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DRAKE v. THOR POWER TOOL COMPANY

September 15, 1967

RUSSELL P. DRAKE FOR AND ON BEHALF OF HIMSELF AND ON BEHALF OF ALL STOCKHOLDERS AND FORMER STOCKHOLDERS OF THOR POWER TOOL COMPANY, SIMILIARLY SITUATED, PLAINTIFF,
v.
THOR POWER TOOL COMPANY, A DELAWARE CORPORATION, AND PEAT, MARWICK, MITCHELL & CO., A PARTNERSHIP, DEFENDANTS.



The opinion of the court was delivered by: Parsons, District Judge.

MEMORANDUM OPINION AND ORDER

Plaintiff Drake complains that he purchased Thor stock through the facilities of the New York Stock Exchange at a time when the assets and profits of Defendant Thor were being fictitiously reported in its financial statements and thereupon promulgated to the public as well as to Thor's stockholders, and that when the true financial condition became known the price of Thor shares as then traded on the New York and Midwest Stock Exchanges dropped precipitously. Thor is charged with falsification of its inventory and sales figures and issuing financial statements reflecting such false figures. Peat, Marwick, Mitchell & Co., Thor's independent accounting firm, is charged with applying inappropriate accounting procedures with respect to the Thor audits and uttering untrue certifications of Thor's false financial statements. The cause is a class action on behalf of certain persons similar to plaintiff who had bought and subsequently sold their shares. In another action, Greenwald et al. v. Lind et al., 65 C 1928, a complaint was filed by persons who are still stockholders as a class action. The two suits have been consolidated.

A Rule 10b-5 claim is alleged as well as claims under § 18 and § 14 of the Securities Exchange Act of 1934, and a common law claim against Peat, Marwick.

The Defendant, Peat, Marwick, has filed a motion to dismiss the action, but the points raised in its motion had been ruled upon by Judge Hoffman in Greenwald and are controlling. However, Defendant also urges that this Court's recent decision in Jordan Building Corp. v. Doyle, O'Connor & Co., 282 F. Supp. 87, N.D.Ill., July 18, 1967, is controlling with regard to the right to sue under Section 10b-5. This memorandum is devoted to an elaboration of the holding in Jordan as the present case is found to be distinguishable.

In Jordan, this Court had granted the defendants' motion to dismiss plaintiff's complaint, which alleged a claim under 10b-5 that plaintiff had purchased debentures which were an original issue in a private sale and relied upon the representations in a prospectus of the defendant and representations of underwriters that the defendant company was in a sound financial condition when in fact the company was on the verge of economic collapse. The holding was based upon a careful consideration of the current state of the law regarding 10(b)-5.

Section 10(b) of the 1934 Act, 15 U.S.C. § 78j, 48 Stat. 891, provides:

    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 —
    (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.

Rule 10b-5 C.F.R. § 240.10b-5, as promulgated by the Securities and Exchange Commission, provides:

    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 statement 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.

Whether Congress intended that an implied private civil remedy exists with reference to 10(b), 15 U.S.C. § 78j, and Rule 10b-5 is questionable. Ruder, Civil Liability Under Rule 10(b)-5: Judicial Revision of Legislative Intent, 57 Nw.U.L.Rev. 627 (1963). Nevertheless, beginning with Judge Kirkpatrick's opinion in Kardon v. National Gypsum Co., 73 F. Supp. 798 (E.D.Pa. 1947), the courts have consistently found that Section 10(b) and Rule 10b-5 imply a remedy for private relief. The issue is no longer raised in litigation. Klein, The Extension of A Private Remedy To Defrauded Securities Investors Under SEC Rule 10B-5, 20 U. of Miami L.Rev. 81 (1965), and cases cited therein. Jennings and Marsh, Securities Regulation: Cases and Materials, at 777 (1963); Fratt v. Robinson, 203 F.2d 627, 37 A.L.R.2d 636 (9th Cir. 1953); Robinson v. Difford, 92 F. Supp. 145 (E.D.Pa. 1950); Speed v. Transamerica Corp. (D.C.Del. 1951) 99 F. Supp. 808; Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2d Cir. 1952); Fischman v. Raytheon Mfg. Co., 188 F.2d 783 (2d Cir. 1951); A.T. Brod & Co. v. Perlow, 375 F.2d 393 (2d Cir. 1967); Vine v. Beneficial Finance Company, 374 F.2d 627 (2d Cir. 1967). This civil remedy has been recognized in the Seventh Circuit as well. James Blackstone Memorial Library Ass'n v. Gulf, M.& O.R.R., 264 F.2d 445 (7th Cir. 1959) cert. den. 361 U.S. 815, 80 S.Ct. 56, 4 L.Ed.2d 62 (1959); Dasho et al. v. The Susquehanna Corp. et al., 380 F.2d 262 (7th Cir., June 26, 1967); Kohler v. Kohler Co., 280 F. Supp. 808 (E.D.Wis. 1962); Northern Trust Co. v. Essaness Theater Corp., 103 F. Supp. 954 (N.D.Ill. 1952).

The courts have used Rule 10b-5 to expand the range of liability in the realm of securities transactions, thereby creating a Federal common law which is in a state of flux. King, Recent Developments Concerning the 1933 Securities Act, and 1934 Securities Exchange Act, 20 U. of Miami L.Rev. 919 (1966); Note, 52 Mich.L.Rev. 893. A recognized authority on the law of securities has expressed his reaction to this development:

  * * * What has happened to Rule 10b-5, the great
  Freeman rule, always reminds me of a cartoon of
  the time showing Mussolini dictating to his
  secretary, and the caption was, "Miss
  Baccigalupi, take a law."
    Whenever I try to explain to a foreign lawyer,
  as I have on a number of occasions, how we have
  developed in this country a scheme for grappling
  with the problems of insider preferences and so
  on, more and more I become increasingly ashamed,
  and that is the only word I can use at this sort
  of jurisprudence. It is awfully hard, really, to
  explain with a straight face, how it is that this
  came about in this great country of ours. It is a
  development that, needless to say, I applaud. It
  was long overdue. But do we have to go on
  indefinitely basing this whole revolutionary
  change on a section of the Exchange Act that says
  it shall be unlawful for any person in the
  purchase or sale of any security to engage in any
  act or practice that the S.E.C. prescribes as
  manipulative or deceptive? How big a house of
  cards can we continue to build on that? This is
  backdoor jurisprudence with a vengeance. Loss,
  History of S.E.C. Legislative Programs And
  Suggestions for A Code, 22 Bus.Lawyer 795, 796
  (1967).

The use of 10b-5, as encouraged by the Securities and Exchange Commission, has lead to the emergence of a Federal law of corporations. Matter of Cady Roberts & Co., CCH Fed.Sec.L.Rep. p. 76803 (1961); Ruder, Pitfalls In the Development of A Federal Law of Corporati ...


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