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July 8, 1981


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


Plaintiffs Eileen Kennedy and Frank Murphy filed this action as a claimed class action on behalf of the stockholders of Xcor International, Inc. ("Xcor") and as a claimed derivative action on behalf of Xcor. Defendants include Xcor, The Seeburg Corporation ("Seeburg"), Consolidated Entertainment, Inc. ("Consolidated"), Xcor's officers, directors, attorneys and accountants and a principal lender, and another alleged controlling person of Xcor, Gulf & Western Industries, Inc. ("G & W").

This Court's December 16, 1980 memorandum opinion and order (the "Opinion") dismissed plaintiffs' First Amended Complaint with leave to replead along the guidelines established in the Opinion, 503 F. Supp. 1116. Plaintiffs have now submitted their Second Amended Complaint (the "Complaint") stating six separate claims, and all defendants have moved to dismiss the Complaint. For the reasons stated in this memorandum opinion and order defendants' motions are granted except for the Complaint's sixth claim.

First Claim

In their first claim plaintiffs assert a class action by Xcor's shareholders for violations of Section 17 of the 1933 Act, 15 U.S.C. § 77q, and Rule 10b-5 arising from plaintiffs' purchase of their Xcor stock.*fn1 Plaintiffs' first two attempts to plead that claim were deficient in failing to allege any reliance by the plaintiffs on the documents containing the alleged misrepresentations and omissions. Plaintiffs now concede that they did not rely on or even read any of the documents generated by defendants containing the alleged misrepresentations and omissions. Rather they assert for the first time an entirely new basis for that claim: a "fraud on the market" theory.

Three Courts of Appeal have accepted such a theory of securities fraud: Shores v. Sklar, 647 F.2d 462 (5th Cir. 1981) (en banc); Blackie v. Barrack, 524 F.2d 891 (9th Cir. 1975); Ross v. A.H. Robins Co., 607 F.2d 545, 553 (2d Cir. 1979). Under that theory (In re LTV Securities Litigation, 88 F.R.D. 134, 142 (N.D.Tex. 1980)):

  A plaintiff asserting fraud on the market need not
  allege individual reliance but only that the
  plaintiff relied upon the integrity of the market
  price of the security which was distorted by the
  impact of the particular misstatements (citations
  omitted). Reliance is presumed once it is shown that
  a misrepresentation is material, or, what is
  substantially identical given the concept of
  materiality — once it is established that the
  material misrepresentation affected the price of the
  stock traded on the open market.

Although our own Court of Appeals has yet to adopt or reject the fraud on the market theory, this Court need not resolve that question to decide this motion. Plaintiffs have failed to plead the necessary ingredients of that cause of action in any event.

In Shores v. Sklar the Fifth Circuit, with ten judges dissenting in an en banc opinion, most recently accepted only a limited version of the fraud on the market theory. It upheld such a Rule 10b-5 action only if the securities were proved entirely unmarketable — if the bonds involved could not even have been offered for sale on the market but for the fraudulent misrepresentation of defendants. As the Court went on to state:

  If he proves no more than that the bonds would have
  been offered at a lower price or a higher rate,
  rather than that they would never have been issued or
  marketed, he cannot recover.

Here Complaint ¶ 95 alleges that the material omissions and misstatements by defendants artificially inflated the price of Xcor's stock. There is no allegation that such securities would not have been marketable but for defendants' allegedly unlawful acts.*fn2 Thus under the limited version of the fraud on the market theory adopted by the Fifth Circuit in Shores plaintiffs would not have a cause of action.

However the Second and Ninth Circuits have adopted a broader version of the fraud on the market theory, under which a cause of action lies for any open market purchaser who alleges that defendants inflated the market price of a security. Koenig v. Smith, 88 F.R.D. 604, 607 (E.D.N.Y. 1980). But even under that more expansive concept plaintiffs have failed to plead a crucial allegation. While plaintiffs allege that they purchased stock for an artificially inflated price they have failed to indicate what if any injury resulted. Complaint ¶ 95 states only that as a result of their acquisition of the Xcor securities "plaintiffs and the members of the class have been damaged by the defendants in an amount that is presently unknown to plaintiffs." But simply purchasing securities at an inflated price does not by itself indicate that an injury has occurred. It is possible, for example, that the defendants' alleged misstatements and omissions have continued to inflate the price and thus might possibly result in a gain rather than a loss for plaintiffs. In the typical fraud on the market case a plaintiff purchases a security when misstatements and material omissions by defendants have artificially inflated its market price. Thereafter corrective statements are issued causing a rapid decline in the value of the securities.

While it may be possible in certain limited circumstances for a plaintiff to suffer a loss even where the price of the stock has continued to rise (see In re LTV Securities Litigation, 88 F.R.D. at 148-49), it is axiomatic that there must be some injury to plaintiff in order to state a cause of action under Rule 10b-5. Because plaintiffs have alleged unlawful actions ...

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