BATEMAN EICHLER, HILL RICHARDS, INC. v. BERNER(1985)

 

No. 84-679

Argued: April 15, 1985Decided: June 11, 1985

Respondent investors (hereafter respondents) filed a damages action in Federal District Court, alleging that they incurred substantial trading losses after a securities broker (employed by petitioner) and the officer of a corporation fraudulently induced respondents to purchase stock in the corporation by divulging false and materially incomplete information about the corporation on the pretext that it was accurate inside information. Respondents contended that this alleged scheme violated, inter alia, 10(b) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5 promulgated thereunder. The District Court dismissed the complaint on the ground that, because respondents themselves had violated the same laws under which recovery was sought by trading on what they believed was inside information, they were in pari delicto with the broker and corporate insider and thus were barred from recovery. The Court of Appeals reversed.

Held:

There is no basis at this stage of the litigation for applying the in pari delicto defense to bar respondents’ action. Pp. 306-319.

    (a) An implied private damages action under the federal securities laws may be barred on the grounds of the plaintiff’s own culpability only where (i) as a direct result of his own actions, the plaintiff bears at least substantially equal responsibility for the violations he seeks to redress, and (ii) preclusion of suit would not significantly interfere with the effective enforcement of the securities laws and protection of the investing public. Cf. Perma Life Mufflers, Inc. v. International Parts Corp., 392 U.S. 134 . Pp. 306-311.
    • (b) Because a tippee’s duty to disclose material nonpublic information typically is derivative from the insider-tipper’s duty, the tippee in these circumstances cannot be said to be as culpable as the tipper whose breach of duty gave rise to the tippee’s liability in the first place. Moreover, insiders and broker-dealers who selectively disclose material nonpublic information about the issuer commit a potentially broader range of violations than do tippees who trade on the basis of that information. Absent other culpable actions by a tippee that can fairly be said to outweigh these violations by insiders and broker-dealers, the tippee cannot

[472 U.S. 299, 300]   

    properly be characterized as being of substantially equal culpability as his tippers. Pp. 311-314.
    (c) Denying the in pari delicto defense in such circumstances will best promote protection of the investing public and the national economy. First, allowing a defrauded tippee to bring suit against his defrauding tipper promotes the important goal of exposing wrongdoers and rendering them more easily subject to civil, administrative, and criminal penalties. Second, deterrence of insider trading most frequently will be maximized by bringing enforcement pressures to bear on the sources of such information – corporate insiders and broker-dealers. Third, insiders and broker-dealers will in many circumstances be more responsive to the deterrent pressures of potential sanctions. Finally, there are means other than the in pari delicto defense to deter tippee trading. Although there might well be situations in which the relative culpabilities of tippees and their sources merit a different mix of deterrent incentives, in cases such as the instant one the public interest will most frequently be advanced if defrauded tippees are permitted to bring suit and to expose illegal practices by corporate insiders and broker-dealers to full public view for appropriate sanctions. Pp. 315-319.

730 F.2d 1319, affirmed.

BRENNAN, J., delivered the opinion of the Court, in which WHITE, BLACKMUN, POWELL, REHNQUIST, STEVENS, and O’CONNOR, JJ., joined. BURGER, C. J., concurred in the judgment. MARSHALL, J., took no part in the decision of the case.

Robert S. Warren argued the cause for petitioner. With him on the briefs were Phillip L. Bosl and Gail Ellen Lees.

Geoffrey P. Knudsen argued the cause for respondents Berner et al. With him on the brief was John H. Boone.

Bruce N. Kuhlik argued the cause pro hac vice for the Securities and Exchange Commission as amicus curiae urging affirmance. With him on the brief were Solicitor General Lee, Deputy Solicitor General Claiborne, Daniel L. Goelzer, Paul Gonson, Jacob H. Stillman, and Larry R. Lavoie. 

Footnote * ] Edward H. Fleischman, Martin P. Unger, Catherine A. Ludden, and William J. Fitzpatrick filed a brief for the Securities Industry Association as amicus curiae urging reversal. [472 U.S. 299, 301]  

JUSTICE BRENNAN delivered the opinion of the Court.

The question presented by this case is whether the common-law in pari delicto defense bars a private damages action under the federal securities laws against corporate insiders and broker-dealers who fraudulently induce investors to purchase securities by misrepresenting that they are conveying material nonpublic information about the issuer.

I

The respondent investors filed this action in the United States District Court for the Northern District of California, alleging that they incurred substantial trading losses as a result of a conspiracy between Charles Lazzaro, a registered securities broker employed by the petitioner Bateman Eichler, Hill Richards, Inc. (Bateman Eichler), and Leslie Neadeau, President of T. O. N. M. Oil & Gas Exploration Corporation (TONM), to induce them to purchase large quantities of TONM over-the-counter stock by divulging false and materially incomplete information about the company on the pretext that it was accurate inside information. Specifically, Lazzaro is alleged to have told the respondents that he personally knew TONM insiders and had learned, inter alia, that (a) “[v]ast amounts of gold had been discovered in Surinam, and TONM had options on thousands of acres in gold-producing [472 U.S. 299, 302]   regions of Surinam”; (b) the discovery was “not publically known, but would subsequently be announced”; (c) TONM was currently engaged in negotiations with other companies to form a joint venture for mining the Surinamese gold; and (d) when this information was made public, “TONM stock, which was then selling from $1.50 to $3.00/share, would increase in value from $10 to $15/share within a short period of time, and . . . might increase to $100/share” within a year. Complaint §§ 16-17, App. 10-12. Some of the respondents aver that they contacted Neadeau and inquired whether Lazzaro’s tips were accurate; Neadeau stated that the information was “not public knowledge” and “would neither confirm nor deny those claims,” but allegedly advised that “Lazzaro was a very trustworthy and a good man.” Id. § 19, App. 12.

The respondents admitted in their complaint that they purchased TONM stock, much of it through Lazzaro, “on the premise that Lazzaro was privy to certain information not otherwise available to the general public.” Id., § 15, App. 10. Their shares initially increased dramatically in price, but ultimately declined to substantially below the purchase price when the joint mining venture fell through. Id. §§ 22-26, App. 13-14.   [472 U.S. 299, 303]  

Lazzaro and Neadeau are alleged to have made the representations set forth above knowing that the representations “were untrue and/or contained only half-truths, material omissions of fact and falsehoods,” intending that the respondents would rely thereon, and for the purpose of “influenc[ing] and manipulat[ing] the price of TONM stock” so as “to profit themselves through the taking of commissions and secret profits.” Id. §§ 23, 30, 38, App. 13, 15-16. The respondents contended that this scheme violated, inter alia, 10(b) of the Securities Exchange Act of 1934, 48 Stat. 891, 15 U.S.C. 78j(b), and Securities and Exchange Commission [472 U.S. 299, 304]   (SEC) Rule 10b-5 promulgated thereunder, 17 CFR 240.10b-5 (1984). They sought capital losses and lost profits, punitive damages, and costs and attorney’s fees. App. 26. 

The District Court dismissed the complaint for failure to state a claim. The court reasoned that “trading on insider information is itself a violation of rule 10b-5” and that the allegations in the complaint demonstrated that the respondents themselves had “violated the particular statutory provision under which recovery is sought.” App. to Pet. for Cert. C-2. Thus, the court concluded, the respondents were in pari delicto with Lazzaro and Neadeau and absolutely barred from recovery. Ibid.

The Court of Appeals for the Ninth Circuit reversed. Berner v. Lazzaro, 730 F.2d 1319 (1984). Although it [472 U.S. 299, 305]   assumed that the respondents had violated the federal securities laws, id., at 1324, the court nevertheless concluded that “securities professionals and corporate officers who have allegedly engaged in fraud should not be permitted to invoke the in pari delicto doctrine to shield themselves from the consequences of their fraudulent misrepresentation,” id., at 1320. The Court of Appeals noted that this Court had sharply restricted the availability of the in pari delicto defense in antitrust actions, see Perma Life Mufflers, Inc. v. International Parts Corp., 392 U.S. 134 (1968), and concluded that, essentially for three reasons, there was no basis “for creating a different rule for private actions initiated under the federal securities laws,” 730 F.2d, at 1322. First, the court reasoned that, in cases such as this, defrauded tippees are not in fact “equally responsible” for the violations they allege. Ibid. Second, the court believed that allowing the defense in these circumstances would be “totally incompatible with the overall aims of the securities law” because the threat of a private damages action is necessary to deter “insider-tipster[s]” from defrauding the public. Id., at 1323. Finally, the court noted the availability of means other than an outright preclusion of suit to deter tippees from trading on inside information. Id., at 1324, n. 3.

The lower courts have divided over the proper scope of the in pari delicto defense in securities litigation. 10 We granted certiorari. 469 U.S. 1105 (1985). We affirm. [472 U.S. 299, 306]  

II

The common-law defense at issue in this case derives from the Latin, in pari delicto potior est conditio defendentis: “In a case of equal or mutual fault . . . the position of the [defending] party . . . is the better one.” 11 The defense is grounded on two premises: first, that courts should not lend their good offices to mediating disputes among wrongdoers; 12 and second, that denying judicial relief to an admitted wrongdoer is an effective means of deterring illegality. 13 In its classic formulation, [472 U.S. 299, 307]   the in pari delicto defense was narrowly limited to situations where the plaintiff truly bore at least substantially equal responsibility for his injury, because “in cases where both parties are in delicto, concurring in an illegal act, it does not always follow that they stand in pari delicto; for there may be, and often are, very different degrees in their guilt.” 1 J. Story, Equity Jurisprudence 304-305 (13th ed. 1886) (Story). Thus there might be an “inequality of condition” between the parties, id., at 305, or “a confidential relationship between th[em]” that determined their “relative standing” before a court, 3 J. Pomeroy, Equity Jurisprudence 942a, p. 741 (5th ed. 1941) (Pomeroy). In addition, the public policy considerations that undergirded the in pari delicto defense were frequently construed as precluding the defense even where the plaintiff bore substantial fault for his injury: “[T]here may be on the part of the court itself a necessity of supporting the public interests or public policy in many cases, however reprehensible the acts of the parties may be.” 1 Story 305. Notwithstanding these traditional limitations, many courts have given the in pari delicto defense a broad application to bar actions where plaintiffs simply have been involved generally in “the same sort of wrongdoing” as defendants. Perma Life Mufflers, Inc. v. International Parts Corp., 392 U.S., at 138 . 14 

In Perma Life, we emphasized “the inappropriateness of invoking broad common-law barriers to relief where a private suit serves important public purposes.” Ibid. That case involved a treble-damages action against a Midas Muffler franchisor by several of its dealers, who alleged that the franchise agreement created a conspiracy to restrain trade in violation [472 U.S. 299, 308]   of the Sherman and Clayton Acts. 15 The lower courts barred the action on the grounds that the dealers, as parties to the agreement, were in pari delicto with the franchisor. In reversing that determination, the opinion for this Court emphasized that there was no indication that Congress had intended to incorporate the defense into the antitrust laws, which “are best served by insuring that the private action will be an ever-present threat to deter anyone contemplating [illegal] business behavior.” Id., at 139. Accordingly, the opinion concluded that “the doctrine of in pari delicto, with its complex scope, contents, and effects, is not to be recognized as a defense to an antitrust action.” Id., at 140. The opinion reserved the question whether a plaintiff who engaged in “truly complete involvement and participation in a monopolistic scheme” – one who “aggressively support[ed] and further[ed] the monopolistic scheme as a necessary part and parcel of it” – could be barred from pursuing a damages action, finding that the muffler dealers had relatively little bargaining power and that they had been coerced by the franchisor into agreeing to many of the contract’s provisions. Ibid.

In separate opinions, five Justices agreed that the concept of “equal fault” should be narrowly defined in litigation arising under federal regulatory statutes. 16 “[B]ecause of the strong public interest in eliminating restraints on competition, . . . many of the refinements of moral worth demanded of plaintiffs by . . . many of the variations of in pari delicto should not be applicable in the antitrust field.” Id., at 151 (MARSHALL, J., concurring in result). The five Justices concluded, however, that where a plaintiff truly bore at least substantially equal responsibility for the violation, a defense [472 U.S. 299, 309]   based on such fault – whether or not denominated in pari delicto – should be recognized in antitrust litigation. 17 

Bateman Eichler argues that Perma Life – with its emphasis on the importance of analyzing the effects that fault-based defenses would have on the enforcement of congressional goals – is of only marginal relevance to a private damages action under the federal securities laws. Specifically, Bateman Eichler observes that Congress expressly provided for private antitrust actions – thereby manifesting a “desire to go beyond the common law in the antitrust statute in order to provide substantial encouragement to private enforcement and to help deter anticompetitive conduct” – whereas private rights of action under 10(b) of the Securities Exchange Act of 1934 are merely implied from that provision 18 – thereby, apparently, supporting a broader application of the in pari delicto defense. Brief for Petitioner 32. Bateman Eichler buttresses this argument by observing that, unlike the Sherman and Clayton Acts, the securities laws contain savings provisions directing that “[t]he rights and remedies provided by [those laws] shall be in addition to any and all other rights and remedies that may exist at law or in equity” 19 – again, apparently, supporting a broader scope for fault-based defenses than recognized in Perma Life. [472 U.S. 299, 310]  

We disagree. Nothing in Perma Life suggested that public policy implications should govern only where Congress expressly provides for private remedies; the classic formulation of the in pari delicto doctrine itself required a careful consideration of such implications before allowing the defense. See supra, at 307. Moreover, we repeatedly have emphasized that implied private actions provide “a most effective weapon in the enforcement” of the securities laws and are “a necessary supplement to Commission action.” J. I. Case Co. v. Borak, 377 U.S. 426, 432 (1964); see also Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 730 (1975). In addition, we have eschewed rigid common-law barriers in construing the securities laws. See, e. g., Herman & MacLean v. Huddleston, 459 U.S. 375, 388 -389 (1983) (common-law doctrines are sometimes of “questionable pertinence” in applying the securities laws, which were intended “to rectify perceived deficiencies in the available common-law protections by establishing higher standards of conduct in the securities industry”); A. C. Frost & Co. v. Coeur d’Alene Mines Corp., 312 U.S. 38, 43 (1941) (rejecting the uncleanhands defense on the facts of the case because it would “seriously hinder rather than aid the real purpose” of the securities laws). 20 We therefore conclude that the views expressed in Perma Life apply with full force to implied causes of action under the federal securities laws. Accordingly, a private action for damages in these circumstances may be barred on the grounds of the plaintiff’s own culpability only where (1) as a direct result of his own actions, the plaintiff bears at least substantially equal responsibility for the violations he seeks [472 U.S. 299, 311]   to redress, and (2) preclusion of suit would not significantly interfere with the effective enforcement of the securities laws and protection of the investing public.

A

The District Court and Court of Appeals proceeded on the assumption that the respondents had violated 10(b) and Rule 10b-5, see supra, at 304-305 – an assumption we accept for purposes of resolving the issue before us. Cf. A. C. Frost & Co. v. Coeur d’Alene Mines Corp., supra, at 40-41. 21   [472 U.S. 299, 312]   Bateman Eichler contends that the respondents’ delictum was substantially par to that of Lazzaro and Neadeau for two reasons. First, whereas many antitrust plaintiffs participate in illegal restraints of trade only “passively” or as the result of economic coercion, as was the case in Perma Life, the ordinary tippee acts voluntarily in choosing to trade on inside information. Second, 10(b) and Rule 10b-5 apply literally to “any person” who violates their terms, and do not recognize gradations of culpability.

We agree that the typically voluntary nature of an investor’s decision impermissibly to trade on an inside tip renders the investor more blameworthy than someone who is party to a contract solely by virtue of another’s overweening bargaining power. We disagree, however, that an investor who engages in such trading is necessarily as blameworthy as a corporate insider or broker-dealer who discloses the information for personal gain. Notwithstanding the broad reach of 10(b) and Rule 10b-5, there are important distinctions [472 U.S. 299, 313]   between the relative culpabilities of tippers, securities professionals, and tippees in these circumstances. The Court has made clear in recent Terms that a tippee’s use of material nonpublic information does not violate 10(b) and Rule 10b-5 unless the tippee owes a corresponding duty to disclose the information. Dirks v. SEC, 463 U.S. 646, 654 -664 (1983); Chiarella v. United States, 445 U.S. 222, 230 , n. 12 (1980). That duty typically is “derivative from . . . the insider’s duty.” Dirks v. SEC, supra, at 659; see also id., at 664. In other words, “[t]he tippee’s obligation has been viewed as arising from his role as a participant after the fact in the insider’s breach of a fiduciary duty” toward corporate shareholders. Chiarella v. United States, supra, at 230, n. 12. 22 In the context of insider trading, we do not believe that a person whose liability is solely derivative can be said to be as culpable as one whose breach of duty gave rise to that liability in the first place. 23 

Moreover, insiders and broker-dealers who selectively disclose material nonpublic information commit a potentially broader range of violations than do tippees who trade on the basis of that information. A tippee trading on inside information will in many circumstances be guilty of fraud against individual shareholders, a violation for which the tipper shares responsibility. But the insider, in disclosing such information, also frequently breaches fiduciary duties toward the issuer itself. 24 And in cases where the tipper [472 U.S. 299, 314]   intentionally conveys false or materially incomplete information to the tippee, the tipper commits an additional violation: fraud against the tippee. Such conduct is particularly egregious when committed by a securities professional, who owes a duty of honesty and fair dealing toward his clients. Cf. 3 Pomeroy 942a, at 741. Absent other culpable actions by a tippee that can fairly be said to outweigh these violations by insiders and broker-dealers, we do not believe that the tippee properly can be characterized as being of substantially equal culpability as his tippers.

There is certainly no basis for concluding at this stage of this litigation that the respondents were in pari delicto with Lazzaro and Neadeau. The allegations are that Lazzaro and Neadeau masterminded this scheme to manipulate the market in TONM securities for their own personal benefit, and that they used the purchasing respondents as unwitting dupes to inflate the price of TONM stock. The respondents may well have violated the securities laws, and in any event we place no “stamp of approval” on their conduct. Chiarella v. United States, supra, at 238 (STEVENS, J., concurring). But accepting the facts set forth in the complaint as true – as we must in reviewing the District Court’s dismissal on the pleadings – Lazzaro and Neadeau “awakened in [the respondents] a desire for wrongful gain that might otherwise have remained dormant, inspired in [their] mind[s] an unfounded idea that [they were] going to secure it, and then by fraud and false pretenses deprived [them] of [their] money,” Stewart v. Wright, 147 F. 321, 328-329 (CA8), cert. denied, 203 U.S. 590 (1906) – actions that, if they occurred, were far more culpable under any reasonable view than the respondents’ alleged conduct. 25   [472 U.S. 299, 315]  

B

We also believe that denying the in pari delicto defense in such circumstances will best promote the primary objective of the federal securities laws – protection of the investing public and the national economy through the promotion of “a high standard of business ethics . . . in every facet of the securities industry.” SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 186 -187 (1963). Although a number of lower courts have reasoned that a broad rule of caveat tippee would better serve this goal, 26 we believe the contrary position adopted by other courts represents the better view. 27 

To begin with, barring private actions in cases such as this would inexorably result in a number of alleged fraudulent practices going undetected by the authorities and unremedied. The SEC has advised us that it “does not have the resources to police the industry sufficiently to ensure that false tipping does not occur or is consistently discovered,” and that “[w]ithout the tippees’ assistance, the Commission could not effectively prosecute false tipping – a difficult practice to detect.” Brief for SEC as Amicus Curiae 25. See also H. R. Rep. No. 93-355, p. 6 (1983) (“In recent years, the securities markets have grown dramatically in size and complexity, while Commission enforcement resources have declined”). Thus it is particularly important to permit [472 U.S. 299, 316]   “litigation among guilty parties [that will serve] to expose their unlawful conduct and render them more easily subject to appropriate civil, administrative, and criminal penalties.” Kuehnert v. Texstar Corp., 412 F.2d 700, 706, n. 3 (CA5 1969) (Godbold, J., dissenting). The in pari delicto defense, by denying any incentive to a defrauded tippee to bring suit against his defrauding tipper, would significantly undermine this important goal. 28 

Moreover, we believe that deterrence of insider trading most frequently will be maximized by bringing enforcement pressures to bear on the sources of such information – corporate insiders and broker-dealers.

    • “The true insider or the broker-dealer is at the fountainhead of the confidential information . . . . If the prophylactic purpose of the law is to restrict the use of all material inside information until it is made available to the investing public, then the most effective means of carrying out this policy is to nip in the bud the source of the information, the tipper, by discouraging him from `making the initial disclosure which is the first step in the chain of dissemination.’ This can most readily be achieved by making unavailable to him the defense of in pari delicto when sued by his tippee upon charges based upon alleged misinformation.” Nathanson v. Weis,

[472 U.S. 299, 317]   

    Voisin, Cannon, Inc., 325 F. Supp. 50, 57-58 (SDNY 1971).

In addition, corporate insiders and broker-dealers will in many circumstances be more responsive to the deterrent pressure of potential sanctions; they are more likely than ordinary investors to be advised by counsel and thereby to be informed fully of the “allowable limits on their conduct.” Kuehnert v. Texstar Corp., 412 F.2d, at 706 (Godbold, J., dissenting). 29 Although situations might well arise in which the relative culpabilities of the tippee and his insider source merit a different mix of deterrent incentives, we therefore conclude that in tipper-tippee situations such as the one before us the factors discussed above preclude recognition of the in pari delicto defense. 30 

Lower courts reaching a contrary conclusion have typically asserted that, absent a vigorous allowance of the in pari delicto defense, tippees would have, “in effect, an enforceable [472 U.S. 299, 318]   warranty that secret information is true,” id., at 705, and thus no incentive not to trade on that information. 31 These courts have reasoned, in other words, that tippees in such circumstances would be in “the enviable position of `heads-I-win tails-you-lose,'” Wolfson v. Baker, 623 F.2d 1074, 1082 (CA5 1980), cert. denied, 450 U.S. 966 (1981) – if the tip is correct, the tippee will reap illicit profits, while if the tip fails to yield the expected return, he can sue to recover damages.

We believe the “enforceable warranty” theory is overstated and overlooks significant factors that serve to deter tippee trading irrespective of whether the in pari delicto defense is allowed. First, tippees who bring suit in an attempt to cash in on their “enforceable warranties” expose themselves to the threat of substantial civil and criminal penalties for their own potentially illegal conduct. 32 Second, plaintiffs in litigation under 10(b) and Rule 10b-5 may only recover against defendants who have acted with scienter. See Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976). Thus “if the tip merely fails to `pan out’ or if the information itself proves accurate but the stock fails to move in the anticipated direction, the investor stands to lose all of his investment. Only in the situation where the investor has been deliberately defrauded will he be able to maintain a private suit in an attempt to recoup his money.” 730 F.2d, at 1324, n. 3. 33   [472 U.S. 299, 319]  

We therefore conclude that the public interest will most frequently be advanced if defrauded tippees are permitted to bring suit and to expose illegal practices by corporate insiders and broker-dealers to full public view for appropriate sanctions. As the Ninth Circuit emphasized in this case, there is no warrant to giving corporate insiders and broker-dealers “a license to defraud the investing public with little fear of prosecution.” Id., at 1323.