413 F.

2d 353

CARROLL et al., Plaintiffs-Appellants,

United States Court of Appeals Seventh Circuit.

COPYRIGHT MATERIAL OMITTED John J. Enright, Sidney R. Zatz,

The principal issue presented by this appeal is whether the amended complaint
adequately states claims against the First National Bank of Lincolnwood,
Illinois (the "Bank"), under Section 10(b), of the Securities Exchange Act of
1934 (15 U.S.C. 78j(b)) and Rule 10b-5 of the Securities and Exchange
Commission (17 C.F.R. 240.10b-5). The district court dismissed this pleading
with respect to the Bank for failure to state a claim upon which relief could be
granted, while denying dismissal as to the individual defendants. Our
conclusion is that the amended complaint is sufficient, so that the case must be
remanded for trial of the claims against the Bank along with the other
defendants.

In order to set out separately the particular securities transactions by which

runs some 88 printed pages in the appendix. The odd-numbered Counts are
brought under Section 10(b) and Rule 10b-5, whereas the even-numbered
Counts are based on common law fraud. The plaintiffs are Link, Gorham, Peck
& Co. ("Link"), a Chicago securities dealer, and the three Chapter X
bankruptcy trustees of Edward N. Siegler & Co. ("Siegler"), a Cleveland, Ohio,
securities dealer having a branch office in Chicago.
3

The amended complaint charges that the Bank was a "main participant" in a
scheme or conspiracy to defraud plaintiff securities dealers "in connection with
the purchase and sale of securities" by means of materially false
representations, untrue statements of material facts, and the making of
misleading statements. Of the 23 individual defendants presently in the case,
five were officers or directors of the Bank and two were employees of
plaintiffs. All seven were described as main participants.

According to plaintiffs, the scheme originated in January 1966 and involved the
purchase of large amounts of securities at different times for speculative
purposes. The essence of the scheme was the creation of a "credit bubble" by
causing plaintiffs to finance such purchases and, in the expectation of rising
market values, "to obtain delay for the participants in payment and settlement
of purchases of securities made through and from the plaintiffs so [that] the
participants [could] hold speculative ownership positions in the securities
purchased by use of plaintiffs' funds and resources." The complaint also alleges
that purchases beyond the financial capacity of the participants were made for
the purpose of manipulating the market price of the purchased securities, thus
allowing the participants to unload the securities at inflated prices in order to
pay for their original purchases.

The purchases were C.O.D., requiring full cash payment only upon delivery of
the securities to the bank designated by the purchaser, in this case the defendant
Bank. The amended complaint alleges that as the relevant settlement drafts
were directed to the Bank, the Bank "received and held [each of] the drafts and
accompanying securities, without paying the draft or returning it, for as long as
possible." If the Bank were questioned about non-payment, the Bank, its
officers and two defendant employees of the Bank "obtained additional time by
making statements and giving assurances that arrangements for payment were
unavoidably delayed or were in progress, and that payment would be
forthcoming," even though these statements were untrue and misleading. Other
purported wrongdoing of the Bank, its officers and certain of its employees is
detailed in the amended complaint.

Finally, the Bank, its chairman, its president, one of its vice presidents, and one

of its assistant vice presidents are said to have assisted two of plaintiffs'
employees, now defendants, in this scheme by arranging for persons other than
the designated customers to pay the drafts and purchase the securities, without
the knowledge of plaintiffs, in order to conceal the participants' inability to
finance the purchase orders which they placed. It is alleged that the scheme
collapsed in a declining market for the accumulated securities, resulting in an
inability to prolong the shoestring purchases. In May 1966, the plaintiffs
discovered that the Bank was holding a large number of uncollectible drafts
drawn by plaintiffs and payable at the Bank for purchases of securities from
plaintiffs on behalf of participants in the scheme. The uncollectibility of these
drafts is said to have resulted in large losses to Link and the insolvency of
Siegler.

The Bank's motion to dismiss the amended complaint asserted that it did not
state a violation of Section 10(b) of the Securities Exchange Act or Rule 10b-5
of the Securities and Exchange Commission. The district court ruled that the
plaintiffs failed to state a claim upon which relief could be granted as to the
Bank, but the court refused to specify the basis for this conclusion. The pendent
common law fraud claims contained in the even-numbered Counts were
simultaneously dismissed as to the Bank, and final judgment was entered in its
favor. This appeal followed.

The Bank's principal argument is that Section 10(b) of the Securities Exchange
Act of 1934 and SEC Rule 10b-5 do not reach this case. On the other hand, in
its brief responding to the SEC's amicus curiae brief, the Bank confesses that it
should be retained as a defendant if the amended complaint charges that it and
the order defendants "attempted to peg the market in certain securities and to
unload the securities at the higher manipulated prices." Such a characterization
of this pleading is justified. For example, paragraphs 8, 9 and 14 of the
amended complaint describe just such a scheme, and the Bank is alleged to
have rendered active and knowing assistance in creating and maintaining the
ensuing credit bubble. Therefore, as the SEC has pointed out, retaining the
Bank in this suit would be entirely consonant with the undisputed goal of the
Securities Exchange Act to curb uncontrolled speculation on securities markets.

The Bank candidly admits that Section 10(b) contemplates protection for
sellers of securities and that plaintiffs "clearly plead having sold securities."
Nevertheless, it relies on the language in Section 10(b) limiting the
Commission to the promulgation of rules "in the public interest" and urges that
there is no public interest in protecting plaintiff brokers. A similar argument
was rejected in A. T. Brod & Co. v. Perlow, 375 F.2d 393 (2d Cir. 1967),1
where Section 10(b) and Rule 10b-5 were held applicable to protect brokers

against manipulative and deceptive devices. As the Court said (at p. 397):
10

"We believe that 10(b) and Rule 10b-5 prohibit all fraudulent schemes in
connection with the purchase or sale of securities, whether the artifices
employed involve a garden type variety of fraud, or present a unique form of
deception. Novel or atypical methods should not provide immunity from the
securities laws."

11

There the Court determined that the artificial demand created by purchasing
securities which, as here, were not to be paid for unless the market value of the
stock rose, could have an unsettling and potentially manipulative effect on the
securities market, contrary to the purpose of the 1934 Act. As Judge Kaufman
observed, practices like those supposedly engaged in by these defendants
"represent a violent form of speculation which serves no useful purpose except
that the speculator always holds the trump card." (Ibid.)

12

The Bank urges that the Brod case is "an unwarranted extension of the scope of
Section 10(b) and Rule 10b-5," but we agree with the Second Circuit that these
broad provisions2 should not be limited to frauds practiced directly on
investors. Moreover, it is settled that the Securities Exchange Act is not
intended to provide protection only for uninformed or unsophisticated
investors. Lehigh Valley Trust Co. v. Central National Bank, 409 F.2d 989 (5th
Cir. 1969). The protections and remedies of that Act are not limited to the
gullible and unwary for "Fraud may also be perpetrated upon the powerful and
the sophisticated." By allowing brokers to sue, speculators will be deterred
from using exchanges and the over-the-counter markets for their own purposes
at the expense of other investors and the public generally. Surely the
victimization of securities dealers by means of manipulative devices, here
alleged to have caused large losses to one such dealer and the insolvency of
another, may have substantial adverse consequences on customers of such
dealers and may impair the confidence of the general investing public as to the
integrity and stability of the nation's securities markets. The district court is
seemingly in agreement with this conclusion as evidenced by its refusal to
dismiss this suit against the other defendants. We perceive no distinction
between the Bank and the individual defendants to show that allowing suit to
proceed against the Bank would be contrary to or outside the public policies
expressed in the Securities Act.

13

We have recently reiterated that frauds "in connection with" sales of securities
are sufficient to invoke the jurisdiction of the 1934 Act and Rule 10b-5 (Buttrey
v. Merrill, Lynch, Pierce, Fenner & Smith, Inc., 410 F.2d 135 (7th Cir. 1969)3 )
so that the Bank's participation in this credit bubble fraud sufficiently states a

claim against it under Section 10(b) and Rule 10b-5. Although the Bank may
have neither bought nor sold securities for its own account, it was in a unique
position to obtain the necessary time during which it was hoped that the value
in the purchased securities would rise sufficiently to allow the participants in
the scheme to use them in financing still further purchases. Moreover, as
alleged in the amended complaint, the Bank was able to conceal the precarious
nature of the speculative purchases by arranging for undisclosed or fictitious
persons to bail out certain overdue transactions. Since the Bank was charged
with being an aider and abettor in the fraud, it must now meet the merits of that
charge. Buttrey v. Merrill, Lynch, Pierce, Fenner & Smith, Inc., supra at p. 144;
Brennan v. Midwestern United Life Insurance Co., 259 F.Supp. 673, 680-682
(N.D.Ind.1966), 286 F.Supp. 702, 725 (N.D.Ind.1968), appeal pending, No.
17167 (7th Cir. 1968). In our opinion the case alleged against it falls well
within the outer limits of Section 10(b) and Rule 10b-5.
14

The Bank also seeks affirmance on the ground that plaintiffs should not be
permitted to recover for bad debts resulting from a careless method of handling
sales of securities. It urges us to read "the narrow tests prescribed by Section
286 of the Restatement of Torts" into Section 10(b) and Rule 10b-5. That
Section deals with implied private rights of action for negligence. Nothing in
the legislative history of the statute has been called to our attention to show that
Congress intended any such limitation. Although the Bank relies on Kardon v.
National Gypsum Co., 69 F. Supp. 512, 513 (E.D.Pa.1946), and Trussell v.
United Underwriters, Ltd., 228 F.Supp. 757, 771 (N.D.Colo.1964), those cases
denied motions to dismiss; neither held that actions under this statute or rule
were to be circumscribed by doctrines of contributory negligence and we also
decline so to hold. Whatever the relevance of plaintiffs' negligence might be to
the issues at a trial on the merits, it does not support the dismissal of the
amended complaint which is based on fraud rather than negligence. The Bank
has found no case to support its theory that dismissal was justified because the
plaintiffs were contributorily negligent or possessed unclean hands.

15

Next the Bank argues that it is not "any person" with the purview of Section
10(b) and Rule 10b-5. However, those provisions are intended to be construed
flexibly to effectuate the remedial purposes of the securities legislation.
Securities and Exchange Commission v. Capital Gains Bureau, 375 U.S. 180,
195, 84 S.Ct. 275, 11 L.Ed.2d 237. Here the Bank, through its officers and
directors, is alleged to have knowingly participated in a fraudulent scheme to
manipulate the market. In such circumstances, it would distort the purpose of
the statute and the rule to exclude the Bank from their applicability to "any
person." Cf. Lehigh Valley Trust Co. v. Central National Bank, 409 F.2d 989
(5th Cir. 1969).

16

The Bank also attempts to justify its dismissal on the ground these acts were
outside the scope of its agents' authority. This may have been the unarticulated
reason why the district court dismissed as to the Bank. However, the plaintiffs
have charged that the two chief executive officers and directors of the Bank, a
vice president, an assistant vice president, and another director were among the
"main participants" with the Bank in this scheme. The complaint alleges
numerous misdeeds by the Bank itself, acting through its principal agents.
Surely the defendant employees of the Bank were "held out to the public as
having authority to act." Minor v. Mechanics Bank, 26 U.S. (1 Pet.) 46, 70, 7
L.Ed. 47. Their alleged acts of processing drafts drawn to its depositors were
within the scope of their apparent authority, and the possibility that they may
have been acting out of personal motives in delaying these normal transactions
or may have been overzealous in their attempts to serve the best interests of
their employer does not exempt the Bank's liability for their acts performed in
the course of their employment. Reading Fed.R.Civ.P. 8 and 9(b) together, we
find no deficiency in the complaint in this regard. See 2A Moore's Federal
Practice 9.03 at 1929-1930 (2d ed. 1968); Carrigan v. California State
Legislature, 263 F.2d 560, 565 (9th Cir. 1959), certiorari denied, 359 U.S. 980,
79 S.Ct. 901, 3 L.Ed.2d 929; Restatement of Agency, 261, 262.

17

The pendent common law fraud claims alleged in the even-numbered Counts
should also have been sustained under Illinois law. The general rule in Illinois
denies recovery for fraud based on a false representation of intention or future
conduct, but there is a well recognized exception, where, as here, the false
promise or representation of future conduct is claimed to be the scheme used to
accomplish the fraud. Howard v. Howe, 61 F.2d 577, 579 (7th Cir. 1932),
certiorari denied, 289 U.S. 731, 53 S.Ct. 527, 77 L.Ed. 1480; Willis v. Atkins,
412 Ill. 245, 260, 106 N.E.2d 370 (1952); Roda v. Berko, 401 Ill. 335, 340-341,
81 N.E.2d 912 (1948); cf. Restatement of Torts 525, 530.4 Moreover, the
amended complaint alleges numerous false statements to the effect that
arrangements for payment of drafts had been unavoidably delayed or were then
in progress, and counsel for the Bank conceded at oral argument that such
statements would, if made as alleged, constitute false statements of fact. As the
above cases make clear, even a false representation of intention or future
conduct, if amounting to a matter of fact, will support an action for fraud.

18

Reversed and remanded.

Notes:
1

We approved theBrod case in Allico National Corp. v. Amalgamated Meat

Cutters and Butcher Workmen of North America, 397 F.2d 727, 730 (7th Cir.
1968).

"The broad anti-fraud purposes of the statute and the rule" were recently
recognized in Securities and Exchange Commission v. National Securities Inc.,
393 U.S. 453, 467, 89 S.Ct. 564, 21 L.Ed. 2d 668

Securities and Exchange Commission v. Texas Gulf Sulphur Co., 401 F.2d 833,
853, 859 (2d Cir. 1968), certiorari deniedsub nom. Kline v. Securities and
Exchange Commission, 394 U.S. 976, 89 S.Ct. 1454, 22 L.Ed.2d 756 (April 21,
1969), also recognizes the broad scope of the "in connection with" phrase,
labeling it "a catch-all clause to prevent manipulative devices."

Repsold v. New York Life Insurance Co., 216 F.2d 479, 485-486 (7th Cir.
1954), did not consider theHoward, Willis and Roda decisions or the Illinois
exception on which plaintiffs rely.