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April 18, 1978


The opinion of the court was delivered by: LORD, III

 In our opinion and order of December 28, 1976, 425 F. Supp. 593, we denied the motions of defendants Baker, Bevan, Caldwell and Ray to dismiss and for summary judgment on the claims of the Securities and Exchange Commission for injunctive relief and disgorgement based on alleged violations of the federal securities laws. We now decide that the motions to dismiss, motions for summary judgment, motions for reconsideration, motions for change of venue and motions for certification under Title 28 U.S.C. § 1292 which have been submitted by Baker and Ray *fn1" must be denied.

 Defendants have advanced a plethora of arguments in support of their motions. Several of these merit discussion, *fn2" in that they either address points which we did not dwell on in our original opinion or raise entirely new legal issues.

 All of these contentions concern the Sixth Cause of Action, Amended Complaint at paras. 60-66, which alleges that defendants violated Section 17(a) of the Securities Act of 1933 as amended (15 U.S.C. § 77q(a)), Section 10(b) of the Securities Exchange Act of 1934 as amended (15 U.S.C. § 78j(b)) and Rule 10b-5 (17 C.F.R. § 240.10b-5) promulgated under § 10(b). The thrust of this cause of action is that the defendants engaged in a scheme to misrepresent the financial condition of several corporations by, inter alia, reporting income improperly, stating incorrectly that increases in reported income were expected to continue and failing to disclose weaknesses in financing. Amended Complaint at para. 62. This scheme is alleged to have resulted in misrepresentations and omissions of material facts to purchasers and sellers of securities. Id. at 61. It is alleged that defendants entered into this scheme because they were parties to employment agreements with two of these corporations, of which they were officers and directors, compensating them on the basis of reported income, id. at PP 63-64, and that they received payments under those agreements which they would not have received had they not made the misrepresentations and omissions which allegedly violated federal securities laws. Id. at P 65.


 A. "In Connection With" Requirement.

 Section 10(b) of the Securities Exchange Act covers fraud "in connection with" the purchase or sale of securities. *fn3" The purchase or sale requirement of § 10(b) contemplates a causal connection between the alleged fraud and the purchase or sale. In a sense, the requisite connection allegedly existed in this case in its most conventional form, since plaintiff alleges that defendants made material misrepresentations and omissions which defrauded purchasers and sellers of the securities of four corporations. Amended Complaint at para. 61. *fn4" It is these misrepresentations and omissions, along with the materiality of them to the reasonable investor in the securities of these corporations, which the SEC must establish in an enforcement action. See 2 A. Bromberg, Securities Law, Fraud, SEC Rule 10b-5 § 10.1, at 235 (1967).

 Defendants advance the argument that the acts alleged in the Sixth Cause of Action, characterized as defrauding the corporations which paid them, constituted "internal mismanagement." Contending that such acts are not actionable under the federal securities laws, defendants cite Superintendent of Insurance v. Bankers Life & Casualty Co., 404 U.S. 6, 30 L. Ed. 2d 128, 92 S. Ct. 165 (1971), in which the Supreme Court observed in dicta that "Congress by § 10(b) did not seek to regulate transactions which constitute no more than internal mismanagement." Id. at 12. In that case, however, the Court rejected the claim of "mere internal mismanagement" and held that § 10(b) covered deceptive practices "touching [the] sale of securities." Id. at 12-13. We hold on two grounds that the fraud alleged in this case is sufficient to state a cause of action for enforcement. First, as we have noted, the allegations contained in para. 61 state that this fraudulent scheme "touched" with pristine directness purchases and sales of securities. Second, even accepting defendants' characterization of the Sixth Cause of Action as an averment that they schemed to make misrepresentations of income to the corporations and that these misrepresentations were transmitted to the investing public in some manner not directly involving defendants, we believe equitable relief can be granted so long as plaintiff shows that defendants' fraud proximately caused material misrepresentations or omissions violative of the securities laws; as part of that requirement, the misrepresentations or omissions must have been the foreseeable results of defendants' conduct.

 As the Third Circuit has observed, a "classic 10b-5 violation" occurs when a defendant has "caused the corporation to issue materially false statements". Landy v. Federal Deposit Insurance Corp., 486 F.2d 139, 163 (2d Cir. 1973). Should we find that the misrepresentations to the corporations and to the investing public in fact occurred and involved conduct which was virtually indistinguishably linked in a causal chain, we would certainly find that the fraud "touched" the purchase or sale of securities. See, e.g., Butler Aviation International, Inc. v. Comprehensive Designers, Inc., 307 F. Supp. 910 (S.D.N.Y. 1969), aff'd, 425 F.2d 842 (2d Cir. 1970). Beyond that, the precise meaning of causation in this context does not appear to be settled. The most cited statement of the requisite causal relationship between a defendant's conduct and dissemination (or the lack thereof) of information to the investing public is the Second Circuit's holding that this element is satisfied "whenever assertions are made . . . in a manner reasonably calculated to influence the investing public." SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 862 (2d Cir. 1968) (en banc), cert. denied sub nom. Coates v. SEC, 394 U.S. 976, 22 L. Ed. 2d 756, 89 S. Ct. 1454 (1969). We agree that this is substantially the proper meaning of the "in connection with purchase or sale" requirement in this context, but we prefer the language of probable cause and foreseeability because the term "calculated" (1) suggests that the standard is a subjective one, turning on the calculation of an individual defendant, whereas we believe the proper test is objective, and (2) invites confusion with the scienter requirement of Rule 10b-5, see Section IV infra, which we feel is an analytically distinct, although factually related, element under the current law.

 As evidence of the fact that Judge Waterman's opinion in Texas Gulf Sulphur is consistent on this point with our analysis, moreover, we point to the following language:

"Therefore it seems clear from the legislative purpose Congress expressed in the Act, and the legislative history of Section 10(b) that Congress when it used the phrase 'in connection with the purchase or sale of any security' intended only that the device employed, whatever it might be, be of a sort that would cause reasonable investors to rely thereon . . .." 401 F.2d at 860 (emphasis added).

 We believe that the required nexus between fraudulent conduct and the issuance of material misrepresentations to the investing public under Rule 10b-5 is most precisely and properly defined with reference to the concept of proximate cause, which courts have borrowed from tort law to define the necessary relationship between fraudulent conduct and damages recoverable under Rule 10b-5, Miller v. Schweickart, 413 F. Supp. 1059, 1067 & n.17 (S.D.N.Y. 1976) (collecting cases). To the extent that this formulation leads to broader boundaries of liability than some other definitions of "causation" might, see generally 2 A. Bromberg, Securities Law, Fraud, Rule 10b-5 § 8.7 (1967), we conclude it is mandated by the liberality with which the requirements of § 10(b) must be construed in an enforcement action. See Kahan v. Rosenstiel, 424 F.2d 161, 173 (3d Cir. 1970), quoting SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 193, 11 L. Ed. 2d 237, 84 S. Ct. 275 (1963).

 We consider our conclusion consistent, furthermore, with the Third Circuit's reasoning in Landy v. Federal Deposit Insurance Corp., where the court held that an accountant's alleged misstatements in financial statements concerning a corporation were not actionable in a private damage suit under Rule 10b-5. The court said that the reports containing these misrepresentations had not been given to any members of the plaintiff class except the named plaintiff and that it was neither foreseen (nor, it was implied by use of the "reasonably calculated" language from SEC v. Texas Gulf Sulphur, reasonably foreseeable) by the accountant that these reports would be used by anyone outside the corporation. Id. at 167-69. The limitations on liability that are imposed by foreseeability are in this context very closely related, both doctrinally and in effect, to those which result from the requirement of proximate cause. See 2 F. Harper and F. James, The Law of Torts, § 20.5, at 1137, 1141 (1956); W. Prosser, The Law of Torts, § 43 (4th ed. 1971). Moreover, the Landy court cited with approval Wessel v. Buhler, 437 F.2d 279 (9th Cir. 1971), where Judge Hufstedler concluded on facts similar to those of Landy that alleged misrepresentations in an accountant's financial ...

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