Opinion ID: 288622
Heading Depth: 1
Heading Rank: 2

Heading: STATUTORY COVERAGE OF SECTION 10(b).8

Text: 34 In addition to the investors' lack of standing to raise their 10b-5 counter-claim, we find that the alleged misrepresentations and nondisclosures on the part of the bank do not fall within the statutory coverage of the 'in connection with the purchase or sale of any security' clause. The defendant investors allege that Smoot misrepresented the financial condition of AHB on October 29, 1965, and that he silently acquiesced to date when he knew or had reason to know that such representations were untrue, because the bank had in its possession monthly financial reports from PL&I and an Arthur Andersen audit of PL&I completed sometime in October of 1965 and because Smoot was the bank official who oversaw the PL&I account. 35 It is apparent that the extent of the coverage and liability imposed under Section 10(b) of the Securities Exchange Act and Rule 10b-5 has not as yet been precisely defined. As noted by the Supreme Court in SEC v. National Securities, Inc., 393 U.S. 453, 89 S.Ct. 564, 21 L.Ed.2d 668 (1969), the statutory section and the rule constitute one of several broad antifraud provisions set forth in the securities law in which application of the 'allegedly proscribed conduct must have been 'in connection with the purchase or sale of any security.' The relevant definitional sections of the 1934 Act are for the most part unhelpful   . Consequently, we must ask whether respondents' alleged conduct is the type of fraudulent behavior which was meant to be forbidden by the statute and the rule.' Id. at 466-467, 89 S.Ct. at 572. 36 The Second Circuit recently considered the question of statutory coverage under Rule 10b-5 and fashioned a two-step test applicable to both private damage actions and suits for injunctive relief. In Heit v. Weitzen, 402 F.2d 909 (2d Cir. 1968), cert. denied, 395 U.S. 903, 89 S.Ct. 1740, 23 L.Ed.2d 217 (1969), a private damage action under 10b-5, the Court made clear that the first step of this statutory coverage test is governed by principles enunciated in SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968) (en banc), cert. denied, 394 U.S. 976, 89 S.Ct. 1454, 22 L.Ed.2d 756 (1969), which 'construed the 'in connection with' requirement broadly and held that the clause was satisfied whenever a device was employed 'of a sort that would cause reasonable investors to rely thereon, and, in connection therewith, so relying, cause them to purchase or sell a corporation's securities,' SEC v. Texas Gulf Sulphur Co., at 860.' 402 F.2d at 913. If the plaintiff has met the requirements of this 'in connection with' test, Heit states that the second step of the statutory coverage tests is 'the question of the standard by which the conduct of the defendants is to be judged.' Id. Although the Second Circuit held that proof of negligence was sufficient to sustain an action for injunctive relief under Rule 10b-5(2) in Texas Gulf Sulphur, Heit did not reach the question of whether negligence would likewise suffice in a private suit for damages. 37 Since we held in Myzel v. Fields, 386 F.2d 718, 734-735 (8th Cir. 1967), cert. denied, 390 U.S. 951, 88 S.Ct. 1043, 19 L.Ed.2d 1143 (1968) that 'proof of 'scienter,' i.e., knowledge of the falseness of the impression produced by the statements or omissions made, is not required under Section 10(b),' we disagree with the second step of the Second Circuit's test to the extent that it does not reflect recognition of a negligence standard but otherwise we are in accord with the standard formulated. 9 38 We think this two-step test breaks down as follows: (1) With regard to misrepresentations, the question is whether a reasonable investor, in light of the facts existing at the time of the misrepresentation and in the exercise of due care, would have been entitled to rely upon the misrepresentation. With regard to nondisclosures, the issue becomes whether a reasonable investor, in light of the facts existing at the time of the nondisclosure and in the exercise of due care, would have been entitled to receive full disclosure from the party charged and would have acted differently had the alleged nondisclosure not occurred. (2) If the plaintiff satisfies this 'in connection with' step, it then becomes necessary to determine whether the defendant's misrepresentation or nondisclosure was made with scienter or from a lack of due diligence. 10 See Texas Gulf Sulphur Co., 401 F.2d at 863. 39 It should be noted from the outset that this 'reasonable investor' test is an objective standard. Whether an investor did in fact rely upon a misrepresentation is immaterial for the purpose of determining statutory coverage, though reliance is a predicate for recovery once coverage is established. In applying this test to the instant case, we find a reasonable investor would not have relied upon any representations made by Smoot and that the bank did not owe a duty of full disclosure to the investors. 40 The investors had access to all the books and records of AHB and PL&I during the four-month option period. The investors allege they have never seen the Arthur Andersen audit of PL&I, that it is as yet still undiscovered by them. Regardless of what this audit might show, the fact remains that the audit was made for PL&I-- not the bank. The investors either had access to this audit report, which was ostensibly in AHB files, or they had the right to secure it from the auditors. Markham, the investors' agent, knew of the report, had access to it and could have produced it if desired. As this court stated in Myzel v. Fields, 386 F.2d at 736: 41 'There is no duty to disclose information to one who reasonably should already be aware of it. Nor is there the necessity for one insider to 'search out details' for another insider, in the same sense that such a duty might exist towards others less informed.' 42 Further support for our conclusion is found in Kohler v. Kohler Co., 319 F.2d 634 (7th Cir. 1963), 7 A.L.R.3d 486, where the Seventh Circuit held that the failure of a director of the corporation to disclose material facts to the plaintiff will not lead to liability under 10b-5 where the plaintiff himself has the ability and opportunity to discover those facts easily. The Supreme Court has also had occasion to state this general principle: 43 'When the means of knowledge are open and at hand or furnished to the purchaser or his agent and no effort is made to prevent the party from using them,    he will not be heard to say that he has been decived to his injury by the misrepresentations of the vendor.' Shappirio v. Goldberg, 192 U.S. 232, 241-242, 24 S.Ct. 259, 48 L.Ed. 419 (1904). 44 Since the investors in the case at bar had ready access to the information involved, it is reasonable to expect them to exercise a higher degree of care than third parties who were not sellers and did not profit from the sale but who might have had some peripheral or general knowledge about the financial condition of AHB. 45 Finally, we think the trial court was correct in its conclusion that even if Hall, the bank's vice-president, did conceal material facts from the investors, neither his action nor any knowledge he possessed of the alleged fraudulent scheme can be imputed to the bank under Arkansas law. The general agency rule that knowledge acquired by an officer or agent of a corporation while acting in his official capacity or within the scope of his duties will be imputed to the corporation is applicable to banks. Hooten v. State, 119 Ark. 334, 178 S.W. 310, 312-313, L.R.A.1916C, 544 (1915). However, where it is in the officer's interest to conceal his knowledge, his knowledge will not be imputed to the bank unless he is the sole representative of the bank in the transaction. Little Red River Levee Dist. No. 2 v. Garrett, 154 Ark. 76, 242 S.W. 555, 557-558 (1922). 46 Hall's personal interest in AHB was disclosed both to the investors and the bank and he disqualified himself from the loan transaction. Nondisclosure or misrepresentation of the real financial condition of the two corporations by Hall cannot be imputed to the bank under the doctrine of respondeat superior since it was manifest to all that Hall, as seller, was not acting in an agency capacity for the bank. Furthermore, any knowledge of a fraudulent scheme which Hall may have had cannot be imputed to the bank because Hall's noninvolvement in the loan transaction precludes the possibility that his knowledge could be imputed to the bank under the sole actor doctrine. 47 No reported case has extended Rule 10b-5's umbrella of protection over such a wide area as is attempted by the investors in this case, nor has a basis been demonstrated for disregarding the corporate integrity of ITC, which was organized by the investors and their agent Markham for the purpose of setting up a public financial institution to secure funds for Markham's enterprises and then later utilized as a corporate entity to purchase control of AHB and its related companies. 48 Since the defendant investors are not entitled to recoup against the bank for their unfortunate investments with Markham and ITC under the more liberal and broader coverage of Rule 10b-5, it is clear that they have not shown any basis for a common law fraud action under Arkansas law against the plaintiff bank. 49 Judgment affirmed.