The plaintiffs assert that Watson's conduct operated as a fraud upon them, and that Bioren, Korn and Bunn controlled Watson within the meaning of Section 20 of the Act, and, consequently, that they are liable therefor.
Bioren, Korn and Bunn raise a number of defenses. First, it is asserted that none of the activities alleged by the plaintiffs rise above mere improprieties, and therefore that no action has been stated under Section 10(b) and Rule 10b-5. Second, it is argued that the plaintiffs failed to allege deception, and that their complaint must therefore be dismissed. Third, the defendants assert that they did not "control" the defendant Watson, within the meaning of Section 20. Next, it is argued that, in any event, the action is barred by the statute of limitations, and, finally, that the plaintiffs have failed to allege specifically that the fraud was perpetrated by the use of "an instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange."
An examination of the complaint confirms the defendants' argument respecting the plaintiffs' failure to allege the use of an instrumentality such as would be necessary to bring the action within the cognizance of the Court. Although the Court will not take judicial notice of this aspect of the case, it would be wasteful of considerable time and effort to dispose of the matter now on the basis of this technicality. The plaintiffs have expressed their willingness to file an appropriate motion to amend their complaint in this regard, and the Court will entertain it. This, of course, will not preclude the defendants from later proving the absence of this element. The Court now proceeds to the merits.
The concept of civil liability ensuing from a violation of the Act where no such remedy is specifically provided therein had its genesis in this district when my colleague, Judge Kirkpatrick, delivered his opinion in the case of Kardon v. National Gypsum Co., 69 F. Supp. 512 (E.D. Pa. 1946). See also 73 F. Supp. 798 (E.D. Pa. 1946) and 83 F. Supp. 613 (E.D. Pa. 1947) involving the same case. That principle is not now seriously open to question. (See the cases which follow that ruling collected in Ruder, Civil Liability Under Rule 10b-5: Judicial Revision of Legislative Intent, 57 Nw. U.L. Rev. 627, 629-35 (1963)). The Supreme Court in J.I. Case Co. v. Borak, 377 U.S. 426, 12 L. Ed. 2d 423, 84 S. Ct. 1555 (1964), by implying a right of action under § 14 (a) of the Act, strengthens that conclusion. Therefore, to avoid dismissal of their action the plaintiffs need only allege facts which, when fairly interpreted in connection with the provision invoked, constitute a violation of the Act. It is clear to the Court that they have done so.
It is true that the regulations enacted pursuant to 10b-5 do not specifically mention churning or excessive trading as constituting a violation of Section 10(b). However, to conclude on that basis alone that no cause of action is stated thereunder would be adhering to the letter of the statute without regard to its intended purpose.
It should be observed that Section 15 (c) (1) of the Act (15 U.S.C.A. § 78 o (c) (1)), one of the sections dealing with broker-dealer frauds, includes within its description of the term "manipulative or deceptive device or contrivance" transactions which are "excessive in size or frequency in view of the financial resources and character of such account." (17 C.F.R. 240.15c1-7(b) (1964)). This definition is certainly instructive to the Court on the issue as to whether the conduct asserted in the complaint amounted to fraud or a manipulative or deceptive device within the meaning of Section 10(b) and Rule 10b-5 thereunder. Moreover, the decisions of the Commission in certain disciplinary proceedings also indicate that excessive trading for the purpose of creating commissions amounts to fraudulent conduct within the meaning of Section 10(b) and Rule 10b-5 thereunder. See e.g., Reynolds & Co., et al, 39 S.E.C. 902 (1960); R.H. Johnson & Co., 36 S.E.C. 467 (1955) aff'd per curiam sub nom R.H. Johnson & Co. v. S.E.C., 97 U.S. App. D.C. 364, 231 F.2d 523 (D.C. Cir. 1956), cert. denied 352 U.S. 844, 1 L. Ed. 2d 60, 77 S. Ct. 48 (1956); Behel, Johnsen & Co., 26 S.E.C. 163 (1947); Looper & Co., 38 S.E.C. 294 (1938); cf. Shearson, Hammill & Co., CCH Fed. Sec. L. Rep. P 77,306 (Nov. 1965).
In the Court's judgment, taking commissions to which one is not entitled differs little from misappropriation of funds. Cf. Merrill Lynch, Pierce, Fenner & Beane, 31 S.E.C. 494 (1950); D.S. Waddy & Co., 30 S.E.C. 367 (1949). If there is a difference, it lies in the fact that the former is more invidious, since the latter is far simpler to detect.
Necessity of Alleging Deception
The Court does not agree with the defendants that it was necessary for the plaintiffs literally to allege deception. When entertaining actions under the anti-fraud provisions of the Securities Exchange Act, the courts are not bound by common law principles of substance or pleading. In view of the facts alleged in the complaint, it is impossible to conclude otherwise than that the plaintiffs are complaining that they were, in fact, deceived. In order to decide differently, it would be necessary to assume that the plaintiffs willingly gave their entire savings to the defendant, Watson, with full knowledge that he had the intention of excessively trading their account.
The Court believes that the better view is that enunciated in Ellis v. Carter, 291 F.2d 270 (9th Cir. 1961) where the court answered a similar argument as follows:
"Section 10(b) speaks in terms of the use of 'any manipulative device or contrivance' in contravention of rules and regulations as might be prescribed by the Commission. It would have been difficult to frame the authority to prescribe regulations in broader terms. Had Congress intended to limit this authority to regulations proscribing common-law fraud, it would probably have said so. We see no reason to go beyond the plain meaning of the word 'any', indicating that the use of manipulative or deceptive devices or contrivances of whatever kind may be forbidden, to construe the statute as if it read 'any fraudulent' devices." (at p. 274).