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MIX v. E.F. HUTTON & CO.

September 1, 1989

KENDALL A. MIX, Plaintiff,
v.
E.F. HUTTON & CO., INC., et al., Defendants; KENDALL A. MIX, II, Plaintiff, v. E.F. HUTTON & CO., INC., et al., Defendants; PHOEBE A. MIX, Plaintiff, v. E.F. HUTTON & CO., INC., et al., Defendants



The opinion of the court was delivered by: HOGAN

 THOMAS F. HOGAN, UNITED STATES DISTRICT JUDGE

 This case is presently before the Court on defendants' Motion to Strike Plaintiffs' Claim under Section 12(2) of the 1933 Act. The motion has been fully briefed and argued, and the Court had previously taken it under advisement. Defendants, with the Court's leave, on August 18, 1989, filed a supplemental brief advising the Court of additional recent case law supporting their motion. However, on August 28, 1989, in response to the defendants' supplemental authority, plaintiffs noticed their intent to "withdraw Count IV of their complaints which alleges that Defendants violated Section 12(2) of the 1933 Act," suggesting that "the complaints can be amended, if necessary, following trial."

 The Court shall construe plaintiffs' surprise notice as a motion to amend the complaints or for partial voluntary dismissal, which in either case requires Court approval. See Fed. R. Civ. P. 15(a), 41(a)(2). For the reasons set forth below -- the same reasons the Court would have granted defendants' motion to strike -- the Court shall permit plaintiffs to withdraw their Section 12(2) claims voluntarily in the face of defendants' motion. Cf. Fed. R. Civ. P. 41(a)(2) (non-stipulated voluntary dismissal subject to "such terms and conditions as the court deems proper").

 The gravamen of plaintiffs' complaints in this case is that defendants, as plaintiffs' broker, engaged in excessive, unsuitable, and unauthorized trading in stock index options, causing plaintiffs to lose money. One of plaintiffs' original claims is that defendants thereby violated Section 12(2) of the Securities Act of 1933, 15 U.S.C. § 771 (1982). *fn1" Second Amended Complaints at Count IV. The question now presented is whether Section 12(2) covers such stock index option transactions. Specifically, defendants contend that "because Section 12(2) applies only to the purchase of securities initially offered via a prospectus or registration statement . . ., [it] is not applicable to securities, such as the index options in the cases at bar, which are traded in the secondary market without the use of a prospectus." Defendants' Memorandum at 1.

 The Court has previously held that defendants qualify as "sellers" for purposes of Section 12(2), and the Court reaffirms that holding. Mix v. E.F. Hutton & Co., Inc., Nos. 85-3108, 85-3109, 85-3110 (D.D.C. Aug. 30, 1988). The Court's holding was based on the United States Supreme Court's reasoning in Pinter v. Dahl, 486 U.S. 622, 108 S. Ct. 2063, 100 L. Ed. 2d 658 (1988), concerning the meaning of "seller" for purposes of Section 12(1). The weight of post-Pinter authority is in accord with this Court's holding. See, e.g., Capri v. Murphy, 856 F.2d 473, 478 (2d Cir. 1988); Abell v. Potomac Insurance Co., 858 F.2d 1104, 1113-15 (5th Cir. 1988). Contrary to plaintiffs' arguments, however, this Court's holding and the Pinter Court's reasoning on the "seller" issue are not dispositive of the present issue, which is whether stock index option trading involves the type of security or the type of transaction covered by Section 12(2).

 The Court must therefore reject defendants' suggestion that index options trading is categorically divorced from the 1933 Act. Indeed, in accordance with Congress's intent, the SEC has promulgated regulations governing the registration and sale of standardized options, pursuant to the 1933 Act. See 47 Fed. Reg. 41,950 (1982). This regulatory scheme includes the optional filing of a registration statement and the provision of a prospectus at an investor's request. See id. at 41,951; 17 C.F.R. § 239.20 (Form S-20 for Standardized Options). Recognizing the "unique nature of standardized options," however, the SEC established a new "options disclosure document" designed to be the main disclosure vehicle to investors of the nature and risks of options trading. Id., 47 Fed. Reg. at 41,951, 41,952-53; 17 C.F.R. § 240.9b-1. Broker-dealers are required to furnish an options disclosure document to their customers before trading in options on their accounts. 17 C.F.R. at § 240.9b-1(d). *fn2"

 The record indicates defendants furnished plaintiffs with the required disclosure documents. See Defendants' Reply Memoranda in Support of Motions for Summary Judgment, No. 85-3108, at 36; No. 85-3109 at 24; and No. 85-3110 at 28 (Feb. 26, 1987) ("Characteristics and Risks of Standardized Options"). Plaintiffs' Section 12(2) claims, however, are not premised on any misrepresentations or omissions in such disclosure documents or in any registration statement, prospectus, or other communication made in connection with the "initial distribution" of the index options. Moreover, it is precisely the lack of any such allegations that defendants contend is fatal to plaintiffs' Section 12(2) claims.

 Defendants' argument is based on the growing body of federal district court decisions, primarily in the Southern District of New York, holding that Section 12(2), and the 1933 Act in general, do not cover post-distribution trading of securities or trading in "secondary" markets. See McCowan v. Dean Witter Reynolds, Inc., [Current Binder]Fed. Sec. L. Rep. (CCH) P94,423 at 92,726-727 (S.D.N.Y. Apr. 11, 1989); Strong v. Paine Webber, Inc., 700 F. Supp. 4, 5 (S.D.N.Y. 1988); SSH Co. Ltd. v. Shearson Lehman Bros., Inc., 678 F. Supp. 1055, 1059 (S.D.N.Y. 1987); Ackerman v. Clinical Data, Inc., [1985-86 Transfer Binder]Fed. Sec. L. Rep. (CCH) para. 92,207 at 91,568 n. 3 (S.D.N.Y. July 8, 1985); Klein v. Computer Devices, Inc., 591 F. Supp. 270, 277-78 (S.D.N.Y. 1984); Gross v. Diversified Mortgage Investors, 431 F. Supp. 1080, 1095 (S.D.N.Y. 1977), aff'd mem., 636 F.2d 1201 (2d Cir. 1980); Bresson v. Thomson McKinnon Securities, Inc., 641 F. Supp. 338, 342 (S.D.N.Y. 1986); Panek v. Bogucz, 718 F. Supp. 1228 (D.N.J. 1989) (available on Lexis); Cheltenham Bank v. Drexel Burnham Lambert, Inc., [Current Binder]Fed. Sec. L. Rep. (CCH) para. 94,391 at 92,542 (E.D.N.C. Mar. 15, 1989); Leonard v. Shearson Lehman/American Express, Inc., 687 F. Supp. 177, 179-80 (E.D. Pa. 1988); First Union Brokerage v. Milos, 717 F. Supp. 1519 (S.D. Fla. 1989) (available on Westlaw, Lexis); Ralph v. Prudential-Bache Securities, Inc., 692 F. Supp. 1322, 1325 (S.D. Fla. 1988). *fn3"

 The principal rationale of these decisions is that the 1933 Act was designed to govern the distribution of securities and that post-distribution trading is governed by the later Securities and Exchange Act of 1934. Judge Leval's reasoning in SSH, one of the seminal cases from the Southern District, is representative:

 
Plaintiff has not made out a claim under § 12(2) of the '33 Act because that section imposes liability only on a 'person who . . . offers or sells a security . . . by means of a prospectus or oral communication.' The phrase 'prospectus or oral communication' refers to a prospectus, registration statement, or other communication related to batch offering of securities, not to subsequent trading. . . . The purpose of the '33 Act was the regulation of the distribution of securities. Post-distribution trading is regulated by the '34 Act.

 678 F. Supp. at 1059 (citations omitted, emphasis in original).

 As subsequent courts have noted, the issue may boil down to the meaning of the words "or oral communications" in Section 12(2), since the term "prospectus" obviously appears to refer to initial distribution. See Elysian, 713 F. Supp. at 750 n. 17 ("The question here concerns the meaning of the words 'or oral communication.' If . . . this reference were more closely linked to the word prospectus (as in 'or related communication') defendants' argument would be more compelling. If Congress intended to so narrowly limit the application of Section 12(2), more narrow words were available to do so." (emphasis in original)). While the term "prospectus" is defined in the 1933 Act, see 15 U.S.C. § 77b(10) -- effectively including certain oral communications by radio and (after a 1954 amendment) television -- the term "oral ...


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