High Court Rules That Brokers May Be Sued for False Insider Tips
In a blow to the brokerage industry, the Supreme Court ruled Tuesday that investors who suffer financial losses from trading on false and misleading insider information have a right to sue those who gave them the information.
The court ruled 8 to 0 that a group of investors may sue the Los Angeles-based brokerage of Bateman Eichler, Hill Richards, even though the investors, by acting on insider information, may themselves be guilty of having violated federal securities laws.
The investors say they lost an undisclosed amount as a result of false and misleading stock tips allegedly provided by a Bateman Eichler broker in 1980.
“The public interest will most frequently be advanced if defrauded tippees (investors) are permitted to bring suit and to expose illegal practices by corporate insiders and broker-dealers to full public view for appropriate sanctions,” Justice William J. Brennan wrote for the court. A major purpose of federal securities law is to expose insider trading, he said.
Trust Called Essential
“You have to be able to trust your broker,” Arnold Keiles, a Palo Alto dentist and one of the investors, said in reaction to the decision. “If you don’t have that confidence, the whole marketplace is definitely affected.”
The justices, however, did not rule on the merits of the lawsuit itself and thus did not determine whether the information supplied by the broker was in fact false or misleading.
The decision, which upholds an appeals court decision in April, 1984, sparked widespread disagreement Tuesday among securities experts as to whether it will enhance investors’ rights and discourage insider trading.
The Securities and Exchange Commission, which has made cracking down on insider trading one of the cornerstones of its regulatory efforts in recent years, strongly applauded the decision.
The threat of private lawsuits “provides a disincentive for tippers to make these tips,” contended Paul Gonson, solicitor for the SEC, which had filed a friend-of-the-court brief in support of the investors.
“The decision reaffirmed our view that the court should protect customers defrauded by brokers, for whatever reason,” Gonson said.
However, Theodore A. Levine, a Washington securities-law attorney and former associate director of the SEC’s enforcement division, contended that the threat of lawsuits will not discourage insider trading.
Brokers guilty of it usually are willing to risk much more significant penalties, such as damage to their professional reputations and jail terms, he said.
In addition, Levine said, Tuesday’s Supreme Court decision “still left open some issues that provide some defenses for broker-dealers” in these cases.
Among those unresolved issues, he said, was whether brokerage firms such as Bateman Eichler can be excused from liability for the actions of their brokers who pass on insider information without the firm’s knowledge or blessing.
Geoffrey P. Knudsen, a San Francisco attorney representing the investors, also said the court left unresolved the issue of whether investors are in fact guilty of insider trading when the information is false.
Some legal experts even contended that the decision might encourage insider trading by reducing the penalties for investors who act on it.
“It creates a ‘heads-I-win, tails-you-lose’ situation for investors,” said Donald B. McNelley, executive vice president and general counsel for Bateman Eichler. “If he (the investor) makes money he obviously is not going to sue, and if he loses, he’s got a warranty on the information.”
But investors might be reluctant to sue because the investors would then expose themselves to prosecution for taking part in an illegal deal, the SEC’s Gonson said. Also, investors may have a tough time winning such suits because they have to prove that the insiders or brokers intentionally provided false information, Gonson said.
In addition, “it’s hard for a plaintiff before a judge or a jury to engender any sympathy for his plight” when he is also guilty of wrongdoing, said William J. Fitzpatrick, general counsel for the Securities Industry Assn., a trade group representing brokerage firms.
The decision clears the way for 10 investors to proceed with a suit against Bateman Eichler and Leslie Neadeau, then president of TONM Oil & Gas Exploration Corp., now based in Thousand Oaks.
The investors said Charles Lazzaro, a Bateman Eichler broker who has since left the firm, told them that TONM stock would rise to between $10 and $15 per share from between $1.50 and $3 per share when the public learned that the firm had acquired rights to a large gold discovery in Surinam.
Sharp Price Drop
The investors bought a substantial amount of the stock, which rose to $7 per share in late 1980 in over-the-counter trading. In 1981, the stock fell sharply to less than $1 per share when the mining venture fell through.
The investors contend that the stock deliberately was manipulated to rise and then fall and that the inside information they received was false.
A federal judge in San Francisco had ruled initially that the investors could not sue Lazzaro, Neadeau and Bateman Eichler because they were of “equal fault” with those who gave them the information.
However, the U.S. 9th Circuit Court of Appeals in San Francisco revived the suit and the Supreme Court on Tuesday upheld the appeals court ruling.
“We’re disappointed with the decision,” Bateman Eichler’s McNelley said. However, he said, the facts in the case “are sharply in dispute” and the firm is preparing “a vigorous defense.”