The opinion of the court was delivered by: POLLACK
Milton Pollack, District Judge.
Plaintiff Moss, who seeks to represent the class of all those who sold shares of Deseret Pharmaceutical Company stock on November 30, 1976, brings this suit for damages against Newman, Courtois and Antoniu and Morgan Stanley in the wake of Newman's conviction for securities fraud and mail fraud in connection with a tender offer made for Deseret stock. Moss asserts claims against Newman, Courtois and Antoniu based on Sections 10(b) and 14(e) of the Securities Exchange Act of 1934 and the Rules promulgated thereunder, Rule 10b-5 and Rule 14e-3. In addition, Moss claims that Morgan Stanley is derivatively liable for these Securities Act violations. Moss also asserts pendent state law claims of fraud and claims that Morgan Stanley is liable under the doctrine of respondeat superior. Finally, Moss asserts that all of the defendants, including Morgan Stanley have violated the Racketeer Influenced and Corrupt Organizations Act, 18 U.S.C. § 1961, et seq., and that they are therefore liable for treble damages.
Defendant Newman has moved to dismiss the complaint for failure to state a claim on which relief can be granted pursuant to Rule 12(b) (6) of the Federal Rules of Civil Procedure, and Morgan Stanley has moved to dismiss the complaint under Rule 12(b) (6) and for summary judgement under Rule 56(b) and for attorneys' fees and costs pursuant to Rule 11. For the reasons appearing hereafter, the motions to dismiss the amended complaint will be granted.
In December 1976, Warner Lambert Company made a cash tender offer for Deseret Pharmaceuticals Company. On or about November 23, 1976, Warner engaged the services of Morgan Stanley, in its capacity as an investment banker, to advise and assist Warner in its effort to acquire control of Deseret. Morgan Stanley was to investigate Deseret, evaluate its stock and recommend a price for Warner to offer Deseret shareholders in a tender offer. The defendant, E. Jacques Courtois, Jr., was employed by Morgan Stanley in its Merger and Acquisition Department. In that capacity, Courtois obtained knowledge of Warner's plan.
On or about November 30, 1976, Courtois disclosed to defendant Adrian Antoniu the information pertaining to Warner's plan to acquire Deseret stock. Antoniu was at the time an employee of Kuhn Loeb & Co., another broker-dealer and investment banker. Antoniu then disclosed the non-public information about the planned Warner offering to defendant James M. Newman, a stockbroker. The latter advised certain of his customers to buy Deseret stock in anticipation of Warner's tender offer, and purchased Deseret stock for his own account and others at prices substantially below the price which Warner offered to Deseret stockholders shortly thereafter.
As a result of these activities, Newman was tried and convicted on 15 counts of fraud. Antoniu pleaded guilty. Courtois was indicted but has not yet been tried as he is presently believed to be living in South America.
A plaintiff claiming damages under Section 10(b) must establish the existence of a special relationship by the defendant with an insider or the plaintiff. Absent this, nondisclosure of nonpublic market information is not actionable. "The essential purpose of Rule 10b-5 . . . is to prevent corporate insiders and their tippees from taking unfair advantage of the uninformed outsiders." Shapiro v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 495 F.2d 228, 235 (2d Cir. 1974), quoting Radiation Dynamics, Inc. v. Goldmuntz, 464 F.2d 876, 890 (2d Cir. 1974). Thus, as stated in Frigitemp Corp. v. Financial Dynamics Fund, 524 F.2d 275, 282 (2d Cir. 1975), "the party charged with failing to disclose market information must be under a duty to disclose it to the plaintiff."
In this case, none of the defendants owed plaintiff a duty of disclosure or abstention. None of the defendants had any tie to the issuer, Deseret, in whose stock they traded. As Morgan Stanley was not employed by Deseret but by Warner, neither Morgan Stanley nor its employees were insiders of Deseret. Thus, Newman, even if he is viewed as standing in the shoes of the Morgan Stanley employee, Courtois, when he traded, purchased stock on the basis of information that was obtained from a source outside of the issuer. While the information that led to the purchase was nonpublic, it was outside not inside information.
The argument that defendants did not owe the requisite duty to the plaintiff is based on Chiarella v. United States, 445 U.S. 222, 63 L. Ed. 2d 348, 100 S. Ct. 1108 (1980), where the Supreme Court held that an individual who was not an insider of the issuer in whose stock he traded could not be found to have violated Section 10(b) based on a theory of the breach of a duty to the shareholders of the issuer. In Chiarella, supra, the Court reversed the conviction under Section 10(b) of a printer who had traded in stock on the basis of non-public information that he had obtained in the course of his employment. Like the defendants in the present action, Chiarella was an outsider of the corporations in whose stock he traded. The Court stated:
The element required to make silence fraudulent -- a duty to disclose -- is absent in this case. No duty could arise from petitioner's relationship with the sellers of the target company's securities, for petitioner had no prior dealings with them. He was not their agent, he was not a fiduciary, he was not a person in whom the sellers had placed their confidence.
This Supreme Court argument compels a finding that Newman, Courtois and Antoniu cannot be liable to plaintiff for a violation of Section 10(b). As outsiders of Deseret, they did not owe the Deseret shareholders any duty of disclosure before trading. As the Ninth Circuit has recently noted:
A purchaser of stock who has no fiduciary relation to the prospective seller of the stock and who owns less than 5% . . . has no duty to disclose circumstances that will insure that the purchaser pays the highest possible price.
Polinsky v. MCA, Inc., 680 F.2d 1286, 1290 (9th Cir. 1982). As no duty to disclose or abstain was owed to the Deseret stockholders, they have no standing to sue for damages under Section 10(b) as the essential element of a breach of a duty owed to them is absent.
Recognizing that in order to set out a claim for damages under Section 10(b) one must show that the defendants have breached a duty owed to the plaintiff, Moss attempts to find a source that could create a duty owed to him by defendants. One of these efforts to create a duty to the stockholders of Deseret focuses on the duty that Courtois owed to Morgan Stanley. Plaintiff argues that Courtois owed a fiduciary duty to Morgan Stanley and to Morgan Stanley's client Warner. He claims that this duty to Morgan Stanley and its client Warner gave rise to a separate duty to disclose or abstain that was owed to the shareholders of Deseret. This argument fails.
It is true that a criminal violation of Section 10(b) can be based upon the breach of a duty owed to a party other than the party to the transaction. While the Supreme Court has not yet specifically addressed the question, the Second Circuit has held that a criminal violation of Section 10(b) can be based on the breach of a duty owed to the acquiring corporation or other party even though no duty is owed to the issuer. United States v. Newman, 664 F.2d 12 (2d Cir. 1981). In Newman, supra, the Court reversed the dismissal of the Section 10(b) count against the defendant Newman of this present action. It held that Courtois did owe a duty to Morgan Stanley and its client Warner and that Newman, as Courtois' tippee, was subject to this same duty. Thus, as there was a breach of a duty, Section 10(b) liability was possible. It is essential to note, however, that this case did not find any duty owed to the issuer, Deseret, or to its stockholders. As Newman, supra, was a criminal prosecution, this question of the privity of the stockholders of Deseret was not before the Court, and it was not addressed.
Thus, even though there may have been a fiduciary duty to Morgan Stanley and Warner in this case, there is no support for the argument that this duty transformed itself into a duty owed to the stockholders of Deseret, as is necessary for a finding that Moss has a claim for damages under Section 10(b). A holding that the duty owed to Morgan Stanley and Warner gives rise to a duty to the stockholders of Deseret would be wholly inconsistent with the teaching of the Supreme Court in Chiarella, supra, that a duty to disclose under Section 10(b) arises out of a relationship of trust and confidence. Id. 445 U.S. at 230. This relationship must be one between the parties themselves. Id. at 231, n.14. Thus, plaintiff cannot hope to piggyback upon the duty owed by defendants to Morgan Stanley and Warner. There is no "duty in the air" to which any plaintiff can attach his claim.
Further support for this analysis comes from the following passage in Chiarella, supra:
We know of no rule of law . . . that a purchaser of stock, who was not an "insider" and had no fiduciary relation to a prospective seller, had any obligation to reveal circumstances that might raise a seller's demands and thus abort the sale.
Id. at 232, n.14. The duty to disclose arises from a relationship between the parties. Here, the defendants were not insiders of Deseret, had no fiduciary relation with Deseret's stockholders, and thus owed them no duty of disclosure. Consequently, there is no Section 10(b) damage liability of defendants to them.
Plaintiff asserts that the Southern District case of O'Connor & Associates v. Dean Witter Reynolds, Inc., 529 F. Supp. 1179 (S.D.N.Y. 1981), suggests a different conclusion. Plaintiff argues that O'Connor, supra, stands for theory that the fiduciary duty that traders owe to their corporation creates a separate duty to the investing public to disclose or abstain. There are several problems with relying on O'Connor, supra.
O'Connor, supra, can be distinguished on its facts. The plaintiffs there claimed that the information traded upon without disclosure had come from the issuer, the other party to the merger, or both. While the Court did not specifically state that its conclusion would differ if the information had not come from the insiders, it did base much of its analysis on the duty of insiders. Thus, the Court did distinguish Chiarella, supra, by noting that in O'Connor, supra, the alleged sources of material information were insiders. This supports a reading of O'Connor, supra, to apply only to the situation of information leaked from the issuer. Any other reading of the case would flatly contradict the language in Chiarella, supra, that states that a duty to disclose arises from a relation between the parties. Id. 445 U.S. at 231, n.14.
Plaintiff points to other alleged sources of a duty to disclose in addition to the duty to Morgan Stanley and Warner. Plaintiff claims that the negotiations between Warner and Deseret established a duty on the part of Morgan Stanley to disclose or abstain before trading and that this duty arose out of a duty that Warner owed to Deseret to bargin in good faith. If during the course of the bargaining leading up to the offer for the Deseret stock, Warner Lambert received confidential information from Deseret with the understanding that this information would be used by Warner only for legitimate corporate purposes, this could have imposed a duty on Warner not to abuse the information that it received. Morgan Stanley and its employees would then have been brought into a trust relation with Warner and thus could have become subject to the same duty owed to Deseret. If valid, this argument might allow plaintiff to prove that Courtois owed the sellers a duty arising out of the trust relationship of the bargaining process.
The most recent Second Circuit case on the question of the duty owed by an investment bank to a potential target when it represents the acquiring corporation is Walton v. Morgan Stanley, 623 F.2d 796 (2d Cir. 1980). Morgan Stanley first represented Kennecott Copper Corporation while that corporation was considering the acquisition of Olinkraft. In the course of these negotiations, Olinkraft gave Morgan Stanley confidential inside information on the condition that Morgan Stanley use the information only in connection with its work on the Kennecott bid and that it then return the information to Olinkraft. The Kennecott bid did not materialize, but other companies did make bids for Olinkraft. Morgan Stanley's Arbitrage Department then purchased stock in Olinkraft. Morgan Stanley's Merger and Acquisitions Department, aware of the purchases by the Arbitrage Department, then used the confidential information to convince Johns-Manville to make a bid for Olinkraft.
Plaintiffs in Walton, supra, sued derivatively, claiming that Morgan Stanley had breached a fiduciary duty that it owed to Olinkraft. The Second Circuit rejected this argument. The Court stated:
Put bluntly, although, according to the complaint, Olinkraft's management placed its confidence in Morgan Stanley not to disclose the information, Morgan Stanley owed no duty to observe that confidence.
Id. at 799. The Court noted that no facts had been presented to it to indicate that anything but an arm's length bargaining relationship had existed between Olinkraft and Morgan Stanley and Kennecott Copper.
Walton was based upon Delaware law as Olinkraft was a Delaware corporation. It is not possible to determine from the complaint and papers whether Deseret is a Delaware corporation or not. Note, however, that the Second Circuit's construction of New York fiduciary law results in a similar result. In Frigitemp Corp. v. Financial Dynamics Fund, 524 F.2d 275 (2d Cir. 1975), the Court found that no fiduciary duty to a corporation had been created under New York law on the part of investment companies that had negotiated with the corporation regarding the purchase of corporate debt. As the negotiations had been at arm's length, no fiduciary duty had been created. The inside information that the investment companies had acquired could be traded upon.
Thus, unless plaintiffs can set forth facts that turn the negotiations from arm's length bargaining into a fiduciary relationship, they cannot claim that Morgan Stanley owed them a fiduciary duty. The plaintiffs assert that the following facts show that there was a fiduciary relationship:
1. The parties to the tender offer had negotiated for some time prior to the announcement.
2. Morgan Stanley had obtained some of its information directly from Deseret.
3. Deseret requested that trading in its stock be suspended upon the offer, thus showing that it wished the offer to proceed in an orderly manner.
These facts do not indicate any more of a duty on the part of Morgan Stanley than was present in Walton, supra, where there had been negotiations and a specific request by the target not to reveal the information. As the Second Circuit found that Morgan Stanley owed the target no duty in Walton, supra, this Court finds that no duty existed here.
Plaintiff also argues that Newman, as a registered broker-dealer breached an additional duty, that of a market professional to the market. Plaintiff relies on Dirks v. S.E.C., 220 U.S. App. D.C. 309, 681 F.2d 824 (D.C. Cir. 1982), cert. granted, 459 U.S. 1014, 103 S. Ct. 371, 74 L. Ed. 2d 506 (1982), for this theory. While it is true that Dirks, supra, did note that broker-dealers were subject to duties not imposed on the general public, this case cannot support an argument that the breach of a duty to the market creates a private cause of action. First, Dirks, supra, was an action to censure a broker-dealer. There was no discussion of what created a duty to disclose or abstain so as to give rise to Section 10(b) damage liability. Second, the information that Dirks failed to make publicly available before he passed it on to clients was inside information received from sources at the issuer.
Plaintiff has failed to state a claim on which relief may be granted under Section 10(b) of the Securities Exchange Act. In order to obtain damages for a violation of this Section, a plaintiff must show that a duty to disclose or abstain was owed by the defendants and that it has been breached. Plaintiff has not shown any duty owed to him by the defendants. They were outsiders of the corporation of which plaintiff was a stockholder. There was no fiduciary relationship of any nature between the parties. The only duty owed by defendants was that to Morgan Stanley and to Warner. Any effort to create a duty to plaintiff out of ...