Model Jury - Section 18

CIVIL INSTRUCTIONS

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18. SECURITIES ACT

18.00     SECURITIES ACT--PRELIMINARY INSTRUCTION

   The plaintiff claims to have suffered a loss caused by the defendant's violation of the securities laws. To help you understand the evidence while it is being presented, I will now explain some of the terms and concepts that may be referred to during this trial.

   A security is an investment in an enterprise with the expectation of profit from the efforts of other people. Some common types of securities are [stocks,] [bonds,] [debentures,] [warrants,] [and] [investment contracts].

   A broker buys and sells securities for clients for a commission.

   A dealer buys securities and resells them to clients. An individual or a corporation can be a broker, a dealer, or both.

   The buying and selling of securities is controlled by the securities laws. One who violates the securities laws is liable for damages caused by the violation. In particular, the securities laws prohibit [misrepresentation of material facts] [omission of material facts] [and] [false registration] in connection with the purchase and sale of securities.

   [A representative of a broker or dealer may also buy and sell securities for or to clients. If a representative violates the securities laws, the broker or dealer may also be liable as a controlling person. A controlling person is one who possesses the power to direct or cause the direction of the management or policies of another.]

   [A controlling person may be excused from liability by proving that [he] [she] [it] acted in good faith and did not induce the act that violated the securities laws.]

18.01.01   SECURITIES ACT--MISREPRESENTATION--ELEMENTS AND BURDEN OF PROOF (15 U.S.C. § 77e, RULE 10b-5)

   [On plaintiff's claim __________________,] the plaintiff has the burden of proving each of the following by a preponderance of the evidence:

   1.   the defendant [made an untrue statement of a material fact] [or] [omitted a material fact necessary under the circumstances to keep the statements that were made from being misleading] in connection with the trading of securities;

   2.   the defendant acted knowingly;

   3.   the defendant [used] [or] [caused the use of] an [instrumentality of interstate commerce] [mail] [telephone] [or] [________________________] in connection with the trading of securities [whether or not the [instrumentality of interstate commerce] [mail] [telephone] [or] [___________________] was used to make an untrue statement or a material omission];

   4.   the plaintiff reasonably relied on [defendant's untrue statement of a material fact] [defendant's failure to state a necessary material fact] in [buying] [or] [selling] [or] [not selling] securities; and

   5.   the plaintiff suffered damages as a result.

[Add appropriate concluding paragraphs from Instructions 5.03, 5.04, or 5.05.]

Comment

   See 15 U.S.C. § 78j(b) and 17 C.F.R. § 240.10b-5. See Instruction 18.01.03 for definition of knowledge.

   In McGonigle v. Combs, 968 F.2d 810, 817 (9th Cir. 1992), cert. dismissed, ___ U.S. ___, 113 S. Ct. 399 (1992), the court confirmed the showing required, as outlined above, for the establishment of a 10b-5 claim.

18.01.02   SECURITIES ACT--MISREPRESENTATIONS OR OMISSIONS AND MATERIALITY--DEFINITIONS (15 U.S.C. § 77e, RULE 10b-5)

   [Whether a statement is true] [and] [whether a fact is material] depends on the facts as they existed at the time the statement was made.

   A fact stated or omitted is material if a reasonable buyer or seller of securities would consider the fact important in deciding whether or not to buy or sell a particular security.

Comment

   The standard for materiality was developed in TSC Indus. v. Northway, Inc., 426 U.S. 438, 449 (1976) (whether a reasonable shareholder would "consider it important" or whether the fact would have "assumed actual significance"). Although the Ninth Circuit adopted both formulations from TSC Indus., the "assumed actual significance" formulation was used most recently. See McGonigle v. Combs, 968 F.2d 810 (9th Cir. 1992) (assumed actual significance), cert. dismissed, ___ U.S. ___, 113 S. Ct. 399 (1992); Grigsby v. CMI Corp., 765 F.2d 1369 (9th Cir. 1985) (adopted both formulations).

18.01.03   SECURITIES ACT--KNOWLEDGE--DEFINITION

     (15 U.S.C. § 77e, RULE 10b-5)

   A defendant acts knowingly when [the defendant makes an untrue statement [with the knowledge that the statement was false] [or] [with reckless disregard for whether the statement was true]] [or] [the defendant omits necessary information [with the knowledge that the omission would make the statement false or misleading] [or] [with reckless disregard for whether the omission would make the statement false or misleading]].

   [Reckless means highly unreasonable conduct that is an extreme departure from ordinary care.]

Comment

   The element of scienter was developed in Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976), reh'g denied, 425 U.S. 986 (1976). In Nelson v. Serwold, 576 F.2d 1332, 1337 (9th Cir.), cert. denied, 439 U.S. 970 (1978), the court interpreted the Ernst & Ernst decision as only eliminating negligence as a basis for liability. The court found that Congress intended Section 10(b) to reach both knowing and reckless conduct. Id. at 1337.

   "Recklessness," in the context of Section 10(b) and Rule 10b-5, was defined by the Ninth Circuit in Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1569 (9th Cir. 1990), cert. denied, ___ U.S. ___, 111 S. Ct. 1621 (1991). See Comment to Instructions 18.02.01 and 18.02.03.

   15 U.S.C. § 78j(b); SEC Rule 10b-5, 17 C.F.R. § 240.10b-5 (1991).

18.02.01   SECURITIES ACT--EXCESSIVE TRADING (CHURNING)--ELEMENTS AND BURDEN OF PROOF (15 U.S.C. § 77e, RULE 10b-5)

   [On plaintiff's _________________ claim,] the plaintiff has the burden of proving each of the following by a preponderance of the evidence:

   1.   the trading in plaintiff's brokerage account was excessive in light of the plaintiff's investment objectives;

   2.   the defendant exercised control over the trading in the account;

   3.   the defendant acted [with intent to defraud] [or] [with reckless disregard of plaintiff's investment objectives];

   4.   the defendant [used] [or] [caused the use of] an [instrumentality of interstate commerce] [mail] [telephone] [or] [_________________________] in connection with the trading in plaintiff's account; and

   5.   the plaintiff suffered damages as a result.

[Add appropriate concluding paragraphs from Instructions 5.03, 5.04, or 5.05.]

Comment

   See 15 U.S.C. § 78j(b) and 17 C.F.R. § 240.10b-5. See also Mihara v. Dean Witter Co., 619 F.2d 814, 821 (9th Cir. 1980); Nesbit v. McNeil, 896 F.2d 380, 382 (9th Cir. 1990) (elements of "churning" under 10b-5; no single factor or test identifies excessive trading).

   "Recklessness," in the context of § 10(b) and rule 10b-5, was defined by the Ninth Circuit in Hollinger v. Titan Capital Corp., 914 F.2d 1564 (9th Cir. 1990), cert. denied, ___ U.S. ___, 111 S. Ct. 1621 (1991).

   While the phrase "willful and reckless" was used in Mihara and Nesbit, the committee believes that the Hollinger definition of "recklessness" accurately sets forth the standard and definition for liability in the rule 10b-5 context for both misrepresentation and churning cases. See Comments to Instructions 18.01.03 and 18.02.03.

   See Comment to Instruction 18.06 regarding special instructions on "Churning" damages.

18.02.02   SECURITIES ACT--EXCESSIVE TRADING (CHURNING)--CONTROL--DEFINITION (15 U.S.C. § 77e, RULE 10b-5)

   A broker exercises control over trading in an account when [the client has authorized the broker to trade without first consulting the client] [or] [the client has not authorized the broker to trade and the broker trades] [or] [the client, without exercising independent judgment, routinely follows the broker's recommendations].

Comment

   See Follansbee v. Davis, Skaggs & Co., 681 F.2d 673, 676-78 (9th Cir. 1982); Mihara v. Dean Witter & Co., 619 F.2d 814, 821 (9th Cir. 1980).

18.02.03   SECURITIES ACT--EXCESSIVE TRADING (CHURNING)--

     INTENT TO DEFRAUD--RECKLESS--DEFINITION

     (15 U.S.C. § 77e, RULE 10b-5)

   [Intent to defraud is an intent to deceive or cheat.]

   [Reckless means highly unreasonable conduct that is an extreme departure from ordinary care.]

Comment

   "Recklessness" was defined by the Ninth Circuit in Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1569 (9th Cir. 1990), cert. denied, ___ U.S. ___, 111 S. Ct. 1621 (1991). While the phrase "willful and reckless" was used in Mihara and Nesbit, the committee believes that the Hollinger definition of "recklessness" accurately sets forth the standard and definition for liability in the section 10(b) and rule 10b-5 context for both misrepresentation and churning cases. See Comments to Instructions 18.01.03 and 18.02.01.

18.03   SECURITIES ACT--AGENT AND PRINCIPAL (15 U.S.C. § 77e, RULE 10b-5)

Comment

   Use Instructions 6.04 Agent and Principal, Definition; 6.05 Agent--Scope of Authority Defined; and 6.06 Act of Agent is Act of Principal--Scope of Authority Not in Issue if there are no issues regarding the principal-agent relationship.

   If there is an issue regarding the existence of the relationship or scope of authority, use 6.09 Both Principal and Agent Sued--Agency or Authority Denied; 6.10 Principal Sued, But Not Agent--Agency or Authority Denied; and 18.03.01 Securities Act--Liability of Controlling Person--Elements and Burden of Proof (15 U.S.C. § 77e, Rule 10b-5).

   Note, however, that the relationship between a controlling person and a controlled person is not necessarily a principal-agent relationship. See Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1574 (9th Cir. 1990) (no authority exists in the statutory scheme to restrict definition of controlling person to exclude independent contractors; court refused to distinguish between registered representatives who are employees or agents and those who might be independent contractors in determining who was a "controlling person"), cert. denied, ___ U.S. ___, 111 S. Ct. 1621 (1991).

18.03.01   SECURITIES ACT--LIABILITY OF CONTROLLING PERSON--ELEMENTS AND BURDEN OF PROOF (15 U.S.C. § 77e, RULE 10b-5)

   On plaintiff's claim against [controlling person], plaintiff has the burden of proving by a preponderance of the evidence that defendant [controlling person] possessed, directly or indirectly, the power to direct or cause the direction of the management and policies of [controlled person].

[Add appropriate concluding paragraphs from Instructions 5.03, 5.04, or 5.05.]

Comment

   See 15 U.S.C. §§ 78o(a)(1), 78t(a); 17 C.F.R. § 230.405; Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1567-78 (9th Cir. 1990), cert. denied, ___ U.S. ___, 111 S. Ct. 1621 (1991).

   For good faith defense, see Instruction 18.03.02.

   This instruction may need to be supplemented with instructions regarding respondeat superior liability. See Instructions 6.04 through 6.10.

   Use this instruction with instructions on rule 10b-5 misrepresentation and excessive trading.

18.03.02   SECURITIES ACT--AFFIRMATIVE DEFENSE OF BROKER OR DEALER (15 U.S.C. § 77e, RULE 10b-5)

   If you find that the defendant [insert name of broker or dealer] is a controlling person, you must consider whether the defendant induced a violation and acted in good faith. The defendant has the burden of proving each of the following by a preponderance of the evidence:

   1.   the defendant did not directly or indirectly induce the violation; and

   2.   the defendant maintained and enforced a reasonable and proper system of supervision and internal control.

[Add appropriate concluding paragraphs from Instructions 5.03, 5.04, or 5.05.]

Comment

   This instruction is to be used only for a controlling person who is a broker or dealer.

   15 U.S.C. § 78t(a) (Section 20(a) of the 1934 Act (Liability of Controlling Persons)); Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1575-76 (9th Cir. 1990), cert. denied, ___ U.S. ___, 111 S. Ct. 1621 (1991). The defendant has the burden of establishing its good faith. Hollinger, 914 F.2d at 1575-76. Hollinger also holds that Section 20(a) does not supplant respondeat superior liability under the common law. Id. at 1578.

18.04   SECURITIES ACT--FALSE OR MISLEADING REGISTRATION STATEMENT--ELEMENTS AND BURDEN OF PROOF (15 U.S.C. § 77e, SECTION 11)

   [On plaintiff's _________________ claim,] the plaintiff has the burden of proving each of the following by a preponderance of the evidence:

1.   [the registration statement misrepresented a material fact] [or] [the registration statement omitted material facts making it misleading];

2.   the defendant [insert appropriate language from 15 U.S.C. § 77k(a)]; and

3.   the plaintiff suffered damages as a result.

[Add appropriate concluding paragraphs from Instructions 5.03, 5.04, or 5.05.]

Comment

   See 15 U.S.C. §§ 77k(a), 77k(e). The specifics of a false registration statement may make additional instructions necessary.

   See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 208 (1976) (issuer has absolute liability under 15 U.S.C. § 77k for damages resulting from a material misstatement or omission).

   For materiality definition, see Instruction 18.01.03.

   Securities Act of 1933, § 11, 15 U.S.C. § 77k.

18.05.01   SECURITIES ACT--AFFIRMATIVE DEFENSE OF WAIVER--ELEMENTS AND BURDEN OF PROOF (15 U.S.C. § 77e)

   The defendant contends that plaintiff waived the right to complain of defendant's conduct.

   The defendant has the burden of proving by a preponderance of the evidence that, at the time, the plaintiff knew the plaintiff had a right to complain of defendant's conduct and voluntarily or intentionally gave up that right.

[Add appropriate concluding paragraphs from Instructions 5.03, 5.04, or 5.05.]

Comment

   See Hecht v. Harris, Upham & Co., 430 F.2d 1202, 1208 (9th Cir. 1970) (waiver is the voluntary or intentional relinquishment of a known right); Royal Air Properties v. Smith, 312 F.2d 210, 213-14 (9th Cir. 1962), appeal after remand, 333 F.2d 568, 570-72 (1964) (common law defenses applicable to judicially-created private right of action under 10(b)).

   For a general discussion on restrictions of waiver clauses in brokerage agreements, see Louis Loss, Fundamentals of Securities Regulations, at 1024-34 (2d ed. 1988).

18.05.02   SECURITIES ACT--AFFIRMATIVE DEFENSE OF ESTOPPEL--ELEMENTS AND BURDEN OF PROOF (15 U.S.C. § 77e)

   The defendant contends the plaintiff is [barred] [estopped] from complaining of defendant's conduct. The defendant has the burden of proving, by a preponderance of the evidence, that:

   1.   the plaintiff knew [describe facts that constitute basis for claim];

   2.   the defendant did not know the plaintiff had objections to [describe facts that constitute basis for claim];

   3.   [the plaintiff intended that the defendant act upon the plaintiff's [acts] [omissions]] [or] [the defendant had a right to believe the plaintiff's [acts] [omissions] were to be acted upon]; and

   4.   the defendant relied upon the plaintiff's [acts] [omissions] to the defendant's injury.

[Add appropriate concluding paragraphs from Instructions 5.03, 5.04, or 5.05.]

Comment

   See Stewart v. Ragland, 934 F.2d 1033, 1041 (9th Cir. 1991) (four elements of estoppel claim).

18.05.03   SECURITIES ACT--AFFIRMATIVE DEFENSE OF RATIFICATION--ELEMENTS AND BURDEN OF PROOF (15 U.S.C. § 77e)

   The defendant contends the plaintiff ratified defendant's conduct. The defendant has the burden of proving, by a preponderance of the evidence, that the plaintiff communicated to defendant, by words or actions, that plaintiff accepted and approved of the conduct.

[Add appropriate concluding paragraphs from Instructions 5.03, 5.04, or 5.05.]

Comment

   See Royal Air Properties v. Smith, 312 F.2d 210, 213-14 (9th Cir. 1962), appeal after remand, 333 F.2d 568, 570-72 (9th Cir. 1964) (common law defenses applicable to judicially-created private right of action under 10(b)).

18.06   SECURITIES ACT--DAMAGES (15 U.S.C. § 77e)

Comment

   See Instruction 7.01 for format. The measure and type of damages should be drafted to fit the facts and law in each particular securities case.

   See also 7.03, Mitigation, and 7.04, Damages, Arising in the Future--Discount to Present Cash Value.

   Damages in "Churning" Cases. There are two different types of damages in churning cases. A plaintiff may recover excessive commissions, that is, the difference between commissions paid and commissions that would have been reasonable on transactions during the pertinent time period. Nesbit v. McNeil, 896 F.2d 380, 387 (9th Cir. 1990). A plaintiff may also recover for portfolio losses. Hatrock v. Edward D. Jones, 750 F.2d 767, 773-73 (9th Cir. 1984). Dividend income may be used to offset portfolio losses. Arrington v. Merrill, Lynch, Pierce, Fenner & Smith, Inc., 651 F.2d 615, 621 (9th Cir. 1981). However, excessive commissions should not be offset by portfolio gains made on the investments. Nesbit v. McNeil, 896 F.2d at 385.