Seolas v. Bilzerian

MEMORANDUM DECISION AND ORDER DENYING DEFENDANT’S MOTION FOR JUDGMENT ON THE PLEADINGS, OR ALTERNATIVELY FOR SUMMARY JUDGMENT, ON PLAINTIFF’S THIRD AND EIGHTH CLAIMS FOR RELIEF

This matter is before the court on Defendant Cimetrix’s motion for judgment on the pleadings, or alternatively for summary judgment, on Plaintiff Dr. Waldron K. Seolas’ third and eighth claims for relief. 1 The court heard counsels’ argument bn January 3,1996. At the hearing, David B. Watkiss represented Plaintiff and Max D. Wheeler and Korey D. Rasmussen represented Cimetrix. Before the hearing, the court had carefully considered all pleadings, memoranda, and other materials submitted by the parties. Following the hearing, the court has further considered the parties’ materials, the argument of counsel, and the law and facts relevant to Cimetrix’s Motion. Now, being fully advised and good cause appearing, the court enters the following memorandum decision and order.

I. BACKGROUND

Plaintiff has charged Cimetrix with violating § 10(b) of the Securities Exchange Act of 1934 (the “1934 Act”), 15 U.S.C. § 78j, and Rule 10b-5, 17 C.F.R. § 240.10b-5 (1993), and with common-law fraud. The facts of this case are fully laid out in the court’s orders of August 20, 1996, and October 9, 1996. Those facts are incorporated into this order and, unless necessary, will not be repeated herein.

Plaintiff claims that in November or December 1994, Paul A. Bilzerian, acting as an agent for Cimetrix, wrongfully induced Plaintiff and his family to return approximately 215,000 shares of Cimetrix stock back to Cimetrix without monetary consideration. Plaintiff alleges that Bilzerian represented to Plaintiff that he had discovered a discrepancy between Cimetrix shareholder records regarding Plaintiffs holdings and what had been reported in prior filings with the Securities Exchange Commission. Bilzerian allegedly told Plaintiff that filing corrected SEC reports would not solve the problem. Instead, Plaintiff contends that Bilzerian represented to him that, to protect Cimetrix from an SEC investigation and a decline in the value of Cimetrix stock, Plaintiff and his family would have to return approximately 215,000 shares back to Cimetrix.

Plaintiff now claims that Bilzerian’s statements were fraudulent and that he wrongfully induced the transfer of those shares. According to Plaintiff, Bilzerian overstated any possible discrepancy between the shareholder records and the SEC filings, and that if a discrepancy existed, it could have easily been corrected by an amended SEC filing. Plaintiff also contends that there was no danger to Cimetrix whatsoever as a result of such discrepancies. Plaintiff argues that Bilzerian made all of the representations knowing that they were false and for the purpose of pressuring Plaintiff and his family into returning the 215,000 shares to Cimetrix to inflate the value of Bilzerian’s own stock options in the company and to use those shares in funding an employee stock option plan without diluting his own interest in Cimetrix.

II. LEGAL STANDARD UNDER RULE 12(c)

The court will treat Cimetrix’s motion under Federal Rule of Civil Procedure 12(c). A Rule 12(c) motion for judgment on the pleadings is governed by the same standards as a Rule 12(b)(6) motion to dismiss. McHenry v. Utah Valley Hosp., 927 F.2d 1125, 1126 (10th Cir.1991). The court will dismiss a cause of action under Rule 12(b)(6) for failure to state a claim upon which relief can be granted “ ‘only when it appears that the plaintiff can *981 prove no set of facts in support of the claim that would entitle the plaintiff to relief. In making this determination, [the court] must accept all the well-pleaded allegations of the complaint as true and must construe them in the light most favorable to the plaintiff.’” Roman v. Cessna Aircraft Co., 55 F.3d 542, 543 (10th Cir.1995) (quoting Sharp v. United Airlines, 967 F.2d 404, 406 (10th Cir.1992)). “[I]f as a matter of law ‘it is clear that no relief could be granted under any set of facts that could be proved consistent with the allegations,’ a claim must be dismissed, without regard to whether it is based on an outlandish legal theory or on a close but ultimately unavailable one.” Neitzke v. Williams, 490 U.S. 319, 327, 109 S.Ct. 1827, 1832, 104 L.Ed.2d 338 (1989) (citation omitted) (quoting Hishon v. King & Spalding, 467 U.S. 69, 73, 104 S.Ct. 2229, 2232, 81 L.Ed.2d 59 (1984)).

III. DISCUSSION

A. Section 10(b) and Rule 10b-5

Plaintiffs third cause of action alleges that Bilzerian, acting as an agent of Cimetrix, violated § 10(b) of the 1934 Act and Rule 10b-5, and that Cimetrix is liable for Bilzeri-an’s alleged violation under a theory of re-spondeat superior. Section 10(b) states:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange—

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(b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the [SEC] may prescribe.

15 U.S.C. § 78j.

Rule 10b-5, the parallel regulation to § 10(b), frames the prohibited conduct in similar terms:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,

(a) To employ any device, scheme, or artífice to defraud,

(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

(e) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.

17 C.F.R. § 240.10b-5 (1993).

Cimetrix advances three arguments in favor of dismissing this claim. 2 First, Cimetrix argues that the Supreme Court’s decision in Central Bank v. First Interstate Bank, 511 U.S. 164, 114 S.Ct. 1439, 128 L.Ed.2d 119 (1994), extinguishes all forms of secondary or vicarious liability under § 10(b), including liability based on respondeat superior. Second, Cimetrix asserts that even if Plaintiffs theory of respondeat superior survives the Central Bank decision the claim fails because Bilzerian’s alleged misstatements were not in connection with a “purchase or sale” of securities as required by § 10(b). Third, Cimetrix challenges the sufficiency of Plaintiffs allegations.

1. Central Bank’s Effect on Respondeat Superior

It is well established that § 10(b) implicitly creates a private cause of action against parties who commit a manipulative or deceptive act in connection with the purchase or sale of securities. Central Bank, 511 U.S. at 166, 114 S.Ct. at 1443; Superintendent of Ins. v. Bankers Life & Cos. Co., 404 U.S. 6, 13 n. 9, 92 S.Ct. 165, 169 n. 9, 30 L.Ed.2d 128 (1971). *982 Before Central Bank, it was also well settled that aiding and abetting a § 10(b) violation itself gave rise to a private cause of action under § 10(b). See Farlow v. Peat, Marwick, Mitchell & Co., 956 F.2d 982, 986 (10th Cir.1992). In Central Bank, however, the Supreme Court eliminated aiding and abetting liability under § 10(b), holding that § 10(b) “prohibits only the making of a material misstatement (or omission) or the commission of a manipulative act.” 511 U.S. at 177, 114 S.Ct. at 1448. Section 10(b) liability does not extend “to those who do not engage in the manipulative or deceptive practice, but who aid and abet the violation.” Id. at 166-67, 177, 114 S.Ct. at 1443, 1448.

The Supreme Court’s primary reasoning in the Central Bank decision was that the text of § 10(b) did not provide for aiding and abetting liability. Id. at 177, 114 S.Ct. at 1448. In determining the scope of conduct prohibited by § 10(b) and Rule 10b-5, the text of the statute controls. Id. at 173, 114 S.Ct. at 1446. 3 Thus, because the text of § 10(b) only proscribes “manipulative or deceptive” acts, and “does not in terms mention aiding and abetting,” the Court refused to extend § 10(b) liability to a party who did not' itself commit a manipulative or deceptive act regardless of whether that party assisted another to commit sueh an act. Id. at 175, 114 S.Ct. at 1447. This is consistent with the Court’s prior rulings concerning.attempts by plaintiffs and the SEC to broaden the statute’s reach to include conduct not prohibited by § 10(b)’s text. See, e.g., Chiarella v. United States, 445 U.S. 222, 235, 100 S.Ct. 1108, 1118, 63 L.Ed.2d 348 (1980) (trading securities without disclosing inside information does not violate § 10(b) unless the trader has an independent duty to disclose); Santa Fe Indus. v. Green, 430 U.S. 462, 476, 97 S.Ct. 1292, 1302, 51 L.Ed.2d 480 (1977) (section 10(b) does not prohibit “a breach of fiduciary' duty by majority stockholders, without any deception, misrepresentation, or nondisclosure” because such an act is not manipulative or deceptive conduct); Ernst & Ernst v. Hochfelder, 425 U.S. 185, 201, 96 S.Ct. 1375, 1384-85, 47 L.Ed.2d 668 (1976) (recognizing that “manipulative or deceptive” language in § 10(b) refers to “knowing or intentional” misconduct and refusing to expand scope of liability under § 10(b) to include negligent misconduct).

Besides aiding and abetting liability, a majority of pre-Central Bank courts had established that respondeat superior was a viable theory of liability in § 10(b) cases. See, e.g., Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1576 n. 27 (9th Cir.1990); Castleglen, Inc. v. Commonwealth Sav. Ass’n, 689 F.Supp. 1069, 1072 (D.Utah 1988); accord Kerbs v. Fall River Indus., 502 F.2d 731, 740-41 (10th Cir.1974). These courts held that § 20(a) of the 1934 Act, which provides for “controlling person” liability under § 10(b), did not supplant common-law agency principles and was therefore not the exclusive source of secondary liability for § 10(b) violations. 4 Under this view, respondeat superior and other agency theories were valid bases of liability under § 10(b) independent from § 20(a). 5 See Hollinger, 914 F.2d at 1576; Castleglen, 689 F.Supp. at 1072.

Cimetrix now asks this court to extend Central Bank’s holding to preclude private § 10(b) actions based on respondeat superior. Cimetrix advances the dissent’s contention that § 10(b) actions “based on respondeat superior and other common-law agency principles” appear “unlikely to survive.” Id. at 200 n. 12, 114 S.Ct. at 1460 n. 12 (Stevens, J., dissenting). Essentially, Cimetrix argues that a corporation can only be held liable for a § 10(b) violation under the “controlling person” provision in § 20(a).

*983 The court holds, however, that the Central Bank decision does not abolish re-spondeat superior as a theory of liability under § 10(b). See AT & T v. Winback & Conserve Program, 42 F.3d 1421, 1429-32 (3d Cir.1994); Pollack v. Laidlaw Holdings, Inc., No. 90-Civ-5788, 1995 WL 261518, at *16-17 (S.D.N.Y. May 3, 1995). 6 The court rejects Cimetrix’s position that, because the text of § 10(b) does not specifically mention agency or respondeat superior, the reasoning of Central Bank makes these theories of liability unavailable. 7 Unlike the issues in Central Bank and the other above-cited Supreme Court cases, the issue in this case— whether respondeat superior is a legitimate basis of liability under § 10(b) — is not a question of defining the scope of affirmative conduct proscribed by the statute. Instead, the issue is “deciding on whose shoulders to place responsibility for conduct indisputably proscribed” by the statute. AT & T, 42 F.3d at 1430-31. “The principal is held liable not because it committed some wrongdoing outside the purview of the statute which assisted the wrongdoing prohibited by the statute, but because its status merits responsibility for the tortious actions of its agent.” Id. at 1431.

The Supreme Court’s approach in American Society of Mechanical Engineers v. Hydrolevel Corp., 456 U.S. 556, 102 S.Ct. 1935, 72 L.Ed.2d 330 (1982), provides the proper framework to determine whether courts should recognize respondeat superior as a valid basis of liability in § 10(b) eases. In Hydrolevel, the Supreme Court confronted a similar issue to the one at hand: whether a principal could be held liable for an agent’s violations of the Sherman Act under a theory of apparent authority. As with § 10(b), the text of the Sherman Act does not specifically mention agency as a basis of liability. The Court, however, did not look solely to the text of- the Sherman Act in its analysis. Instead, after recognizing that “[t]he apparent authority theory has long been the settled rule in the federal system,” id. at 567, 102 S.Ct. at 1943, the Court inquired whether an agency theory of liability in the context of antitrust statutes was “consistent with the intent behind the antitrust laws,” id. at 570, 102 S.Ct. at 1944., Finding that it was, the Court held that a principal may be held liable for the antitrust violations of its agent. Id. at 570-74, 102 S.Ct. at 1944-47; accord In re Atlantic Fin. Management, 784 F.2d 29, 35 (1st Cir.1986) (“The extent to which a federal statute, such as the Securities Act, embraces common law agency principles, depends ... upon the extent to which their adoption is consistent with the statute’s language and furthers its purpose.”). Following this approach, the court will recognize § 10(b) liability based on respondeat superior if such a theory is consistent with the language of and the intent behind the securities laws.

The court finds that the respondeat superior theory of liability is consistent with the language of § 10(b) and the intent of the securities laws to promote full disclosure and discourage fraud in the securities markets. The legislative history supports this finding. See generally In re Atlantic Fin. Management, 784 F.2d at 32-33; Paul F. Newton & Co. v. Texas Commerce Bank, 630 F.2d 1111, 1115-16 (5th Cir.1980); Castleglen, 689 F.Supp. at 1072. So does the conclusion *984 that, by explicitly including corporations in its definition of “person,” 15 U.S.C. § 77b(a)(2), Congress foresaw that corporations would be held liable under agency principles. As the Third Circuit explained, “in some instances, liability cannot be imposed without reference to agency principles — a corporation can only act through its agents, and therefore only can be bound through application of agency principles.” AT & T, 42 F.3d at 1431.- Indeed, even the Supreme Court, by acknowledging that entities may be primary violators of § 10(b), recognizes the need to apply agency principles to effectuate the purposes of the securities law. The Court stated in Central Bank:

The absence of § 10(b) aiding and abetting liability does not mean that secondary actors in the securities markets are always free from liability under the securities Acts. Any person or entity, including a lawyer, accountant, or bank, who employs a manipulative device or makes a material misstatement (or omission) on which a purchaser or seller of securities relies may be liable as a primary violator under 10b-5, assuming all of the requirements for primary liability under Rule 10b-5 are met.

511 U.S. at 191, 114 S.Ct. at 1455. If, as the Supreme Court envisions, entities may be held liable under § 10(b) as primary violators, then courts must recognize agency principles as a source of primary liability, as stated above, corporations and other entities can act only through their agents. 8

In sum, “Central Bank’s discussion of aiding and abetting should not be transplanted into the more settled realm of agency law.” AT & T, 42 F.3d at 1432. Following the Supreme Court’s guidance in Hydrolevel, the court concludes that the respondeat superior theory of liability in § 10(b) cases is consistent with, and furthers the intent óf, the securities laws. Accordingly, Cimetrix’s motion for judgment on this issue is denied. 9

2. Purchase or Sale

Section 10(b) and Rule 10b-5 apply to fraud and material misstatements or omissions in connection with the “purchase or sale” of any security. 10 See 15 U.S.C. § 78j(b); ,17 C.F.R. § 240.10b-5. Plaintiff asserts that his transfer of 215,000 shares of Cimetrix stock back to Cimetrix, which was allegedly induced by Bilzerian’s misrepresentations that such a transfer was necessary, constitutes a purchase or sale of securities.

Cimetrix contends that this transaction does not constitute a purchase or sale. Cimetrix does not argue that the transaction *985 fails as a purchase or sale merely because it involved a transfer of securities from a security holder back to the issuing corporation. Various courts have held, and this court agrees, that such transactions may qualify as a purchase or sale within the meaning of § 10(b) and Rule 10b-5. 11 Frigitemp Corp. v. Financial Dynamics Fund, 524 F.2d 275, 281-82 (2d Cir.1975) (contribution of shares by shareholders could be a “sale”); Drachman v. Harvey, 453 F.2d 722, 736-38 (2d Cir.1971) (rehearing en banc 1972) (redemption of debentures constitutes a “purchase”); Dasho v. Susquehanna Corp., 380 F.2d 262, 266 (7th Cir.1967) (acquisition by surviving corporation of its own shares in a merger with another corporation constitutes a “purchase”); Green v. Hamilton Int’l Corp., 437 F.Supp. 723, 727 (S.D.N.Y.1977) (Mowing Drachman, supra). Instead, Cimetrix argues that the transaction does not constitute a purchase or sale because there was no monetary consideration flowing to Plaintiff.

The Tenth Circuit has not established a full analytical framework for determining what constitutes a purchase or sale for purposes of § 10(b). However, following the lead of several other jurisdictions, the court concludes that an exchange of value or consideration, while helpful to establish a purchase or sale, is not determinative. 12 See Rathborne v. Rathborne, 683 F.2d 914, 920 (5th Cir.1982) (“[T]he fact that no “value’ was paid is not necessarily dispositive.”); Frigitemp Corp, 524 F.2d at 281 (“[T]he mere absence of consideration in a stock disposition does not necessarily prevent the transaction from being a ‘sale’ for § 10(b) purposes.”); International Controls Corp. v. Vesco, 490 F.2d 1334, 1346 (2d Cir.1974) (“[W]e find the rote emphasis on consideration inconsistent with the broad scope of protection under § 10(b) for those who engage in transactions eventuating in the acquisition or disposition of securities.”); see also Broad v. Rockwell Int’l Corp., 614 F.2d 418, 437-38 (5th Cir.1980) (not listing “consideration” as a factor for analyzing “purchase of sale” requirement). Instead, the court believes that there are other, equally important factors to consider.

a. Textual Definitions

To determine the meaning of the terms “purchase” and “sale” in connection with § 10(b), the court must first look to the statutory definitions of those terms. See Central Bank v. First Interstate Bank, 511 U.S. 164, 174-75, 114 S.Ct. 1439, 1446-1447, 128 L.Ed.2d 119 (1994) (beginning analysis of securities laws by looking at text); Pinter v. Dahl, 486 U.S. 622, 641, 108 S.Ct. 2063, 2075-76, 100 L.Ed.2d 658 (1988) (same); Chiarella v. United States, 445 U.S. 222, 226, 100 S.Ct. 1108, 1113-14, 63 L.Ed.2d 348 (1980) (same). The 1934 Act provides: “The terms ‘buy’ and ‘purchase’ each include any contract to buy, purchase, or otherwise acquire.” 15 U.S.C. § 78c(a)(13). Also: “The terms ‘sale’ and *986 ‘sell’ each include any contract to sell or otherwise dispose of.” Id. § 78c(a)(14). 13

However, the Supreme Court has stated that the definitions of “purchase” and “sale” in the 1934 Act are “for the most part unhelpful” because they only declare generally that the terms shall include contracts to purchase or sell. SEC v. National Sec., 393 U.S. 453, 466, 89 S.Ct. 564, 571-72, 21 L.Ed.2d 668 (1969). The definitions are also unhelpful because they are prefaced with the phrase “unless the context otherwise requires.” 14 15 U.S.C. § 78c(a). Thus, the Supreme Court has held that when the statutory definitions of “purchase” or “sale” are not helpful in the context of a given case, a court must ask whether the conduct in question “is the type of fraudulent behavior which was meant to be forbidden by the statute and the rule.” National Sec., 393 U.S. at 467, 89 S.Ct. at 572. The court concludes that the definitions in the 1934 Act are not helpful in the present case and therefore, as National Securities directs, the court must analyze the challenged conduct in light of the purposes behind the 1934 Act.

b. Purposes of the Securities Exchange Act of 1934

The Supreme Court has acknowledged that it is not “able to divine from the language of § 10(b) the express ‘intent of Congress’ as to the contours of a private cause of action under Rule 10b-5.” Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 737, 95 S.Ct. 1917, 1926, 44 L.Ed.2d 539 (1975). It is well understood, however, that Congress intended § 10(b) and Rule 10b-5 to be flexible antifraud provisions designed to protect investors and the securities market from a broad array of fraudulent behavior. See, e.g., Chiarella, 445 U.S. at 226, 100 S.Ct. at 1113 (“Section 10(b) was designed as a catchall clause to prevent fraudulent practices.”); National Sec., 393 U.S. at 466, 89 S.Ct. at 572 (“Section 10(b) and Rule 10b-5 together constitute one of the several broad antifraud provisions contained in the securities laws.”); see also 3 Fletcher Cyclopedia of Corporations, § 900.65, at 456 (perm. ed. 1994) (“The general purpose and intent of the broad anti-fraud provisions of Section 10(b) and Rule 10b-5 is to protect investors, to prevent inequitable and unfair practices and to insure fairness in securities transactions generally!”).

With this general view of § 10(b), the Supreme Court has stated that “[s]ection 10(b) must be read flexibly, not technically and restrietively.” Superintendent of Ins. v. Bankers Life & Cas. Co., 404 U.S. 6, 12, 92 S.Ct. 165, 169, 30 L.Ed.2d 128 (1971); see also SEC v. Capital Gains Research Bureau, 375 U.S. 180, 195, 84 S.Ct. 275, 284, 11 L.Ed.2d 237 (1963) (noting that Congress intended securities legislation, enacted for the purpose of avoiding frauds, to be construed “not technically and restrietively, but flexibly to effectuate its remedial purposes”). Indeed, the Supreme Court has interpreted terms in the Securities Exchange Act of 1933 and the 1934 Act in a manner which “embodies a flexible rather than static principle, one that is capable of adaptation to meet the countless and variable schemes devised by those who seek the use of the money of others on the promise of profits.” See Tcherepnin v. Knight, 389 U.S. 332, 338, 88 S.Ct. 548, 554, 19 L.Ed.2d 564 (1967); SEC v. W.J. Howey Co., 328 U.S. 293, 299, 66 S.Ct. 1100, 1103,