Opinion ID: 318563
Heading Depth: 2
Heading Rank: 2

Heading: Duty Standard of the Second Circuit

Text: 21 Recently the Second Circuit began to develop a duty analysis approach. In Chris-Craft Industries, Inc. v. Piper Aircraft Corp., 480 F.2d 341 (2d Cir. 1973), it held that section 14(e) of the Exchange Act created a private action for misrepresentations and omissions made in connection with a tender offer. In defining the elements of a section 14(e) action, the court noted that since the underlying proscriptions were virtually identical, the principles developed under rule 10b-5 should apply. The Second Circuit, citing our Royal Air and Ellis cases for authority, stated: 'The initial inquiry in each case is what duty of disclosure the law should impose upon the person being sued.' 480 F.2d at 363. We hold this to be the correct approach in rule 10b-5 cases. We believe it unfortunate that the Second Circuit attempted to limit this duty by requiring some degree of scienter or culpability and by holding that mere negligent conduct would not be sufficient for liability. The exact standard that the court would apply, however, is not clear to us. 22 The court's reasoning in defining culpability was, first, to ask what duty of disclosure the law should impose upon the person being sued, second, to examine factors such as the access to information or special relationships that may impose an 'affirmative duty' of disclosure, third, to decide whether the person has knowingly or recklessly failed to discharge these duties. The court then summarized that these three liability factors could be stated as: 23 whether plaintiff has established that defendant either (1) knew the material facts that were misstated or omitted, or (2) failed or refused to ascertain such facts when they were available to him or could have been discovered by him with reasonable effort. 24 480 F.2d at 364. It may well be that the analysis in Chris-Craft accurately reflects what the courts have been doing in deciding what state of mind is sufficient for recovery under rule 10b-5, 10 but we choose not to adopt it. We have difficulty with the court's announced position that mere negligence is not sufficient for liability while in the same case it summarizes with language that sets forth a negligence standard, at least for persons with a special duty. 25 One month after Chris-Craft, the Second Circuit, sitting en banc, again used a duty analysis in defining rule 10b-5 liability in relation to a corporate director. In Lanza v. Drexel & Co., 479 F.2d 1277 (2d Cir. 1973), it affirmed a trial court's decision rejecting the contention that the defendant corporate director had violated rule 10b-5 because as a matter of law, 26 in the circumstances disclosed by the record, he was under no duty to investigate more than he did at the material times or to seek out and advise the plaintiffs in any way. 27 479 F.2d at 1289 (quoting the lower court's findings). In support of this conclusion the court, 11 after setting forth extensively the history and development of private actions under the securities laws, carefully analyzed the corporate director's relationship to the plaintiffs, his access to the omitted and misrepresented information and his role in conducting the affairs of the corporation. After concluding that the director was under no duty to convey this particular information, the court then announced that in the Second Circuit, a mere negligent omission or misrepresentation is not enough to establish liability under rule 10b-5. Thus the court adopted a duty theory, but set a lower limit on the duty by requiring more than negligent conduct for liability to arise. Judge Hays, 12 dissenting from the majority opinion, would have found that rule 10b-5 did impose upon the director a duty 'to acquaint himself with developments in important intercorporate negotiations.' His failure to inform himself 'was a breach of a duty he owed as a director and a 'controlling person to the plaintiffs. Judge Hays then concluded: 28 That Coleman's failure to act was negligent as opposed to calculated should not insulate him from liability when action on his part might have prevented the fraud perpetrated by the corporation whose activities he was under a duty to supervise. I would hold, therefore, that Coleman's negligent 'omission to state material facts' to the purchasers of BarChris stock was a violation of 10(b) and Rule 10b-5, and that Coleman should be held liable for the damages which the plaintiffs suffered. 29 479 F.2d at 1319. The dissent, therefore, also adopted the duty approach, but would not impose the limitation preventing liability based upon negligence.