The opinion of the court was delivered by: OWEN
In this multi-faceted litigation, before me for pretrial purposes pursuant to an order of the Judicial Panel on Multidistrict Litigation, there are various motions to dismiss. These actions have a common origin in the near financial collapse of the City of New York in late 1974 and early 1975.
The several complaints allege that the City of New York, former Mayor Abraham Beame and Comptroller Harrison Goldin (the "City Defendants"), and certain banks and brokerage firms (the "Underwriter and Seller Defendants") deliberately misled the public as to the City's desperate financial condition in connection with the underwriting and subsequent resale of various New York City obligations issued during 1974 and 1975.
Plaintiffs allege that the foregoing constitutes violations of Section 17(a) of the Securities Act of 1933 (the "Securities Act" or the "1933 Act"), 15 U.S.C. § 77q(a) and Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act" or the "1934 Act"), 15 U.S.C. § 78j(6) and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5.
Eleven separate lawsuits have been consolidated for pretrial matters in this litigation.
In five of the actions, the City is named as a defendant along with the underwriters and sellers.
Two of the actions have been certified as class actions pursuant to Fed. R. Civ. P. 23(b)(3), Friedlander v. City of New York, 71 F.R.D. 546 (S.D.N.Y. 1976), and Spector v. City of New York, 71 F.R.D. 550 (S.D.N.Y. 1976). In Friedlander, plaintiffs allege that on June 1, 1974, New York City had outstanding $ 4.4 billion short-term notes, of which the defendant banks held approximately $ 3.5 billion, and of which large of the defendant brokers owned approximately $ 900 million. (Plaintiff's Complaint at para. 31.) According to the complaint, based on "inside" information that the City was unable to repay these obligations, the underwriter defendants underwrote for distribution to the general public approximately $ 2.6 billion of the City's notes. The proceeds of these sales were allegedly to be used to "bail out" the banks' and brokerage firms' own holdings of City notes by reducing those holdings from $ 4.4 billion in June 1974 to $ 1.9 billion in June 1975. The City of New York and its Mayor and Comptroller are alleged to have aided and abetted the foregoing acts by, inter alia, concealing the City's critical financial condition from the public and falsifying certain records to conceal the fiscal crisis. The Friedlander class consists of the first non-dealer purchasers of the City's Revenue Anticipation Notes (the "RANS") issued on December 13, 1974, January 13, 1975, February 14, 1975 and the City's Bond Anticipation Notes issued March 12, 1975. See Friedlander v. City of New York, 71 F.R.D. 546, 548 (S.D.N.Y. 1976).
The Spector class consists of the holders of the City's general obligation bonds who purchased such bonds between May 1, 1974 and September 30, 1975. Plaintiffs allege that the commercial banks and brokerage firms conspired to conceal information as to the City's desperate financial condition from the investing public. These acts of concealment, along with other short term steps designed to avoid default, were allegedly taken to preserve prevailing bond prices to allow the defendants to profitably dispose of their own holdings of City bonds. Certain of the defendants are said to have reduced their holdings in City bonds from $ 2.5 billion on May 1, 1974 to virtually nil by the time the prices of those bonds plummeted. Here, as in Friedlander, the City is alleged to have aided and abetted this conspiracy by virtue of material misrepresentations and nondisclosures to the public concerning the City's finances. Plaintiffs contend that as a result of the acts of the City defendants and the underwriter and seller defendants, the members of the class -- predominately "after-market" purchasers of the City general obligation bonds -- incurred substantial economic losses.
The allegations in Goldfarb, Weisberg and Manchester are essentially the same as those in Friedlander and Spector. The remaining cases, while not alleging securities fraud on the part of the City defendants, allege violations of § 17(a) of the Securities Act and/or § 10(b) of the Securities Exchange Act by certain of the commercial banks or brokerage firms.
It is undisputed that all of the conduct at issue occurred prior to the enactment of the 1975 amendments to the Securities Exchange Act.
The City and the underwriter and seller defendants move to dismiss for failure to state a claim upon which relief may be granted, Fed. R. Civ. P. 12(b)(6),
on the following legal theories:
(1) That transactions involving municipal securities whether by the City, the underwriters or other sellers, are not covered by § 10(b) of the Securities Exchange Act; and, consequently, no private right of action is conferred upon a purchaser of such securities; and
(2) That while § 17(a) of the Securities Act expressly includes municipal securities and has been construed to confer enforcement rights upon the Securities and Exchange Commission ("SEC") in the event of violations, it does not confer a private right of action upon an investor; and
(3) That if the antifraud provisions of the securities laws apply to municipal securities, the tenth amendment to the United States Constitution would render such provisions unconstitutional as applied to the City defendants.
In the alternative, certain of the underwriter defendants argue that if a private right of action does exist as to them with respect to transactions in municipal securities, it must also be implied against the City as issuer.
From a careful consideration of the 1933 and 1934 Acts (and their amendments) viewed in the light of their extensive legislative I conclude that the motions of the City defendants to dismiss should be granted, while those of the underwriter and seller defendants should be denied.
I. The Applicability of § 10(b) of the Securities Exchange Act to Municipal Securities and to the Underwriters and Sellers Thereof
The threshold question presented is whether the private right of action unquestionably available to a purchaser of corporate securities under § 10(b) of the 1934 Act,
and Rule 10b-5 promulgated thereunder,
is equally available to a purchaser of municipal securities. This is "basically a matter of statutory construction." TransAmerica Mortgage Advisors v. Lewis, 444 U.S. 11, 100 S. Ct. 242, 62 L. Ed. 2d 146 (1979).
The Securities Exchange Act was designed "to provide for the regulation of securities exchanges and of the over-the-counter markets... to prevent inequitable and unfair practices in such exchanges and markets..." S.Rep.No. 792, 73d Cong. 2d Sess. 1 (1934). Nevertheless, Congress, by including § 3(a)(12), 15 U.S.C. § 78c(a)(12) in the 1934 Act, clearly contemplated that, at least for some purposes, governmental securities, including those of municipalities, would be exempted from certain of its requirements. The defendants argue that the mere inclusion of § 3(a)(12) in the 1934 Act evidences a Congressional intent to exempt municipal securities from the operations of 10(b). I reject this contention.
At the time of the events in question, § 3(a)(12) defined an "exempted security" as follows:
The term "exempted security" or "exempted securities" includes securities which are direct obligations of or obligations guaranteed as to principal or interest by the United States;... securities which are direct obligations of or obligations guaranteed as to principal or interest by a State or any political subdivision thereof, or by any agency or instrumentality of a State or any political subdivision thereof, or by any municipal corporate instrumentality of one or more states;... and such other securities... as the Commission may, by such rules and regulations as it deems necessary or appropriate in the public interest or for the protection of investors,... exempt from the operation of any one or more provisions of this chapter which by their terms do not apply to an "exempted security" or to "exempted securities".
1934 Act, ch. 404, § 3, 48 Stat. 882. This section is strictly definitional. Whether or not a given substantive section applies to "exempted securities" is left to the express language of the particular section. In the Senate Report on the 1934 Act, the draftsmen confirm this view by noting that a "large number of the provisions in the Act expressly include 'exempted securities'".
In short, when Congress wanted to exclude exempted securities from a section of the Act, it knew how to do so.
It is significant, therefore, that the language of § 10(b) does not evidence such an intent. That section makes it unlawful for "any person... 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...." (emphasis added). The Congressional intent to have § 10(b) extend to fraudulent conduct in connection with all securities in the broadest sense, including those defined in § 3(a)(12) could not be clearer. The draftsmen not only omitted reference to "exempted securities," they also specifically included both registered and unregistered securities, as well as transactions on the national securities exchange and the over-the-counter market.
The legislative history of § 3(a)(12) further demonstrates that it only serves to define "exempted securities." The original draft of § 3(a)(12) expressly exempted only United States Government securities,
and the Federal Trade Commission was to be vested with the authority to broaden the scope of § 3(a)(12).
In discussing this grant of authority, the draftsmen wrote:
A large number of provisions in the act expressly exclude "exempted securities." Thus the Commission is able to remove from the operation of any one or more of these provisions any securities as to which it deems them inappropriate.
H.R.Rep.No.1383, 73rd Cong., 2d Sess., 17 (1934) (Emphasis added); see also S.Rep.No. 792, 73d Cong., 2d Sess., 14 (1934). Thus, Congress granted the Commission the authority to add other securities to the list of exempted securities, but it did not empower the Commission to exclude "exempted securities" from other sections of the Act. That Congress later expanded the definition of "exempted securities" to include those of state and municipal issuers does not alter the limited function of § 3(a)(12).
It is also clear that obvious political considerations motivated Congress to enact the exemptions it eventually provided for municipal securities in the 1933 and 1934 Acts. Landis, the Legislative History of the Securities Act of 1933, 28 Geo.Wash.L.Rev. 29, 39 (1959). The political, as well as economic, justifications underlying § 3 (a)(12) are most visible in the Congressional hearings on the 1934 Act. Paramount among the political concerns was the impact on federal-state relations of vesting the Federal Trade Commission with the discretionary authority to affect the credit of a state or municipality. Senate Hearings, supra, at 7477. In testimony before the Senate, George B. Gibbons, a New York City municipal bond dealer, highlighted the danger of vesting such power in the Federal Trade Commission:
State bonds and the bonds of their political subdivisions and agencies are not exempted by the provisions of this Act, and they are under the power of the Federal Trade Commission. That gives them, if they so care to use it, a very dangerous power over the financial affairs of all the states, cities, counties and political subdivisions and agencies in them; and it might be exercised to their great disadvantage.
The credit of a state, or a municipality or agency within it, and its ability to finance its many needs for roads, schools, preservation of health, and so on, would be seriously crippled by the refusal of the Federal Trade Commission to exempt its bonds or by the imposing of unreasonable conditions for granting such exemptions, and cause irreparable damage and loss to both the State or municipality and to the holders of their outstanding bonds by the withdrawal of exemption in cases where it had once been granted.
Senate Hearings, supra, at 7446.
In fact, these very same objections prompted one member of the House Committee to note that "a real [constitutional] question" existed as to "the power of Congress to place any burden upon a state in the marketing of its bonds...." House Hearings, supra, at 822.
An equally compelling argument was addressed to Congress detailed the economic impact of failing to include state and municipal obligations in § 3(a)(12). Numberous witnesses observed that the failure to provide a blanket exemption for municipal and state obligations, while providing such an exemption for securities of the federal government, would impose a serious economic burden on the nonexempted securities. See, e.g., House Hearings, supra, at 721. As one witness explained to the Senate Committee:
The inclusion of State and municipal bonds in the bill does not confer any benefit on the holders of municipal bonds nor on the municipalities issuing them. On the contrary, it imposes a very distinct hardship on both municipalities and the purchasers of their bonds and will seriously affect their value as an investment. The exemption of a municipal bond would not add to its present value, and refusing exemption would seriously impair its value.
If being exempted from this bill is helpful to the United States Government bonds, certainly States and municipalities need that help also. If not being exempted would be harmful to Government bonds, certainly ...