
that the defendants knew their statements were false.
See
15 U.S.C. § 78u-5(c)(1)(B)(i) (requiring “actual knowledge …
that the statement was false or misleading” in private securities actions challenging forward-looking statements). The
FN10. The conclusion that we require either knowledge of falsity or conscious recklessness is supported by our decision
in
In re Silicon Graphics Inc. Securities Litigation,
183 F.3d 970 (9th Cir.1999),
abrogation on other grounds recognized by
South Ferry LP,
542 F.3d at 784, where we explained that, in the securities fraud context, scienter requires “deliberate
recklessness,” which we defined as conduct reflecting “some degree of intentional or conscious misconduct.”
Id.
at 977.
Cir.1994) (applying good faith standard);
In re Worlds of Wonder Sec. Litig.,
35 F.3d 1407, 1425 (9th Cir.1994) (same);
In re Apple
Computer Sec. Litig.,
886 F.2d 1109, 1117-18 (9th Cir.1989) (same);
cf.
Restatement (Second) of Torts § 526 cmt. d (“The fact that
the misrepresentation is one that a man of ordinary care and intelligence in the maker’s situation would have recognized as false is
not enough to impose liability …,
but
it is evidence from which his lack of honest belief may be inferred.” (emphasis added)).FN11
FN11. Our decision in
Kaplan
is illustrative of the respective roles played by the objective and subjective components of
the scienter inquiry. We began by citing
Hollinger
and observing that scienter can be established by showing an extreme
departure from the ordinary standards of care and an obvious danger of misleading investors. 49 F.3d at 1378. But we
also observed that several defendants had submitted sworn declarations testifying that they believed in good faith that
their statements were true.
Id.
at 1379. The plaintiff argued that he had presented sufficient evidence of scienter to survive
CHAPTER 42: CORPORATE SECURITIES LAW AND CORPORATE GOVERNANCE 665
objective inquiry and disregarding evidence of subjective good faith. We disagree. The SEC considered all of the evidence bearing
on the Gebharts’ actual state of mind, including the Gebharts’ extreme departure from ordinary standards of care, and found that
the Gebharts were consciously aware of the risk that their statements were false. There was no error.
The SEC certainly considered the objective unreasonableness of the Gebharts’ actions as
part
of its analysis. The SEC found that
statements to clients.” It evaluated “the evidence the Gebharts put forward to demonstrate their good faith beliefs” as “part of the
complete mix of facts bearing on an evaluation of their [actual] state of mind” and concluded that the “[e]vidence from the Gebharts
about their subjective belief [wa]s not sufficient to overcome” the inference of scienter created by the evidence as a whole. The
Gebharts’ assertions of good faith were “not plausible” and lacked “credibility.” Based on the evidence as a whole, the SEC
determined that the Gebharts “knew they had no direct knowledge of the truth or falsity” of their statements, and made their
Munoz v. INS,
327 F.3d 892, 895 (9th Cir.),
amended by
339 F.3d 1012 (9th Cir.2003) (quoting
Singh-Kaur v. INS,
183 F.3d 1147,
1149-50 (9th Cir.1999)) (internal quotation marks omitted). If the evidence is susceptible to more than one rational interpretation,
we may not substitute our judgment for that of the agency.
Bear Lake Watch, Inc. v. Fed. Energy Regulatory Comm’n,
324 F.3d
1071, 1076 (9th Cir.2003).
[15] The Gebharts point out that there is
some
evidence supporting an inference that they genuinely believed that they had an
FN12. The Gebharts contend that they conducted an adequate investigation into the MHP program and that they
666 CASE PRINTOUTS TO ACCOMPANY BUSINESS LAW
sincerely believed they had a reasonable basis for their statements that the MHP notes were secured and that the parks
were not overencumbered. In addition to their own purchases of MHP notes, they point to (1) their mistaken belief (based
on Archer’s statements) that MONY had approved the MHP program; (2) their having informed MSC’s compliance officer
740–41.
PETITION DENIED.
Case 42.3
C.A.7 (Wis.),2009.
Stark Trading v. Falconbridge Ltd.
552 F.3d 568, Fed. Sec. L. Rep. P 95,028
United States Court of Appeals,
Seventh Circuit.
STARK TRADING and Shepherd Investments International Ltd., Plaintiffs-Appellants,
v.
FALCONBRIDGE LIMITED and Brascan Corporation, Defendants-Appellees.
No. 08-1327.
Argued Sept. 8, 2008.
Decided Jan. 5, 2009.
POSNER, Circuit Judge.
The plaintiffs have appealed from the dismissal, for failure to state a claim, of their securities fraud suit. The suit is
CHAPTER 42: CORPORATE SECURITIES LAW AND CORPORATE GOVERNANCE 667
based primarily on the Securities and Exchange Commission’s Rule 10b-5. The claims they make under other
provisions of federal securities law-all but section 11 of the Securities Exchange Act, 15 U.S.C. § 77k, which we
discuss at the end of this opinion-fall with the 10b-5 claim.
The parties have spent too much time in this court, as they did in the district court, arguing over whether the typically
without regard*570 to scienter or the other issues that the parties have spent years jousting over.
The complaint tells the following story. Brascan Asset Management, Inc. (now called Brascan Corporation) owned 41
percent of the common stock of Noranda, Inc., which in turn owned 59 percent of Falconbridge, Inc., both being large
Canadian mining companies. Brascan wanted to get out of Noranda. It was able to cause Noranda to offer Noranda’s
common stockholders, who of course included Brascan, preferred stock in exchange for their common stock. (That is
called an issuer bid.) Noranda agreed to redeem the preferred stock for cash, at a price of $25 a share, which
exceeded the current market value of the common stock. By redeeming, Brascan would be able to exchange its
shares for cash and thus achieve its objective of getting out of Noranda. Why it didn’t cause Noranda simply to offer
$25 per share to all the common stockholders, thus cutting out the intermediate swap of common for preferred, is not
explained, but probably was connected with the next and critical transaction, for which Noranda needed a lot of its
common stock.
For on the same day that it announced the issuer bid (March 9, 2005), Noranda also announced that it would offer
every minority shareholder in Falconbridge 1.77 shares of Noranda common stock for each share of Falconbridge
common stock that the shareholder tendered. The offer was conditioned on being accepted by more than half the
minority shareholders (the half being weighted of course by number of shares).
The offer succeeded, and the two hedge funds that are the plaintiffs in this case were among the minority
shareholders who tendered their stock by the expiration date, May 5. Three months later, Noranda and Falconbridge
merged. The resulting firm was named Falconbridge Limited, and was eventually acquired by a Swiss mining
company named Xstrata. But in October 2005, before that acquisition, another mining company, Inco, offered to buy
Falconbridge Limited at a price substantially above the tender-offer price (1.77 shares of Noranda common stock for
every share of Falconbridge common stock) that the plaintiffs had received for their Falconbridge stock.
The plaintiffs had begun buying that stock on March 17; they do not say when they stopped, except that it had to be
before the May 5 deadline for tendering. They had bought into Falconbridge because they thought the company was
worth more than its current capitalization by the stock market. At the same time that they had bought Falconbridge
shares they had sold some Noranda stock short, apparently as a hedge. According to the complaint, Falconbridge
was Noranda’s major asset (how major, no one has bothered to tell us), so if its shares fell in value or even just failed
to rise Noranda’s share price would probably fall and the plaintiffs would obtain some profits from their short sales to
offset the lack of profit from being long in Falconbridge. By the same token, if Falconbridge’s stock rose in price
Noranda’s stock price probably would rise too and if it did the plaintiffs would lose money from their short sale. But
they thought Falconbridge stock more likely to rise, and so invested much less in selling stock in Noranda short than
in buying stock in Falconbridge.
668 CASE PRINTOUTS TO ACCOMPANY BUSINESS LAW
plaintiffs believed they were buying an undervalued stock, and events after their purchase, culminating in Xstrata’s
purchase of Falconbridge Limited (Falconbridge’s successor) at a high price, proved them correct. They do argue that
the issuer bid (the offer to swap preferred stock in Noranda for common stock) inflated the apparent value of Noranda
stock, and therefore made the offer of Noranda stock for Falconbridge stock look generous. But they were not fooled.
They knew that the tender offer undervalued Falconbridge-that Noranda was trying to buy out the minority
shareholders (thus including the plaintiffs) cheap.
They admit that before the period for tendering their Falconbridge shares to Noranda expired, they “became aware of
some of the inaccuracies in the offering documents”-and that is an understatement. On April 29, a week before the
deadline in the tender offer, they wrote a letter to the Ontario Securities Commission that alleges, and in considerable
detail (the letter, including enclosures, runs to 21 pages, much of it in fine print), most of the facts that their complaint
charges as fraud, such as: (1) concealing a conflict of interest of the investment bank that had provided a valuation of
Falconbridge for the tender offer, and of the special committee of Falconbridge that had advised Falconbridge’s
minority shareholders to accept the offer on the basis of the investment bank’s valuation, and (2) overstating
Noranda’s value, thus enabling Noranda to pay for Falconbridge in a thoroughly debased currency (Noranda’s
overvalued stock), which further reduced the real price at which Noranda was able to buy out Falconbridge’s minority
shareholders.
The plaintiffs must have been gratified to learn, from their perceiving the “inaccuracies” in the tender-offer registration
statement, that they had been right that Falconbridge was undervalued; their letter to the securities commission was
calculated to force Noranda to sweeten its offer (though that never happened). But they say in paragraph 205 of the
complaint, which is the heart of their case, that they were afraid that the tender offer would succeed and that unless
they tendered their shares they would be squeezed out and Canadian law, which governs the squeezing out of
minority shareholders in a Canadian corporation, would not protect them, as U.S. law does, from a predatory majority
shareholder.
CHAPTER 42: CORPORATE SECURITIES LAW AND CORPORATE GOVERNANCE 669
and would have given the other minority shareholders pause.
This assumes that the plaintiffs knew something about the tender offer that other investors did not know. That is
unlikely, since the plaintiffs were not insiders. Almost certainly there was no deception but just a difference of opinion
in the investor community about the significance of the widely known circumstances of the tender offer. And if there
was
deception and the other minority shareholders were too dumb to perceive it even after being warned, why didn’t
the plaintiffs sue to enjoin the tender offer?
[4][5] If contrary to the common sense of the situation other minority shareholders were fooled even though the
plaintiffs were not, this might seem to allow the plaintiffs recourse to the doctrine of fraud on the market.
Basic Inc. v.
Levinson,
485 U.S. 224, 243-47, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988). If a fraud affects the price of a publicly traded
security, investors will be affected even if they trade without knowledge of the misrepresentations that influenced the
price at which they traded. They are “relying,” albeit indirectly, on the misrepresentations. “ ‘[R]eliance’ is a synthetic
term. It refers not to the investor’s state of mind but to the effect produced by a material misstatement or omission.
Reliance is the confluence of materiality and causation. The fraud on the market doctrine is the best example; a
$34.43, so that the 1.77 Noranda shares that the plaintiffs had received in exchange for each share of Falconbridge
were now worth C$60.94, which exceeded by C$21.35 what they had paid for the shares when they accepted the
tender offer. The plaintiffs coyly suggest that maybe they sold their shares, or some of them, before they sued, and
802-03 (7th Cir.2008). This suit was dismissed by the district court in January 2008, more than two years after it had
been filed. Just imagine how long it would have taken to dispose of the case by summary judgment after the usual