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In re Franklin National Bank Securities Litigation

decided: April 3, 1978.

IN RE FRANKLIN NATIONAL BANK SECURITIES LITIGATION, ROBERT GOLD, ON BEHALF OF HIMSELF AND ON BEHALF OF ALL OTHERS SIMILARLY SITUATED, PLAINTIFF-APPELLANT, AND LOUIS PERGAMENT, INTERVENOR-PLAINTIFF-APPELLANT,
v.
ERNST & ERNST, HAROLD V. GLEASON, PAUL LUFTIG, PETER R. SHADDICK, MICHELE SINDONA, CARLO BORDONI, HOWARD D. CROSSE, ANDREW N. GAROFALO, DONALD H. EMRICH, AND ROBERT C. PANEPINTO, DEFENDANTS-APPELLEES



Appeal from two orders of the District Court for the Eastern District of New York, dated October 27, 1976 and November 30, 1976, Thomas C. Platt, Jr., Judge. This is an appeal by Plaintiff in a securities fraud case, arising under Federal Rules of Civil Procedure, Rule 23, as revised in 1966. It involves a complex series of legal questions incidental to the use of "street names" or "nominees" as owners of record by those purchasing securities. The members of the class, as alleged by Plaintiff, are: "the purchasers of common stock, preferred stock or capital notes of Franklin New York Corporation between July 16, 1973 and May 16, 1974." Opinions below reported at 73 F.R.D. 25 (E.D.N.Y. 1976). The orders and the stay are vacated, and the case is remanded. Jurisdiction retained. No costs.

Medina and Oakes, Circuit Judges, and Mishler, District Judge.*fn*

Author: Medina

MEDINA, Circuit Judge:

This class action appeal*fn1 was first argued before the present panel of judges of this Court on April 27, 1977. Plaintiff, who purchased 300 shares of common stock of Franklin New York Corporation on the over-the-counter market in New York City on May 9, 1974, seeks a recovery of money damages for an alleged security fraud against the independent accountants and certain former officers, directors, and employees of Franklin New York Corporation and Franklin National Bank. The class is described as "purchasers of common stock, preferred stock or capital notes of Franklin New York Corporation between July 16, 1973 and May 16, 1974."

The record discloses that many purchases had been recorded in "street names."*fn2 This appeal is from orders of Judge Thomas C. Platt, Jr., dated October 27, 1976 and November 30, 1976, In re Franklin National Bank Securities Litigation, 73 F.R.D. 25 (E.D.N.Y. 1976), in which he: (1) certified the class as defined by plaintiff; (2) held that the cost of the search of records and the use of computers necessary to the compilation of a list containing the names and addresses of the beneficial owners was part of the plaintiff's burden in maintaining the action (apparently assuming that notice was required to be sent to the beneficial owners where the securities were held in "street names"); and (3) refused to order the brokerage houses and banks to prepare such lists at their own cost and without reimbursement from the class representatives. The upshot was orders requiring plaintiff to pay for giving notices by mail to the "street names" with the direction to forward the notices to the beneficial owners, and to ascertain the names and addresses of the beneficial owners and mail notices to them also. This was deemed to be a proper compliance with the mandate of Federal Rule 23 that individual notice be given to all the members of the class who could be identified with reasonable effort. No brokerage house or bank is a party to this class action.

It appeared on the first oral argument that what seemed to be a similar case, Sanders v. Levy, was sub judice before this Court, sitting en banc, and that no decision had yet been forthcoming. So we decided to hold the appeal in abeyance until the opinion or opinions in the Sanders case were filed. The majority and dissenting opinions in Sanders were filed on June 22, 1977. (Sanders v. Levy, 558 F.2d 636 (2d Cir. 1977) (en banc).) Also, since the oral argument on April 27, 1977, opinions were filed in related cases, involving "street names" or other so-called "absentee" owners, by the Third and Fifth Circuits in In re Nissan Motor Corporation Antitrust Litigation, 552 F.2d 1088 (5th Cir. 1977), and In Re: Penn Central Securities Litigation, 560 F.2d 1138 (3d Cir. 1977). Accordingly, we asked the parties to file supplemental briefs, and we set the case down for a second oral argument on November 15, 1977. The Supreme Court has granted certiorari in Sanders sub nom. Oppenheimer Fund, Inc. v. Sanders, 434 U.S. 919, 98 S. Ct. 391, 54 L. Ed. 2d 275, 46 U.S.L.W. 3284 (Oct. 31, 1977) (No. 77-335).

The net result is that we vacate the stay and the orders appealed from, agree with the trial judge's certification of the class as defined by plaintiff, and otherwise remand the case. We retain jurisdiction, as we did in Eisen II, 391 F.2d at page 570.*fn3

As the scope of this opinion covers a wide field of complex and interlocking legal issues, all arising out of the use of "street names" in the context of a securities fraud class action governed by Federal Rule 23, as revised in 1966, we have thought it more conducive to clarity and the elimination of much of the confusion in the existing case law on the subject to avoid preliminaries and to proceed at once with our disposition of these legal issues. Thus, we have divided this opinion into three sections: PART ONE, relating to our formulation of the principles governing The Basic Issues; PART Two, an Intermediate Summary and Commentary; and PART THREE, a brief historical sketch of how the "street names" practice expanded to help meet the so-called "paperwork crisis" in the securities industry, during the years 1967-1970 and a statement of suggested procedures to be followed according to the discretion of the trial judge in the management of the case.

PART ONE.

The Basic Issues.

A.

The District Court Had No Jurisdiction to Enter a Judgment Requiring the Brokerage Houses to Defray the Expense of Compiling a List of the Names and Addresses of the Beneficial Owners as None of the Brokerage Houses is a Party to This Action.

It is difficult to imagine a principle of jurisprudence more fundamental than that requiring that no judgment be rendered against any person without giving that person notice of the claim made against him and an opportunity to be heard. And yet, when it comes to saving cash outlay by class representatives and putting this burden on the brokerage houses, judge after judge has apparently felt no hesitancy in making such orders, despite the fact that the brokerage houses were not parties to the class actions.

The briefs before us contain numerous references to the fact that in Jahre v. Joseph M. Rait, Proflex Limited and Pelorex Corp., No. 74 Civ. 805 (E.D.N.Y. May 19, 1976), a class action, Judge Jack B. Weinstein, of the Eastern District, made an ex parte order in which he

Ordered, that any bank, brokerage firm or other nominee which purchased the common stock of Pelorex Corp. for the account of others (beneficial owners) shall immediately transmit to each beneficial owner a copy of the Stipulation of Settlement, Notice to class members and Proof of Claim and request reimbursement for mailing costs, or supply the names and addresses of such beneficial owners to Defendants' counsel, without cost.

We do not know what representations were made to Judge Weinstein before he signed that order. But the twelve brokerage houses involved started a special proceeding in which they sought to have the order vacated on the ground that none of them was a party to the class action and that the court had no jurisdiction to make the order. The record on file in the office of the Clerk of the District Court for the Eastern District of New York discloses the following summary of petitioners' argument:

The brokerage firms were not on notice, had no opportunity to be heard, were not parties, and hence not subject to the court's jurisdiction.

Judge Weinstein vacated the order without comment on October 15, 1976.

In connection with the huge class actions in In Re: Penn Central Securities Litigation, 416 F. Supp. 907 (E.D.Pa. 1976), Judge Joseph H. Lord of the Eastern District of Pennsylvania on August 22, 1975 made similar ex parte orders directing fourteen named brokerage houses, none of which was a party to any of the class actions, to ascertain the names and addresses of the beneficial owners of stock held in "street names" and to mail the class action notices to them. In these orders it was provided that the brokerage houses would be reimbursed for "reasonable postage expenses incurred in connection with [the] mailing." In contrast to what occurred in Jahre v. Rait, these brokerage houses went ahead and performed the necessary research, and they produced a list, apparently containing the names and addresses of the beneficial owners whose purchases had been recorded in "street names." They also mailed the class notices to the persons and corporations on this list. When they sought reimbursement for the $24,106.03 they had spent doing what they had been ordered to do, Judge Lord denied their application, and even refused reimbursement for the "reasonable postage expenses incurred in connection with [the] mailing." He expressed the view that it was the individual beneficial owners, who had used "street names," rather than the class as a whole, who should pay. No explanation was given for the inconsistent rulings with respect to the postage. The Third Circuit in In Re: Penn Central Securities Litigation, 560 F.2d 1138 (3d Cir. 1977), supra, reversed this order and remanded the matter to the District Court with a direction to consider various alternative sources for reimbursement, including the large settlement fund of over eight million dollars, or the settling defendants.

The Third Circuit opinion makes no reference to the fact that, when made, Judge Lord's ex parte order was void for lack of personal jurisdiction over any of the brokerage houses directed to defray the expense of the research necessary to prepare the list of beneficial owners. But, as we must discuss Judge Lord's ex parte order with reference to the issues now before us, we see no alternative to stating, as we now do, that the ex parte order was wholly ineffectual, because the District Court in the Eastern District of Pennsylvania had no jurisdiction to make the order. Nor did this voluntary compliance constitute any submission by the brokerage houses to the jurisdiction of the District Court. The District Court had personal jurisdiction over the brokerage houses for the first time when the brokerage houses petitioned the District Court for reimbursement. In this way Judge Lord did have jurisdiction to deny the application for reimbursement and, in reversing this order denying reimbursement, the Third Circuit had no occasion to comment on the lack of personal jurisdiction to make the ex parte order on which this plaintiff relies. It is difficult for us to see how plaintiff here finds any comfort in this case.

B.

Unlike Sanders, This Case Did Not Involve and Could Not Have Involved the Exercise of Any Discretion by the Trial Judge With Respect to the Question of Whether or Not the Brokerage Firms Were to Pay the Expense of Ascertaining the Names and Addresses of the Beneficial Owners of Stock Registered in "Street Names."

We come now to the question whether the decision in Sanders v. Levy, 558 F.2d 636 (2d Cir. 1977) (en banc), cert. granted sub nom. Oppenheimer Fund, Inc. v. Sanders, 434 U.S. 919, 98 S. Ct. 391, 54 L. Ed. 2d 275, 46 U.S.L.W. 3284 (Oct. 31, 1977) (No. 77-335), supra, governs this case. We hold that it does not.

In Sanders there were two consolidated actions. The first was a class action to recover money damages for an alleged security fraud, and the second was a derivative action, the proceeds of which, if plaintiffs were successful, would go to the Oppenheimer Fund, Inc. In the class action the Fund was not named as a party, but, as required by law, the Fund was a party defendant in the second suit, the derivative action. Plaintiffs owned shares in the defendant Fund, an open-ended investment fund registered under the Investment Company Act of 1940, 15 U.S.C. ยงยง 80a-1 et seq. The other defendants were various corporations and individuals alleged to have participated in the failure to disclose material information to investors. The class consisted of all persons who purchased shares of the Fund between March 15, 1968 and April 24, 1970, including those persons who had sold their shares. The part of the case relevant to this present appeal concerns the question whether the class representatives or the defendants were obliged to pay the expense of compiling a list of the names and addresses of the past and present beneficial owners who constituted members of the class, so that the plaintiffs could then prepare the necessary notice required by Federal Rule 23 and mail it to the members of the class at plaintiffs' expense. District Judge Griesa ruled that the compilation of the list of the names and addresses, which involved culling these names and addresses from computer tapes, "is the responsibility of defendants." Sanders v. Levy, 20 Fed.R.Serv.2d 1218, 1222 (S.D.N.Y. 1975). The record in the District Court does not reveal any discovery proceedings nor was the subject of discovery referred to.

On appeal a panel of this Court reversed the District Court and held that the specific question above referred to was one of notice under Rule 23 and that, as held by the Supreme Court in Eisen IV, 417 U.S. 156, at pages 177-179 (1973), the cost of such notice must be borne in the first instance by the plaintiffs. Judge Hays dissented on two grounds, one of which was that the question was not one of notice under Rule 23 but of "class member identification costs," which Judge Hays said was governed by Federal Rule 34, applicable to computerized information. As Federal Rule 26 gives the District Court discretionary power to shift the expense of discovery, Judge Hays stated that the District Court in Sanders had not abused its discretion in holding that the defendant Fund should bear the expense of culling the names and addresses of the members of the class.

On the en banc rehearing, the majority sustained the view expressed by Judge Hays, with Judges Mulligan, Van Graafeiland, and Meskill dissenting. The opinion by Judge Hays holds that the judgment of the District Court was affirmed: (1) because the question involved is not one of notice under Rule 23 but a question of discovery under Rules 26 and 34; and (2) because the District Court had not abused its discretion in directing defendants to bear the costs of identifying the class members.

We think that Sanders is not controlling, because Judge Platt made his ruling in the case now before us as matter of law, and that ruling was called for by the notice requirements of Rule 23. Rule 34, relied upon in Sanders, refers only to parties. Rule 34 is thus of no force or effect with reference to non-parties such as the brokerage houses in the case before us. Not only is it clear that Judge Platt ruled as matter of law and not in the exercise of discretion, but it is also clear that in no aspect of the record in the case before us did Judge Platt have any discretion to exercise, for the discovery rules applicable to non-parties, such as the ...


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