This securities case comes before us on plaintiff's motion in limine to preclude defendant from introducing at trial evidence purporting to show that plaintiff was "reckless" in either ignoring or discounting various facts concerning the Anchor Wire Company ("Anchor") before purchasing Anchor from defendant. For the reasons given below, we deny the motion.
In April 1986, plaintiff Elco Industries, Inc. ("Elco") purchased Anchor from defendant James W. Hogg ("Hogg"). A few months after the sale, Elco brought suit against Hogg, alleging that Hogg had violated sections 10(b), 12(2), and 17(a) of the Securities and Exchange Act, Illinois and Tennessee securities laws, and the common law of fraud. These violations resulted from Hogg's alleged failure, during negotiations leading to the sale, to disclose material facts about Anchor's embroilment in a price war. Hogg denied these allegations in his answer, but also maintained, as an affirmative defense, that Elco failed to exercise appropriate "due diligence" as a buyer in determining the material facts about Anchor and Anchor's market position. In our order of November 9, 1988, we granted Elco's motion to preclude Hogg from introducing evidence concerning Elco's due diligence. When Hogg responded that it would offer some evidence concerning Elco's "recklessness" as a purchaser, Elco made the present motion.
The principal evidence that Hogg has offered concerning Elco's alleged recklessness is the deposition and additional proposed testimony of its expert witness, Stanley V. Smith, a third party involved in the sale of Anchor. Smith's testimony concerns the information that Hogg passed on to Elco regarding Anchor's efforts to meet its competitors' price cuts with competitive pricing and Smith's opinions of what a prudent purchaser would have done with this information. Additionally, Hogg apparently wishes to introduce Smith's opinions to the effect that Elco was "reckless" in its method of evaluating the impact of price competition upon Hogg's revenue and profitability.
As this court held in its November 9, 1988 order, it is not a defense to a 10(b) fraud claim that a buyer failed to exercise due diligence in investigating the securities for sale. Although such a standard was used at one time, it was generally abandoned in the wake of Ernst & Ernst v. Hochfelder, 425 U.S. 185, 47 L. Ed. 2d 668, 96 S. Ct. 1375 (1976), in which the Supreme Court held that plaintiffs in 10(b) actions must show that defendants acted with scienter in failing to make material disclosures. Since defendants could no longer be sued under 10(b) for merely negligent omissions, courts in subsequent cases found it unreasonable to permit a defendant to use a plaintiff's negligence as a defense.
Although it is clear that a plaintiff's actions as purchaser can still constitute a defense to a 10(b) action, there are a number of standards concerning what type of behavior precludes recovery. These varied standards were aptly summarized by Justice White in 1977, when he urged the Supreme Court to clarify the applicable law by granting certiorari in Dupuy v. Dupuy, 551 F.2d 1005 (5th Cir. 1977):
This case concerns the standard of care required of plaintiffs seeking to recover damages for violations of § 10(b) . . . and SEC Rule 10b-5. In the wake of this Court's decision in Ernst & Ernst v. Hochfelder, the Courts of Appeals have reached differing conclusions as to the degree of diligence appropriately required. The court below held that because Ernst & Ernst had imposed on defendants a standard not stricter than nonrecklessness, a plaintiff would not be barred from recovery unless he had been reckless. Similarly, the Tenth and Seventh Circuits have held that, after Ernst & Ernst, the contributory fault of the plaintiff would bar recovery only if it constituted "gross conduct somewhat comparable to that of defendant." Also, the Third Circuit now "requires only that the plaintiff act reasonably" and has shifted to the defendant the burden of proving the plaintiff's unreasonable conduct. The Second Circuit, however, appears to adhere to the view that the plaintiff must demonstrate due diligence in discovering important information. . . .
Dupuy v. Dupuy, 434 U.S. 911, 54 L. Ed. 2d 197, 98 S. Ct. 312 (1977) (J. White, dissenting) (citations omitted).
The Court, however, denied certiorari in Dupuy, and the ambiguity in the law which concerned Justice White remains a decade later. Even within the Seventh Circuit, it is an open question whether a plaintiff's recklessness is a defense to a seller's intentional deceptions. The leading Seventh Circuit case, Sundstrand Corp. v. Sun Chemical, 553 F.2d 1033 (7th Cir.), cert. denied, Meers v. Sundstrand, 434 U.S. 875, 54 L. Ed. 2d 155, 98 S. Ct. 224 (1977), requires a defendant to show that the plaintiff engaged in "gross conduct somewhat comparable" to the defendant's own behavior, but leaves unclear whether a plaintiff's recklessness is "somewhat comparable" to a defendant's intentional misconduct. However, we believe that such a reading is at least implicitly supported by Sundstrand's language:
"If contributory fault of plaintiff is to cancel out wanton or intentional fraud, it ought to be gross conduct somewhat comparable to that of defendant." (citations omitted).