Lumbard, Chief Judge, and Kaufman and Hays, Circuit Judges. Hays, Circuit Judge (concurring in part and dissenting in part).
IRVING R. KAUFMAN, Circuit Judge:
We are called upon to decide two significant questions relating to § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5: Under what circumstances does Fed.R.Civ.P. 23 permit a class action alleging a violation of 10b-5? And, may punitive damages be assessed against those who do not meet the standards of conduct required by that rule?
Leon Green appeals from an order of the District Court for the Southern District of New York striking those parts of his complaint which purported to make the suit a class action and those other allegations which sought punitive damages. We believe that this litigation has been properly brought as a class action but that the District Court should not reinstate Green's claim for punitive damages.
The Wolf Corporation was organized in January, 1961 by three real estate investors, Joseph Wolf, Joseph Eckhaus, and Leon Spilky*fn2 who exchanged certain real estate holdings for $775,000 of the corporation's subordinated debentures. Wolf Corp. [hereinafter Wolf] then filed a registration statement and prospectus [the first prospectus] with the Securities and Exchange Commission in February 1961, to become effective on June 2, 1961, in connection with the issuance of 806,350 shares of Class A common stock and $3,583,000 in fifteen year, 7.2% subordinated debentures. 746,350 shares of the stock and $2,808,000 of the debentures were to be exchanged for the interests of various limited partners in certain real estate syndicates of which Messrs. Wolf, Eckhaus and Spilky were the general partners. The other 60,000 shares of Class A common stock were offered to the public at $10 a share, conditioned on consummation of the "exchange" offer with the limited partners. This registration was approved by the SEC and the stock in question was sold to the public.
On January 26, 1962, Wolf filed a second registration with the SEC, accompanied by a prospectus [the second prospectus]. These documents related to a proposed issue of $4,500,000 of 6.5% convertible subordinated debentures with detachable warrants to purchase 450,000 shares of Class A common stock. This second registration was amended in June 1962 to cover the issuance of a different combination of securities: $1,321,500 in 6 1/2% convertible subordinated debentures and 264,300 shares of Class A common. Another prospectus [the third prospectus] was prepared in connection with this amended second registration. The third prospectus was subscribed "Underwriter Troster, Singer & Co." [hereinafter Troster, Singer]. The second prospectus noted that this was Troster, Singer's first venture as an underwriter. Troster, Singer is a defendant in this action, and Green concedes that its liability, if any, is only to those who purchased Wolf stock after June 1, 1962, the date of the third prospectus.
The SEC began an investigation of Wolf on July 13, 1962. This was grounded on allegedly untruthful statements in the second registration statement, including alleged inaccuracies in the cash Wolf claimed was available for distribution to stockholders. By a decision and order dated May 4, 1966, the SEC found "serious and extensive" deficiencies in the second registration statement, as amended in June 1962, but nonetheless consented to Wolf's offer to withdraw the registration and the second and third prospectuses accompanying it. As a condition to the SEC's consent it required Wolf to notify its stockholders and all those who had received the prospectuses of what the Commission characterized as "the dismal record of the abortive financial program and the deceptive financial presentation of the registrant's earlier record of operations." Wolf Corp. No. 4830 at 11 (SEC, May 4, 1966). Thus the second registration never became effective and no stock was sold pursuant to it.
Green began his association with Wolf by purchasing a limited partnership in one of the real estate syndicates covered by the "exchange offer" for the sum of $3,500. On June 2, 1961 he surrendered this interest for 350 shares of Wolf Corp. stock and $777 in subordinated debentures. On June 13, 1962, shortly after the third prospectus was issued, Green purchased 100 shares of Wolf stock in the open market at a price of $10 1/4 a share for a total price of $1,042.27 (including commissions). The purchase of these shares, he acknowledges in his brief,*fn3 is the sole basis for his suit. All 100 shares were still in his possession when this action was commenced.
We are presented with the difficult task of interpreting the class action rule, Fed.R.Civ.P. 23 [hereinafter Rule 23], because Green seeks to bring this action on behalf of all those who purchased the common stock or subordinated debentures of Wolf Corp. between June 2, 1961 and the end of 1963, a group consisting of about 2,200 persons. It is conceded that no other purchaser has brought an action arising from the alleged acts which were committed approximately six years ago. Nor has any shareholder sought to intervene in this suit.
Green asserts that the three prospectuses, which together are alleged to be the sum of information disclosed by Wolf to the general public and to the financial community during the period in question, contain untrue or misleading statements. In particular, he claims that the item "Cash Available for Distribution to Shareholders" in the balance sheet incorporated in each prospectus was overstrated. Green claims that this item is of great significance to potential buyers of shares in a real estate corporation, for it is said to be the key to what the likely return may be on this type of investment. Thus, he argues that the more cash the balance sheet reflects as available for distribution, the higher the potential price of the stock is expected to reach, and hence the greater the inflation of the cash available item, the more significant the impact on the price of the stock. These serious misrepresentations and omissions, Green alleges, artificially inflated the price of Wolf stock.*fn4 The complaint alleges that Green (and presumably members of the class he seeks to represent), relied on the misstatements and omissions in that none were aware the price of the stock had been inflated to an artificially high level by the misleading information. All of this, it is claimed, violates § 10(b) and Rule 10b-5 [hereinafter 10b-5]. For himself, Green seeks to recover the difference between the price he paid, $10 1/4, and the "true" or unmanipulated value of Wolf stock, which he puts at between $1 and $2 1/2; the total damage to Green is thus less than $1,000.*fn5
We are mindful that the serious and troublesome question as to when to allow a class action under 10b-5*fn6 is one of great importance. This is so because "the ultimate effectiveness of the federal remedies when the defendants are not prone to settle may depend in large measure on the applicability of the class action device." 3 Loss, Securities Regulation 1819 (2d ed. 1961). While other federal securities antifraud provisions are important none have become as far-reaching as Rule 10b-5 which, although little used in its early years, now represents approximately one-third of all current cases, public and private, brought under the whole array of SEC statutes. It generates almost as much litigation as all the other general antifraud provisions combined. Bromberg, Securities Law: Fraud: SEC Rule 10b-5, § 2.5(6) at 45-46 (1968); 77 Yale L.J. 1585 (1968). If, as here, the security in connection with which the alleged misrepresentations and violations of 10b-5 have been made is publicly held, a class action may well be the ...