Appeal from a judgment of the United States District Court for the Southern District of New York, Thomas P. Griesa, Judge, granting summary judgment in favor of defendants in an action by a publicly held mutual fund charging defendant accounting firm and its employees with violating section 10(b) of the Securities Exchange Act of 1934, SEC Rule 10b-5, section 17(a) of the Securities Act of 1933, sections 206(1) and 206(2) of the Investment Advisers Act of 1940, common law fraud and breach of fiduciary duty.
Hays and Feinberg, Circuit Judges, and Holden, District Judge.*fn*
This is an appeal by plaintiff Competitive Associates, a publicly held mutual fund, from summary judgment entered on July 3, 1974, in the United States District Court for the Southern District of New York, in favor of defendants Laventhol, Krekstein, Horwath and Horwath, an accounting firm, and Morton Dear, Robert E. Bier, and Thomas Martino, Jr., three individual employees of that firm.*fn1 The action is based variously on section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), SEC Rule 10b-5, section 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q, sections 206(1) and 206(2) of the Investment Advisers Act of 1940, 15 U.S.C. §§ 80b-6(1) and 80b-6(2), common law fraud and breach of fiduciary duty.*fn2 Plaintiff alleges that defendants, in furtherance of a fraudulent scheme to induce plaintiff to retain one Akiyoshi Yamada and his company, Takara Asset Management Corporation, to manage a portion of its portfolio, knowingly certified false and misleading financial statements of Takara Partners, a private investment fund managed by Yamada. As a result, plaintiff avers, it subsequently lost several million dollars from purchases and sales of securities which Yamada, in his capacity as adviser, unlawfully caused it to make.*fn3 Specifically, plaintiff contends that the investment performance of Takara Partners was generally regarded as the primary measure of Yamada's expertise as an investment adviser, that the statements for the period ended December 31, 1969, certified by Laventhol, Krekstein, were materially false and misleading with respect to the size and quality of the partnership's assets and its profit and loss performance, that Laventhol, Krekstein knowingly and with intent to defraud certified these statements in order to facilitate, aid and abet Yamada's scheme to attract a showcase of investors to Takara, inflate his reputation as a successful investment adviser, and thereby create a dumping ground for securities which he was manipulating. An examination of the record convinces us that under the circumstances of this case, summary judgment was inappropriate; we therefore reverse and remand for trial.
Competitive Associates retained defendant Yamada and his company Takara Asset Management Corporation as one of its portfolio managers on October 9, 1970. Prior to his retention, Yamada's credentials were investigated by Competitive Associates. Jerome Randolph, then president of Competitive Capital, the fund manager for Competitive Associates,*fn4 was responsible for conducting the investigation. In the course of his investigation, Randolph interviewed various people in the securities industry. In addition he received a letter from Yamada dated June 12, 1970, which included a list of Takara's general and limited partners, and set forth certain financial information concerning Takara Partners, although it did not refer to the financial statements audited by the accounting defendants. Randolph also examined "portfolio sheets" for Takara Partners consisting of lists of stocks owned and their respective market values. Randolph prepared a summary description of Yamada and the funds he was then managing*fn5 together with a description of other potential portfolio managers for Competitive Associates and presented this material to its Board of Directors who thereupon approved Yamada as one of the portfolio managers. This choice was subsequently ratified by the shareholders of Competitive Associates. Yamada served as adviser until May 14, 1971, at which time his contract was terminated. During this period, Competitive Associates suffered substantial losses as a result of purchases and sales of securities made by Yamada on its behalf.
The district court granted defendants' motion for summary judgment on the theory that proof of direct reliance on the financial statements of Takara was an indispensable element of plaintiff's cause of action. Relying on excerpts from testimony given by Randolph before the SEC on May 10, 1971,*fn6 asserting that he, Randolph, had not seen the Takara financial statements prior to that date, the admissibility of which evidence plaintiff vigorously contests, the court concluded that plaintiff would be unable to prove the necessary reliance at trial. The court further held that even if the Takara financial statements did constitute an inducement to plaintiff to hire Yamada as its investment adviser, the connection between the fraudulent acts and omissions of the accounting defendants and the purchase or sale of securities which is required to support a claim under the federal securities laws was lacking. We disagree.
As a matter of law, the district court erred in its determination that plaintiff could not prevail unless it could prove direct reliance on the false financial statements certified by defendants. The Supreme Court specifically rejected such a restrictive reading of section 10(b) and Rule 10b-5 in Affiliated Ute Citizens v. United States, 406 U.S. 128, 31 L. Ed. 2d 741, 92 S. Ct. 1456 (1972). In that case, members of a large class of stockholders alleged that two employees of a bank in which their shares were deposited had, contrary to Rule 10b-5, arranged for sales of this stock without disclosing to plaintiffs facts regarding the role of the bank and its employees as "market makers" or the true value of the stock. In reversing the Court of Appeals, which had held that section 10(b) and Rule 10b-5 necessitated a showing of reliance for recovery, the Supreme Court stated that
"under the circumstances of this case, involving primarily a failure to disclose, positive proof of reliance is not a prerequisite to recovery. All that is necessary is that the facts withheld be material in the sense that a reasonable investor might have considered them important in the making of this decision. (Citations omitted.) This obligation to disclose and this withholding of a material fact establish the requisite element of causation in fact." 406 U.S. at 153-54.
This Court has also expressed the view that a plaintiff need not prove that non-disclosure of material facts induced its purchases, but need only allege that it would not have acted as it did had it known of the information withheld by defendants. Shapiro v. Merrill, Lynch, Pierce, Fenner and Smith, Inc., 495 F.2d 228, 240 (2d Cir. 1974). "To the extent that reliance is necessary for a finding of a 10b-5 violation in a non-disclosure case . . ., the test is properly one of tort 'causation in fact.'" Id. at 239, quoting Chasins v. Smith, Barney & Co., 438 F.2d 1167, 1172 (2d Cir. 1970).
Defendants, relying on a distinction set forth in dicta in Schlick v. Penn-Dixie Cement Corp., 507 F.2d 374 (2nd Cir. 1974), submit that the instant case involves allegations of misrepresentation as opposed to nondisclosure and that therefore plaintiff must show reliance in addition to causation in fact. However, as this court made quite clear in the Schlick case in which the district court's dismissal of plaintiff's complaint was reversed, a showing of reliance is not required where a comprehensive scheme to defraud which includes not only omissions and misrepresentation, but substantial collateral conduct as well, is alleged. 507 F.2d at 381. Not every violation of the anti-fraud provisions of the federal securities law can be, or should be, forced into a category headed "misrepresentations" or "nondisclosures". Fraudulent devices, practices, schemes, artifices and courses of business are also interdicted by the securities laws. In the case before us, plaintiff has charged the accounting defendants not only with affirmative misrepresentations in the financial statements, but also with a failure to disclose the true financial condition of Takara Partners and the alleged receipt of payoffs in return for its certification; furthermore, both misrepresentations and omissions are alleged to be only one aspect of an elaborate scheme to defraud. Under these circumstances, plaintiff need only show causation in fact; in order to do so plaintiff should have the opportunity to prove, but is not required to prove, that it saw, or directly relied upon, the financial statements certified by the accounting defendants. Cf. Hochfelder v. Ernst & Ernst, 503 F.2d 1100, 1115 (7th Cir. 1974).
The finding of the district court that the auditing and certification activities of defendants was not conduct "in connection with the purchase or sale" of a security involving plaintiffs within the meaning of section 10(b) and Rule 10b-5 is error. The "in connection with" requirement has been broadly interpreted by the Supreme Court to require only that plaintiff shall have "suffered an injury as a result of deceptive practices touching its sale of securities as an investor." Superintendent of Insurance v. Bankers Life and Casualty Co., 404 U.S. 6, 12-13, 92 S. Ct. 165, 30 L. Ed. 2d 128 (1971). The broad "touch" test enunciated in Bankers Life is certainly met by plaintiff's allegations that the very purpose of defendants' certification of Takara's ...