SOME D E V E L O P M E N T S I N T H E R E L I A N C E R E Q U I R E M E N T
UNDER R U L E 1 0 B - 5 S I N C E A F F I L I A T E D U T E
B E T T Y L I T T L E
502

Some Developments in the Reliance Requirement
Under Rule 10b-5 Since Affiliated Ute
A discussion of the reliance requirement for private actions
1 under Rule 10b-5 usually begins with List v. Fashion Park, Inc.
In that case, Judge Waterman, writing for the Second Circuit, related the common law requirements for "reliance" and "materiality" to liability under Rule 10b-5. He combined the definition of materiality—whether "a reasonable man would attach importance [to the fact misrepresented^ In determining his choice of action . . .
1,2 with the definition of reliance—whether "the misrepresentation is a substantial factor in determining the course of conduct which results in [the recipient
1 s]loss"3—to achieve an objective standard of reliance for private 10b-5 actions. In other words, not only must this specific plaintiff have relied on the misrepresentation, but it must be a misrepresentation that a reasonable man would have acted upon. ' Judge Waterman explained that the common law reliance requirement, as well as the materiality requirement, must be carried over into civil suits under 10b-5 in order to
6 preserve the concept of "causation in fact." Otherwise, Rule
7
10b-5 would become a scheme of investor's insurance, if the plaintiff did not have to prove that the defendant in fact caused the plaintiff's injury.
In regard to cases involving non-disclosure of material information, rather than affirmative misrepresentations, Judge Waterman specified a further test; whether "the plaintiff would have been g disclosed to him the undisclosed fact." with this test he
503

51.2?
-10denounced Intimations in the trial court opinion that plaintiffs in nondisclosure cases must prove that they actively relied on the defendant's silence. To require proof of active reliance would
"dilute the obligation of insiders to inform outsiders of all material facts, regardless of the sophistication or naivete of the persons with whom they are dealing.
Another case that is often cited as a landmark in the early development of the reliance requirement is Globus v. Law Research
Service, I n c . ^ There, the defendants had challenged the court's instruction on causation. According to the defendants, the plaintiffs should have to prove not only that the misleading statement caused them to purchase the stock, but also that the statement caused the actual economic loss by causing the market price of
Law Research Service stock to go down."'"''" However, the Second circuit thought the instruction sufficient. The judge of the lower court had instructed the jury to consider all the factors surrounding the misrepresentation, and had given this specific explanation:
In other words, the plaintiff must show that the misleading statement or omission played a substantial part in bringing about or causing the damage suffered by him or her and that the damage was either a direct result or a reasonably foreseeable result of the misleading statement.
Basically, the Globus court seemed to require the same proof for reliance as did the List court; that is, that the defendant substantially caused the plaintiff's injury.
These two second circuit cases were followed by the rather unsettling Supreme Court decision of Affiliated Ute Citizens v.
13
United States.
v
In Affiliated Ute, a bank and its employees

made purchases from a group of unsophisticated investors without disclosing the fact that the securities would bring a higher price on a secondary market fostered by the bank. In a private action under l0b-5» the Court had this to say concerning the reliance requirement:
Under the circumstances of this case, Involving primarily a failure to disclose, positive proof of reliance is not a prerequisite to recovery.
All that is necessary is that the facts withheld be material in the sense that a reasonable investor might have considered them Important In the making of this decision, [citation omitted^
This obligation to disclose and this withholding of a material fact establish the requisite element of causation in fact.
It would be a safe statement to say that the Affiliated Ute decision created more confusion than it solved.concerning the reli-
1 h ance requirement under 10b-5 actions. For example, it left unanswered in what cases specifically proof of materiality and failure to disclose would suffice to show causation ih fact. Further, it was uncertain after Affiliated Ute whether the showing of nondisclosure and materiality merely raised a rebuttable presumption or whether they were conclusive on the issue of causation. A related question was who would have the burden of proof on the reliance issue, assuming the defendant was permitted to rebut i t . ^
18 fall into several patterns. The second circuit's use of the
19
Affiliated Ute precedent is limited to cases of non-disclosure.
According to this view, causation is a necessary element in a
20 private action for damages under Rule 10b-5,
v
and Affiliated Ute is "a doctrine applicable only to 'claims predicated on the non-
505

79 materiality, rather than reliance must be slown. ^ According to the Second Circuit, per the Titan court, the thrust of Affiliated
Ute was not to do away with the reliance requirement altogether, but to recognize the difficulty of proving reliance on an omitted statement. Hence, because reliance is difficult to prove, materiality is a requisite of recovery because it also is a limit the potential thrust of Rule 10b-5.
2
3
24
Further, materiality gives rise to an Inference of reliance.
There is some support for the proposition that the Second Circuit allows the defendant to rebut this inference of reliance. In
Lorber v.
B e e b e
2
^ (which followed the Titan holding concerning
Affiliated Ute
2 6
), the court states that "it is still open to a defendant to show that a given plaintiff would not have acted dif-
" 27 ferently had he been aware of the undisclosed facts. This statement would appear to allow the defendant to rebut the presumption of reliance, and appear to prescribe what he must show to do
Circuit case for this proposition. In the Titan case itself, the
Second Circuit upheld, under the clearly erroneous rule, the trial court's finding that the omissions involved there were not m a t e r i a l .
This finding was based upon ample evidence in the record that the plaintiff buyer had been induced into his bargain by many factors besides the alleged misrepresentations and omissions. Simply, because the bargain was attractive in so many respects, the alleged omissions could not have been material. Although Titan has been cited for the proposition that the inference of reliance is
31 rebuttable, the case does not appear conclusive of the matter.
It is not clear from a reading of Titan whether the defendant adequately refuted the inference of reliance, or whether the plain-

tiff simply failed to carry his burden on the issue. Either alternative invokes one of the questions raised by Affiliated Ute; i.e. who has the burden of proof on the reliance issue in an omission case? and second, it there is an inference of reliance, can It be r e b u t t e d ? ^ Going a step further, it is clear that the Titan case does not settle whether a defendant can rebut the inference of reliance, because there was no inference in Titan due to the court's finding that the omission was immaterial.
In sum, it would seem safest to say that, in the Second Circuit a plaintiff must prove materiality of the omission to raise an infer ence of reliance under Affiliated Ute. However, it Is still not
34 clear, in an omissions case, whether the inference can be rebutted, and it so, who has the burden of proof.
The Fifth Circuit's response to Affiliated Ute provides an interesting variation. In Simon v. Merrill Lynch, Pierce, Fenner and Smith, Inc.,^-5 plaintiffs sought damages in an attempted class action against Merrill Lynch for failing to disclose the precarious financial condition of Scientific Control Corporation, whose stock it recommended. The plaintiff claimed, as one conceivable interpretation of Affiliated Ute,that no reliance at all need be shown in a non-disclosure case. The Fifth Circuit responded that since the district court had specifically found that the plaintiff did not rely on Merrill Lynch's representatious, Affiliated Ute did not
38 reliance, even in non-disclosure cases, is necessary. It was the
Simon court's thought that Affiliated Ute could be distinguished because it was clearly a case where there was some general reliance.
507

While the Fifth Circuit's statement that general reliance was necessary in even non-disclosure cases seemed to fly in the face of
Affiliated Ute, there was an opportunity to clarify it later in tin
Vohsi v. Dickson. In Vohs , the court said that Affiliated Ute's language must "be confined to making proof of specific reliance on particular omissions unnecessary when the circumstances indicate that the plaintiff placed some general reliance opon the defendant's
41 disclosing material information."
The Fifth Circuit rationale is supportable, even under a strict reading of Affiliated Ute. The Supreme Court confined it's oftenprimarily a failure to disclose . . .." There can be no doubt that the sellers in Affiliated Ute were in a fairly dependant position with the bank and its employees. A logical distinction could be drawn between the circumstances of the two situations, were well-informed about their trading transactions.
The Third Circuit apparently views Affiliated Ute as having shifted the burden of proof in non-disclosure cases. As it expres-
Llk sed in Rochez Bros., Inc. v. Rhoades,
We do not read this decision to say that the question of reliance vol non may not be considered at all in a non-disclosure case, but only that proof of reliance is not required for recovery. If defendant is able to demonstrate that there was clearly no reliance, that is, even it the material facts had been disclosed, plaintiff's decision . . . would not have been different from what it was
. . . recovery should be denied.^""
This view is supportable also, if the rationale of Affiliated Ute was the difficulty in proving reliance on a non-disclosure.
It might be considered that this Third Circuit approach is
47 similar to that of the Titan case, because a showing that the
508

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LlQ disclosure was immaterial. Thus, the outcome might be the same as that in Titan, although reached by different analysis. Under the Rochez approach, the defendant, having rebutted the inference of reliance, would essentially have shown that the non-disclosure was immaterial. Under the Titan approach, If the non-disclosure was immaterial, the inference of reliance never arises; thus, whether the defendant can rebut it is never reached.
A further interesting development in the reliance area is the situation presented when an insider trades on a national or over the counter exchange without revealing Inside information. Even if his conduct clearly violates Rule 10b-5, what degree of reliance must be shown by a purchaser in order to recover damages in a private action? This situation has arisen twice recently, in
Shapiro v. Merrill Lynch, Pierce, Fenner & Smith, I n c . ^ and in
Fridrich v. Bradford.
In Shapiro, Merrill Lynch, managing underwirter for a Douglas
Aircraft debeuture issue, disclosed to certain of Its preferred customers material adverse inside information about Douglas
1 financial future. The "tlppees" who received the information sold their stock in Douglas on a national securities exchange. Plaintiffs were purchasers who bought shares during and after the time the tippees were trading, before the material Information was disclosed to the public by Merrill Lynch. The Second Circuit held both Merrill Lynch and the defendant tippees liable to the pur-
51 chasers who bought before the information became public.
Having first found a violati on of Rule 10b—5 in the mandate of
52
Texas Gulf Sulfer to "disclose or abstain," the Shapiro court
509

51.2?
-10proceecenl to find recourse in a private action for damages. Crucial to the Scicond Circuit'a decision was a broad interpretation of the language of Affiliated Utg. j n
response to the defendants' contention that the requinlte causation was lacking, the court replied
53 that Affiliated Ute all but pre-empted the issue of reliance.
In fact, the Shapiro court stated rather summarily that causation in fact had been established by non-disclosure of material infor-
54 matlon, coupled with a duty to disclose. Apparently, the Second
Circuit found a duty to disclose in the same Texas Gulf Sulpher rule tc disclose or abstain from trading.
.he defendants further argued that the Affiliated Ute rationale should be Halted to face-to-face transactions. The Second Circuit also dismissed this contention, stating that the rule did not turn o- the character of the transaction, but rather, on the existence cf a duty to d i s c l o s e . F u r t h e r , it found support for applyl:vc Affiliated Ute to impersonal transactions in the purpose behind rule 10b-5. which is to "insure fairness In securities transaction* generally, whether face to face, over the counter, or or. tie exchanges . . .."
Thf fact altuatlon in Frldrlch v.
B r a d f o r d ^ ?
arose in the sas? There, the son and wife of a director in Old Line
Insuis-.^ct Co»p«njr, purchased shares in Old Line on the basis of lnsid? laforaatlon that a profitable merger was in store for the ccrraro» Charts were also purchased in the name of Life Stock
53
HesearO jr. which was wholly owned by the insider's family.
Each c: v
purchasers sold at sizeable profits or their shares aprre.v-..«: proflUtly . In addition, a brokerage firm owned by the dirvtM^r act»2 as a raarket maker in the stock, gathering a

commission of $103,214 in the year prior to the merger, as well as
60 a 475,000 profit from trading in Old Line Stock. Plaintiffs were parties who had purchased and sold stock without any knowledge of
61 the pending merger. Although they sold at slight profits, and
62 although they had received a settlement under an SEC action, the plaintiffs recovered $361,186.75 in damages, according to the judgement of the district c o u r t . ^ Assuming a position contrary to Shapiro, however, the Sixth Circuit reversed the district
64 court. According to the circuit court, "the defendants' act of trading with third persons was not causally connected with any claimed loss by plaintiffs who traded on the impersonal market and who were otherwise unaffected by the wrongful acts of the
Insider."^
The crux of Frldrich's disagreement with Shapiro was whether
Affiliated Ute should apply. The Sixth Circuit in Frldrich construed Affiliated Ute narrowly, noting that the Indians and the oank there had an established relationship, and that the bank's employees had conceived a deliberate scheme to defraud the plaintiff sellers.^ in that situation, the Sixth Circuit agreed that there was a duty to disclose, the violation of which would suffice
Affiliated Ute "totally lacking" in Frldrich.
As a parallel to the statement in Shapiro that civil actions should extend to impersonal market transactions, the Frldrich court maintained that while 10b-5 obviously should extent to market result in disproportionate damages for an insider who traded on a
69 market. ^

-10-
In essence, it appears that the distinction in Shapiro and
Frldrich is the interpretation of the "duty" mentioned in Afflllat d
Ute. The Shapiro court endorsed the concept broadly, finding the general duty under Texas Gulf Sulpher to disclose inside information, and hence, It found reliance, since there was also a material omission.''® It is as if the Shapiro court supplied a missing link.
There was, admittedly, the general duty to disclose to the public, but could this duty serve to hold the defendant personally liable in damages to a specific stranger fortuitously trading on the market before the information was revealed, regardless of how long the insider had ceased trading?
In this regard, the Frldrich court's reference to Chaslns seems
71 well-taken. As support for its narrow interpretation of Affiliathat case, of Chaslns v. Smith, Barney & Company. In Chaslns, which originally mentioned non-disclosure and a duty to disclose, the parties were a stock brokerage firm and its client. In handling its client's account, the firm did not disclose that it was engaged in market-making in the same stook. The Second Circuit
74 upheld damages between the parties, finding causation in fact.
The close relationship between broker and client is certainly distinguishable from remote buyers and sellers on a impersonal market.
The Supreme Court's reference to "duty," citing Chaslns, might also be distinguishable from the general duty to disclose inside infor-
75 matlon if the insider chooses to trade his stock.
The Frldrich court's requirement that there be some relationship apparently speaks to the duty Involved In the case. This thinking is analogous to the Fifth Circuit rationale in Simon and
51.2?

-11-
76
Vohs. It will be recalled that they held Affiliated Ute is applicable only if there is some general reliance on the party omitting the material information. In this requirement of some relationship or general reliance is maintained the semblance of a causal connection or causation in fact between the plaintiff's injury and the defendants misconduct. Under Shapiro, the reliance requirement is practically deleted, rendering the insider potentially "liable to all the world," if they fortuitously trade on a stock exchange In the stock before inside information is disclosed.
Admittedly, Shapiro was a bad case, Illustrating the maxim that "bad cases make bad law." No clearer example could be found of where disclosure of information would have caused the reasonable investor to act otherwise than he did. Further, all the events were closely related,in time, so that it was not at all unreasonable for the court to extend liability to any purchaser who traded before the information was made public. As the concurring opinion i n
Frldrlch noted, the harm was not so much in the insiders' trading, but in the tippees' trading, because the informational imbalance on the market was prolonged, and thus the fairness of recovery by purchasers. En this regard, Shapiro's reference to
Affiliated Ute was unfortunate, because the facts did not demand the presumption of reliance from materiality. The plaintiffs
77 in Shapiro, as that court pointed out, could easily have established causation in fact under List v. Fashion Park, because they alleged that they would not have purchased Douglas stock if they had known of the information withheld by defendants. The logical extension of the Shapiro holding and its use of Affiliated Ute m 3

-12is relected in the facts of Frldrich. The Frldrich court correctlyretreated from use of Affiliated Ute in those situations where a presumption of reliance would, in effect, make the insider liable to all the world.
It seems safe to say, from this cursory survey of cases since
Affiliated Ute that that case did not do away with the reliance requirement in 10b-5 cases. The trend has been more to limit and define the situations where it will apply, and what its effect is, in those cases. he'-,, i.
M-H-k^
514

FOOTNOTES
1. List v. Fashion Park, Inc., 340 F.2d 457 (2nd Cir.), cert, denied, 332 U.S. 811 (1965).
2. id. at 462, citing Res Tort I 542 (2) (a) and Prossej: Torfe
55^-55.
3. Id. at 462, citing Res Torts § 546 (1938) and grosser,
Tgstjs 550 (2ed 1955).
4. See Comment, Reliance Under Rule 10b-5; Is the "Reasonable Investor" Reasonable? 72 Colum. L. Rev. 562, 566-67 (1972).
5. Judge Waterman used similar words; List v. Fashion Park,
Inc., 340 F.2d 45?, 462 (2nd Cir.), cert, denied, 382 U.S. 811 (1065)
6. Id. at 463.
7. Id.
8. Id. at 463.
9. Id.
10. Globus v. Law Research Service, Inc., 418 F.2d 1276 (2nd
Cir 1969), cert, denied, 397 U.S. 913 (1970).
11. Id. at 1291.
12. Id.
13. Affiliated Ute Citizens v. United States, 406 U.S. 128
(1972).
14. Id. at 128-41.
15. Id. at 153-5^. citing Chaslns v. Smith, Barney & Co.,
438 F.2d 1167, 1172 (2nd Cir. 1970).
16. See Note, The Reliance Requirement in Private Actions
Under SEC Rule 10b-5. 88 Harv. L. Rev. 584, 587 (1975).

17. Id.
18. See generally, Securities Survey, VIII Tex, Tech L. Rev.
(1977).
19. Titan Group, Inc. v. Faggen, 513 F.2d 234, 238-39 (2nd Cir), cert, denied, 433 U.S. 840 (1975). A frequent statement is made to this effect by the courts\ i.e. "no proof of reliance is necessary in an omission case." See, e.g., Pierre J. LeLandais & Co., Inc. v.
MDS-Atron, Inc., 387 P. Supp. 1310 (S.D. N.Y. 1974).
20. Titan Group, Inc. v. Faggen, 513 F.2d 234, 239 (2nd Cir.), cert, denied, 433 U.S. 840 (1975).
21. Lorber v. Beebe, 407 P. Supp. 279. 289 (S.D. N.Y. 1975).
22. Titan Groups, Inc. v. Faggen, 513 F.2d 234, 239 (2nd Cir.), cert, denied, 433 U.S. 840 (1975).
23. Id. at 538-39.
24. Id., citing Chris-Craft Industries, Inc. v. Piper Aircraft
Corp., 480 F.2d 341 (2nd Cir.), cert, denied, 414 U.S. 910 (1973).
25. Lorber v. Beebe, 407 P. Supp. 279 (S.D. N.Y. 1976); see note 21 supra.
26. See note 21 supra.
27. Lorber v. Beebe, 407 F. Supp. 279- 289 (S.D. N.Y. 1976).
28. The Lorber case cites Rochez Bros., Inc. v. Rhoades, 491
F.2d 402 (3rd Cir. 1974).
29. Titan Group, Inc. v. Faggen, 513 F.2d 234, 239 (2nd Cir.), cert, denied, 433 U.S. 840 (1975).
30. Id. at 238-39.
31. Securities Survey, VIII Tex. Tech L. Rev. (1977).
32. Note, The Reliance Requirement in Private Actions Under
SEC Rule 10b-5. 88 Harv. L. Rev. 584,587 (1975).
516

33- See text accompanying note 30 supra.
34. Other leading cases from the Second Circuit in this area involve affirmative misrepresentations, or both omissions and representations. See generally, Schlick v. Penn-Dixie Cement Corp.,
507 P.2d 374 (2nd Cir.), cert, denied, 421 U
. S .
976 (1975); Competitive Associates, Inc. v. Laventhol, Kreckstein, Horwath & Horwath,
516 P.2d 811 (2nd Cir. 1975).
35. Simon v. Merrill Lynch, Pierce, Fenner and Smith, Inc.,
482 P.2d 880 (5th Cir. 1973).
36. Id. at 883, 884. This is not an uncommon argument; see note 19 supra.
37. Simon v. Merrill Lynch, Pierce, Fenner and Smith, Inc.,
482 F.2d 880, 884 (5th Cir. 1973).
38. Id.
39. Id.
40. Vohs v. Dickson, 495 F.2d 607 (5th Cir. 1974).
41. Id. at 622.
42. Affiliated Ute Citizens v. United States, 406 U.S. 128,
153 (1972).
43. The plaintiffs in Vohs possessed cumulatively, degrees in business and finance from Duke University and Georgia Institute of
Technology, several years of experience in financial information and control systems. Vohs, note 40 supra, at 611-12. In fact, the
Vohs plaintiffs were unable to prove any general reliance, because of their special knowledge.
44. For further discussion of Simon and Vohs, particularly as they relate to class actions under Rule 10b-5. see Schnorbach v.
Fuqua, ?0
PRD 424, 436-37 (S.D. Ga. 1975).
517

45. Rochez Bros. Inc., 491 P . 2 d > 0 2 (3rd Cir. 197^).
46. Id. at 410.
4?. See note 19 supra.
48. See note 30 supra t
and accompanying text.
49. Shapiro v. Merrill Lynch, Pierce, Penner & Smith, Inc.,
495 F.2d 228 (2nd Cir. 197*0.
50. Fridrich v. Bradford. 5^2 F.2d 307 (6th Cir. 1976), cert. denied, 97 S.Ct. 767 (1977).
51. Shapiro v. Merrill Lynch, Pierce, Penner & Smith, Inc.,
495 P.2d 228, 230-34 (2nd Cir. 1974).
52. Id. at 234-38.
53. Id. at 238.
54. Id. at ZfyO.
55. Id.
56. Id.
57. Fridrich v. Bradford, 542 P.2d 307 (6th Cir. 1976), cert, denied, 97 S. Ct. 767 (1977).
58. Id. at 308-10.
59. Id. at 310-11.
60. Id.
61. Id. at 311.
62. Id.
63. Id. at 313. The district court in essence held that recovery can be had by sellers who buy without knowledge from
Insiders, even though it is undisputed that they did not purchase shares sold by plaintiff sellers. Further, the defendants can be liable in damages far in excess of the profits they made from illegal purchases of stock. Id.
518

64. Id. at 318.
65. Id. at 318-19 It should be noted that the Fridrich court throughout qualifies its decision in two respects: first, it notes that defendants did not purchase stock from the plaintiffs, and second, the defendant's act of trading did not affect the plaintiff's decision to sell. Id. at 318,321. These would obviously present different considerations concerning reliance.
66. Id. at 319.
67. Id. at 320.
68. Id. at 320-21.
69. I^*
a t
321. There is a persuasive concurring opinion in t h e
Fridrich decision. Id. at 323-27. Judge Celebruze, concurring, apparently would extend the "disclose or abstain rule" to contemporaneous traders, who are in the market simultaneously with the insiders, while the informational imbalance exists. Id. at 326-27.
By logical extension, this opinion is consistent with the majority on the Affiliated Ute question. Non-disclosure and the duty arising from the relationship of trading simultaneously on the market would establish causation in fact.
70. See note supra, and accompanying text.
71. Fridrich v. Bradford, 542 F.2d 307, 319-20 (6th Cir. 1976), cert, denied, 97 S. Ct. 767 (1977).
72. Chasins v. Smith, Barney & Co., 438 F.2d 1137 (2nd Cir.
1970).
73. Id. at 1168-70.
74. Id. at 1172.
75. An interesting point noted by the Fridrich majority and concurring opinion is that there is no absolute duty to disclose.
5 1 s

The insider may choose to abstain from trading instead. Thus, the investor has no absolute right to the information. Id. at
318, 326. This Illustrates that the plaintiffs were in exactly same situation they would have been in had defendants abstained from trading. Id. at 326.
76.
See notes 35-41 supra and accompanying text.
77. Shapiro v. Merrill Lynch, pierce, Fenner & Smith, Inc.,
495 F.2d 228, 239-40 (2nd Cir. 1974).
520