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June 14, 1984


The opinion of the court was delivered by: Prentice H. Marshall, District Judge.




Plaintiffs' § 10(b) claims are predicated on their allegation that defendants Waste Management, Inc. ("Waste Management") and several of its managing officers misrepresented or withheld information concerning the company's compliance with environmental regulations and disputes with regulatory authorities. Plaintiffs allege that defendants engaged in a course of conduct designed to deceive the public as to these matters, beginning with the issuance of Waste Management's 1981 annual report on March 31, 1982. Included in the course of conduct was an allegedly misleading prospectus issued in connection with a proposed merger between Waste Management and Chem-Nuclear, Inc. ("Chem-Nuclear"), a merger that was consummated in October 1982. In March 1983 the information allegedly withheld became public, and the price of Waste Management's stock dropped considerably.

Plaintiffs Stanley Grossman and Kenneth Frohlick both purchased Waste Management stock after receiving "buy" recommendations from an investment advisory service in February 1983. They represent the § 10(b) class. Plaintiff Cathy Chester acquired her Waste Management stock in connection with the merger with Chem-Nuclear; she was a Chem-Nuclear shareholder who tendered her stock in exchange for Waste Management stock. Though Chester has pleaded claims under § 10(b), we ruled in our February 6 decision that she was not a proper representative of the § 10(b) class because she was subject to a unique defense to which the class might not be subject. However, Chester does represent the § 11 class, which is made up of those persons who acquired Waste Management stock in connection with the Chem-Nuclear merger and who sustained damages as a result thereof. The § 11 claim stems from the allegedly misleading prospectus issued to Chem-Nuclear shareholders in connection with the proposed merger.

A. Introduction.

As we noted in our decision certifying the § 10(b) class, the primary legal theory upon which plaintiffs base their § 10(b) claims is that defendants' conduct amounted to a "fraud on the market" that resulted in the inflation of the price of Waste Management stock. In the present motions, defendants argue that we should not accept the fraud on the market theory as providing a basis for relief under § 10(b) and SEC rule 10b-5, and that in any event defendants have shown that plaintiffs are not entitled to the benefit of that theory under the facts of this case. We will first discuss the general principles that govern our consideration of defendants' motions and then will address each named plaintiff's claim separately.

In addition, defendants urge that their disclosures were adequate, at least in certain respects; they therefore ask that we find in their favor as to certain of plaintiffs' allegations, pursuant to Fed.R.Civ.P. 56(d).*fn1 We will address that question after dealing with the named plaintiffs' claims.

In a typical 10b-5 action in which the plaintiff asserts that the defendant made misrepresentations, the plaintiff bears the burden of persuasion as to several factors as prerequisites to recovery:

  1) that he purchased or sold securities, Blue Chip
  Stamps v. Manor Drug Stores, 421 U.S. 723, 95 S.Ct.
  1917, 44 L.Ed.2d 539 (1975);
  2) that the defendant misrepresented facts either
  with an intent to deceive, Ernst & Ernst v.
  Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d
  668 (1976), or with a reckless disregard for the
  truth, Sundstrand Corp. v. Sun Chemical Corp.,
  553 F.2d 1033, 1043-45 (7th Cir.), cert. denied,
  434 U.S. 875, 98 S.Ct. 224, 54 L.Ed.2d 155 (1977);
  3) that the defendant's misrepresentations were
  material, Sundstrand, 553 F.2d at 1040 (citing TSC
  Industries, Inc. v. Northway, Inc., 426 U.S. 438,
  440, 96 S.Ct. 2126, 2128, 48 L.Ed.2d 757 (1976));
  4) that the plaintiff relied upon the
  misrepresentations, id.; and
  5) that the plaintiff's reliance was justifiable in
  the sense that plaintiff did not disregard a risk
  known to him or so obvious that he must be taken to
  have been aware of it, and so great as to make it
  highly probable that harm would follow. Id. at 1048
  (citing with approval Holdsworth v. Strong,
  545 F.2d 687, 693 (10th Cir. 1976) (en banc)); Dupuy v. Dupuy,
  551 F.2d 1005, 1017-20 (5th Cir.), cert. denied,
  434 U.S. 911, 98 S.Ct. 312, 54 L.Ed.2d 197 (1977).

The courts have also recognized that materiality, reliance, and the justifiability of the reliance are all elements of the plaintiff's burden of showing causation. See, e.g., Affiliated Ute Citizens v. United States, 406 U.S. 128, 154, 92 S.Ct. 1456, 1472, 31 L.Ed.2d 741 (1972) (materiality and reliance are elements of causation); Bell v. Cameron Meadows Land Co., 669 F.2d 1278, 1283 (9th Cir. 1982) (reliance is normally shown in order to demonstrate the causal connection between a defendant's wrongdoing and a plaintiff's loss); Holdsworth, 545 F.2d at 694 (viewing justifiability of reliance as element of causation). See generally R. Crane, "An Analysis of Causation under Rule 10b-5," 9 Sec.Reg.L.J. 99, 101 (1981).

In Affiliated Ute Citizens v. United States, the Court held that in a 10b-5 case involving primarily a failure to disclose, "positive proof of reliance is not a prerequisite to recovery." Affiliated Ute, 406 U.S. at 153, 92 S.Ct. at 1472. In such a case what must be shown to establish that defendant's conduct was the cause of plaintiff's purchase is that "the facts withheld [are] material in the sense that a reasonable investor might have considered them important in the making of [his] decision." Id. at 153-54, 92 S.Ct. at 1472-73. The courts have also held, as in the case of misrepresentations, that if plaintiff's failure to discover the truth was the result of his own reckless or conscious disregard of information available to him, his right to recover is defeated. Sundstrand, 553 F.2d at 1048. However, since under Affiliated Ute reliance is essentially "presumed" to exist in an omissions case if the omission is material, the defendant bears the burden of showing that the plaintiff's non-discovery was attributable to his own conduct. Id.

In addition, most courts have held that the Affiliated Ute presumption of reliance may be rebutted in other ways. If, for example, the defendant can prove that the plaintiff's decision to buy or sell would have been the same even had he known the truth, it has rebutted the presumption of reliance. See, e.g., Bell v. Cameron Meadows Land Co., 669 F.2d at 1283. Some courts have expressed this in a slightly different way: if defendant can show that plaintiff's decision would not have been affected if defendant had disclosed the omitted facts, then recovery is barred. See, e.g., Zobrist v. Coal-X, Inc., 708 F.2d 1511, 1519-20 (10th Cir. 1983); Rifkin v. Crow, 574 F.2d 256, 262 (5th Cir. 1978). For example, proof that the plaintiff did not read the publication in which the omissions occurred has been held sufficient to rebut the presumption of reliance. Zobrist, 708 F.2d at 1519-20; Shores v. Sklar, 647 F.2d 462, 468 (5th Cir. 1981) (en banc), cert. denied, 459 U.S. 1102, 103 S.Ct. 722, 74 L.Ed.2d 949 (1983).

Affiliated Ute's presumption of reliance is based on the practical impossibility of proving reliance in a case where no allegedly false statements have been made. See Wilson v. Comtech Telecommunications Corp., 648 F.2d 88, 93 (2d Cir. 1981). See also Note, The Reliance Requirement in Private Actions Under SEC Rule 10b-5, 88 Harv.L.Rev. 584, 590 (1975). However, where the omissions that form the basis for plaintiff's claim are contained in a particular disclosure (such as a prospectus or offering circular), it has been held that the plaintiff cannot recover if he never read or knew of the disclosure, for in such a case the omissions cannot have been a cause of his purchase of the security. Wilson, 648 F.2d at 93-94; see R. Crane, supra at 106.

B. Fraud on the Market

Some courts have extended the Affiliated Ute presumption of reliance to cases in which, unlike Affiliated Ute, there is no direct contact between the plaintiff and the person making the alleged misrepresentations or omitting to disclose material facts. One such situation is the "fraud on the market" theory on which plaintiffs rely. Under Blackie v. Barrack, 524 F.2d 891 (9th Cir. 1975), cert. denied, 429 U.S. 816, 97 S.Ct. 57, 50 L.Ed.2d 75 (1976), the seminal case concerning fraud on the market, an open market purchaser of a security for which there is a developed market may maintain a cause of action by alleging that he purchased stock the price of which was inflated due to defendant's fraud. Under this theory, "a plaintiff . . . 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." In re LTV Securities Litigation, 88 F.R.D. 134, 142 (N.D.Tex. 1980). The rationale for extending the presumption of reliance to such a case was explained in Blackie v. Barrack:

  A purchaser on the stock exchanges . . . relies
  generally on the supposition that the market price is
  validly set and that no unsuspected manipulation has
  artificially inflated the price, and thus indirectly
  on the truth of the representations underlying the
  stock price — whether he is aware of it or not, the
  price he pays reflects material misrepresentations.
  Requiring direct proof from each purchaser that he
  relied on a particular representation would defeat
  recovery by those whose reliance was indirect,
  despite the fact that the causational chain is broken
  only if the purchaser would have purchased the stock
  even had he known of the misrepresentation.

Blackie, 524 F.2d at 907. According to the court in LTV,

  [t]he presumption can be considered as recognition of
  the market's role as a transmission belt linking the
  misrepresentation and the individual purchaser or
  seller . . . . In face-to-face transactions, the
  inquiry into an investor's reliance upon information
  is into the subjective pricing of that information by
  the investor. With the presence of a market, the
  market is interposed between seller and buyer, and
  ideally, transmits information to the investor in the
  processed form of a market price. Thus the market is
  performing a substantial part of the valuation
  process performed by the investor in a face-to-face
  transaction. The market is acting as the unpaid agent
  of the investor, informing him that given all the
  information available to it, the value of the stock
  is worth the market price.

LTV, 88 F.R.D. at 143.

At least one other court of appeals had approved of Blackie. In Panzirer v. Wolf, 663 F.2d 365 (2d Cir. 1981), vacated as moot, 459 U.S. 1027, 103 S.Ct. 434, 74 L.Ed.2d 594 (1982), the Second Circuit, noting that "[p]roving reliance is difficult where the fraud has affected the market and damaged the plaintiff only through its effect on the market," id. at 368, the court approved of Blackie and indeed extended it to one whose reliance on the market is only indirect, as will be seen infra. See also Ross v. A.H. Robins Co., 607 F.2d 545, 553 (2d Cir. 1979) (implicitly approving Blackie), cert. denied, 446 U.S. 946, 100 S.Ct. 2175, 64 L.Ed.2d 802 (1980). In addition, the Blackie theory has been expressly or implicitly accepted by most of the district courts considering it. See, e.g., Beebe v. Pacific Realty Trust, 99 F.R.D. 60, 68 (D.Ore. 1983); HSL, Inc. v. Daniels, [Current] Fed.Sec.L.Rep. (CCH) ¶ 99,557 at 97,197-98 (N.D.Ill. 1983) (Roszkowski, J.); Schlanger v. Four-Phase Systems, Inc., 555 F. Supp. 535, 537-38 (S.D.N.Y. 1982); McNichols v. Loeb Rhoades & Co., 97 F.R.D. 331, 336 (N.D.Ill. 1982) (Getzendanner, J.); Mottoros v. Abrams, 524 F. Supp. 254, 258-60 (N.D.Ill. 1981) (Grady, J.); Pellman v. Cinerama, Inc., 89 F.R.D. 386, 388 (S.D.N.Y. 1981); Wolgin v. Magic Marker Corp., 82 F.R.D. 168, 174 (E.D.Pa. 1979); Lewis v. Capital Mortgage Investments, 78 F.R.D. 295, 308-09 (D.Md. 1977); Sargent v. Genesco, Inc., 75 F.R.D. 79, 85 (M.D.Fla. 1977).

Defendants argue that two courts of appeal have declined to adopt Blackie when faced with circumstances that might have occasioned its adoption. In Shores v. Sklar, 647 F.2d 462 (5th Cir. 1981) (en banc), cert. denied, 455 U.S. 936, 102 S.Ct. 1424, 71 L.Ed.2d 646 (1982), the court addressed a 10b-5 claim concerning securities that plaintiff had purchased in connection with an initial offering. Plaintiff alleged in part that defendants had engaged in a scheme to create a bond issue that would appear genuine but that was so deficient that it never would have been approved for issuance absent the scheme to defraud. The court reversed the district court's dismissal of the complaint, stating that "[t]he requisite element of causation in fact would be established if [plaintiff] proved the scheme was intended to and did bring the bonds onto the market fraudulently and proved he relied on the integrity of the offerings of the securities market." Id. at 469. The court went on to state that 10b-5 misrepresentation cases requiring reliance on the document making the misrepresentation "are inapposite to a case in which the buyer relied on the integrity of the market to furnish securities which were not the product of a fraudulent scheme." Id. at 471. In support of that assertion, the court cited Blackie. Id. at 471 n. 11.

We view Shores as an extension of Blackie to a case in which no developed market for the security existed. In the case of shares of stock for which a developed market exists, the investor under the Blackie theory relies on the supposition that the price of the stock has not been affected by fraudulent misrepresentations or omissions. In a case under the Shores theory, since no market as such exists, the investor relies on the fact that the securities would not have been offered absent the scheme to defraud — in other words, upon the integrity of the market itself, rather than the integrity of market's price. Rather than rejecting or limiting Blackie, the Shores court's implicit reliance upon the case in footnote 11 implied acceptance of the Blackie doctrine. See Lipton v. Documentation, Inc., [Current] Fed.Sec.L.Rep. (CCH) ¶ 98,788 at 94,042 (M.D.Fla. 1982) (reading Shores as an extension of Blackie).

The fraud on the market theory, as applied to a developed securities market, assumes that the market price of stock reflects all available public information, including material misrepresentations. As discussed at length in LTV, 88 F.R.D. at 144-45, economic studies tend to support this assumption. In addition, the policies of the securities law supports adoption of the fraud on the market approach. As defendants themselves suggest, one central purpose of the 1933 and 1934 acts is full disclosure. See Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 477-78, 97 S.Ct. 1292, 1302-03, 51 L.Ed.2d 480 (1977); LTV, 88 F.R.D. at 145. Notwithstanding defendants' arguments to the contrary, we think that the Blackie theory promotes that goal in that if full disclosure is made by an issuer of securities, that information is, under the "efficient market" theory that underlies Blackie, absorbed by the market, and recovery by an open market purchaser is unavailable. That Blackie may tend to put more of a premium on full disclosure by an issuer does not make it antithetical to the goals of the securities laws.*fn2

We also reject defendants' suggestion that adoption of the fraud on the market theory is tantamount to establishment of a scheme of investor insurance. First, the Supreme Court itself has noted that the 1933 and 1934 acts were aimed "to protect investors against fraud and . . . to promote ethical standards of honesty and fair dealing. Ernst & Ernst v. Hochfelder, 425 U.S. at 195, 96 S.Ct. at 1382 (citing H.R. Rep. No. 85, 73d Cong., 1st Sess. 1-5 (1933)). "The basic intent of section 10(b) and rule 10b-5 . . . is to protect investors and instill confidence in the securities markets by penalizing unfair dealings." Shores, 647 F.2d at 470 (quoting Sargent v. Genesco, Inc., 492 F.2d 750, 760 (5th Cir. 1974)). See also Sundstrand, 553 F.2d at 1050 ("the ultimate goal of securities regulation is to achieve fundamental fairness in the marketplace . . . . [T]he focus is on controlling practices which smack of fraud."); Sargent v. Genesco, Inc., 75 F.R.D. at 84 (one purpose of the 1934 act is to "achiev[e] a high standard of integrity in the securities industry"). In addition, the fraud on the market theory does not excuse a 10b-5 plaintiff from showing that the defendant intentionally or recklessly made misstatements or omissions of fact that were material, and that plaintiff purchased or sold securities the price of which was inflated by the misrepresentations.

For these reasons, we hold that the fraud on the market theory of recovery, as described in Blackie v. Barrack, is a viable means of proving liability in a 10b-5 action.

C. Reliance on Factors Other Than the Market

Defendants next argue that the plaintiffs here are not entitled to the benefit of the Blackie theory. We will discuss the particular facts of each named plaintiff's case infra at 407-414. For the present, we will confine ourselves to a discussion of defendants' argument that where a plaintiff is shown to have relied in purchasing securities on factors ...

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