author: TIMBERS, Circuit Judge:

text:
    Maurice SHAPIRO et al., Plaintiffs-Appellees, v. MERRILL LYNCH, PIERCE, FENNER & SMITH, INC., et al., Defendants-Appellants.
    No. 270, Docket 73-1677.
    United States Court of Appeals, Second Circuit.
    Argued Jan. 7, 1974.
    Decided April 3, 1974.

      Donald N. Ruby, New York City (Lester L. Levy and Wolf, Popper, Ross, Wolf & Jones, New York City, on the brief), for plaintiffs-appellees Maurice Shapiro, Isadore Shapiro, William M. Naigles, Chaylie Saxe and Thomas F. Gibson, Jr.
    Roger J. Hawke, New York City (Brown, Wood, Fuller, Caldwell & Ivey, New York City, on the brief), for defendants-appellants Merrill Lynch, Pierce, Fenner & Smith, Inc., Winthrop Lenz, Julius H. Sedlmayer, Gillette K. Martin, Dean S. Woodman, Edward N. McMillan, Phillip F. Bilbao, Norman H. Heindel, Jr., Lee W. Idleman, Lawrence Zicklin, James A. McCarthy, Elias A. Lazor and Chester T. Smith, Jr.
    Samuel E. Gates, New York City (De-bevoise, Plimpton, Lyons & Gates, New York City, on the brief), for defendants-appellants Burden Investors Services, Inc. and William A. M. Burden & Co.
    Shearman & Sterling, New York City, for defendants-appellants Anchor Corp., City Associates and Fairfield Partners.
    Ballard, Spahr, Andrews & Ingersoll, Philadelphia, Pa., for defendant-appellant Madison Fund, Inc.
    Shereff, Friedman, Hoffman & Goodman, New York City, for defendants-appellants J. M. Hartwell & Co., J. M. Hartwell & Co., Inc., Hartwell Associates and Park Westlake Associates.
    Milbank, Tweed, Hadley & McCloy, New York City, for defendant-appellant Van Strum & Towne, Inc.
    Sullivan & Cromwell, New York City, for defendant-appellant Fleschner Becker Associates.
    Seward & Kissel, New York City, for defendants-appellants A. W. Jones & Co. and A. W. Jones Associates.
    Before DANAHER, LUMBARD and TIMBERS, Circuit Judges.

       Senior Circuit Judge of the United States Court of Appeals for the District of Columbia Circuit, sitting by designation.

   TIMBERS, Circuit Judge:

This appeal presents important questions, some of first impression, involving the scope of the antifraud provisions of the federal securities laws in their application to transactions on a national securities exchange when material inside information has not been disclosed.

Specifically, the questions presented are (1) whether Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 were violated by a prospective managing underwriter of a debenture issue and the underwriter’s officers, directors and employees when they divulged material inside information to the underwriter’s customers for the purpose of protecting the latters’ investments in the stock of the issuer; (2) whether the same antifraud provisions of the securities laws were violated by the underwriter’s customers when they traded in the stock of the issuer without disclosing the material inside information which had been divulged to them by the underwriter; and (3) whether those referred to above, if they did violate the antifraud provisions of the securities laws, are liable in damages to those persons who during the same period purchased stock in the same company in the open market without knowledge of the material inside information. In short, this case involves the liability of non-trading “tippers” and trading “tippees” under Section 10(b) and Rule 10b-5.

Defendants appeal, pursuant to 28 U.S.C. § 1292(b) (1970), from an order entered in the Southern District of New York, Charles H. Tenney, District Judge, 353 F.Supp. 264 (S.D.N.Y.1972), denying their motion for judgment on the pleadings on the ground that the complaint failed to state a claim upon which relief can be granted.

The action was brought to recover damages claimed to have been sustained as the result of defendants’ trading or recommending trading of common stock of Douglas Aircraft Company, Inc. (Douglas) on the New York Stock Exchange (NYSE) in 1966. Such acts or transactions are alleged to have violated Sections 10(b) and 15(c)(1) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b) and 78o(c)(l) (1970); Rules 10b-5 and 15c-l and 2, 17 C.F.R. §§ 240.106-5 and 240.156-1 and 2 (1973), promulgated by the Securities and Exchange Commission (SEC); and Section 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a) (1970).

Applying to the admitted facts before us what we believe to be controlling principles of law as enunciated by the Supreme Court and by our Court, we affirm.

I.

In summarizing here the facts necessary to a determination of the legal issues raised on this appeal, we must take as admitted the well-pleaded material facts alleged in the complaint, as the district court did, 353 F.Supp. at 268, since the order under review denied defendants’ motion for judgment on the pleadings pursuant to Fed.R.Civ.P. 12 (c).

The course of events which culminated in the instant action occurred during the period April 1966 through July 1966. During this period, Merrill Lynch, Pierce, Fenner & Smith Inc. (Merrill Lynch) was engaged as the prospective managing underwriter of a proposed Douglas offering of $75,000,000 principal amount of a new issue of 4%% convertible subordinated debentures. A registration statement for this offering was filed with the SEC on June 7; it became effective on July 12, with Merrill Lynch the managing underwriter. On June 7, Douglas had released an earnings statement which reported the results of operations for the first five months of its 1966 fiscal year, i. e. through April 30, 1966. This statement indicated that Douglas had earned 85 cents per share on its common stock during that period.

During the period June 17 through June 22, Merrill Lynch and certain of its officers, directors and employees (the individual defendants) were advised by Douglas’ management of certain material adverse inside information regarding Douglas’ earnings. This information was essentially that (a) Douglas would report substantially lower earnings for the entire first six months than it had reported for the first five months of its 1966 fiscal year; (b) Douglas had sharply lowered its estimate of earnings for its full 1966 fiscal year in that it now expected to have little or no profit for that year; and (c) Douglas had substantially reduced its projection of earnings for its 1967 fiscal year. This information was given to Merrill Lynch solely because of its position as the prospective underwriter for the Douglas debenture issue. The individual defendants and Merrill Lynch knew or should have known that the information had not yet been publicly announced.

During the period June 20 through June 24, Merrill Lynch and the individual defendants disclosed this confidential information to the following Merrill Lynch customers (the selling defendants), most of whom were institutional investors: Investors Management Co., Inc. (a wholly owned subsidiary of Anchor Corporation), Madison Fund, Inc., J. M. Hartwell & Co. (predecessor of J. M. Hartwell & Co., Inc.), Hartwell Associates, Park Westlake Associates, Van Strum & Towne, Inc., Fleschner Becker Associates, A. W. Jones & Co., A. W. Jones Associates, City Associates, Fair-field Partners, Burden Investors Services, Inc. and William A. M. Burden & Co. The selling defendants knew or should have known that this information had not yet been publicly announced.

During the period June 20 through June 23, the selling defendants either sold from existing positions or made short sales of more than 165,000 shares of Douglas common on the NYSE. This was approximately one-half of the total number of Douglas shares sold on the NYSE during this period. These sales were made prior to Douglas’ public disclosure of the revised earnings information on June 24 and without the sellers having disclosed this information to the investing public, including plaintiffs. As a result of these sales, the individual defendants and Merrill Lynch received commissions from the execution of the selling defendants’ orders and also received compensation in the form of customer directed “give ups” — i. e. division of commissions earned by other brokers who executed orders for the selling defendants.

On June 23, plaintiff Gibson purchased an unspecified number of shares of Douglas common on the NYSE; his purchase was prior to the public release on June 24 of Douglas’ revised earnings report. The other four plaintiffs— Maurice Shapiro, Isadore Shapiro, Nai-gles and Saxe — purchased an unspecified number of shares of Douglas common on the NYSE on June 24; their purchases were made without knowledge of the material adverse earnings information released by Douglas that day.

Beginning about June 22 or 23, the market price of Douglas common on the NYSE took a sudden and substantial drop. This coincided with and, according to the complaint, was caused by the substantial sales by the selling defendants on the basis of material inside information, the disclosure of which after plaintiffs’ purchases precipitated a further severe drop in the market price of Douglas common.

On August 21, 1970, plaintiffs commenced the instant action in the Southern District of New York. They sued on behalf of themselves and all others similarly situated who purchased Douglas common during the period June 21 through June 24, 1966. Essentially the complaint alleges that defendants were under a duty to disclose to the general investing public, including plaintiffs, the material inside information regarding Douglas’ earnings; that defendants defrauded plaintiffs by not disclosing such information, in violation of the anti-fraud provisions of the securities laws; that plaintiffs would not have purchased Douglas stock if they had known of the information withheld by defendants; and that plaintiffs sustained substantial damages as a result of the acts of defendants. Plaintiffs do not claim to have purchased specific shares of Douglas stock sold by any of the selling defendants. The complaint demands damages sustained by plaintiffs and an accounting of profits realized by defendants.

After the pleadings were closed and certain limited discovery proceedings had taken place, both sides brought on motions before Judge Tenney. Plaintiffs moved, pursuant to Fed.R.Civ.P. 23(c), for an order declaring that the action be maintained as a class action. Defendants moved for judgment on the pleadings on the ground that the complaint failed to state a claim upon which relief can be granted. In support of their motion, defendants contended that plaintiffs lacked standing to sue; that the information defendants withheld was not material; that there was no privity between plaintiffs and defendants; that scienter was absent; and that plaintiffs had failed to allege facts sufficient to establish causation and reliance.

On December 26, 1972, Judge Tenney filed a well reasoned opinion, 353 F. Supp. 264, denying the motions by both sides. In denying defendants’ motion for judgment on the pleadings, the judge carefully considered but rejected each of defendants’ contentions. He held in substance that Merrill Lynch and the individual defendants violated a duty which they owed to plaintiffs when these defendants disclosed material inside information to the selling defendants ; that the selling defendants in turn.violated a duty which they owed to plaintiffs when they sold the Douglas stock without disclosing the material inside information which had been divulged to them; that the conduct of all-defendants had caused plaintiffs to sustain damages; and that accordingly the complaint stated a claim upon which relief can be granted against all defendants under Section 10(b) and Rule 10b-5.

Since there was no issue before Judge Tenney on defendants’ motion for judgment on the pleadings with respect to the measure of damages to which plaintiffs would be entitled or other appropriate relief to be fashioned in the event plaintiffs were successful after trial on the merits, he made no determination on that issue.

On February 22, 1973, upon motion by defendants, Judge Tenney amended his earlier order by adding the certification required by 28 U.S.C. § 1292(b) (1970) to permit appeal from an interlocutory order. On March 27, 1973, we granted leave.to appeal.

II.

Upon the basis of the foregoing summary of the facts and prior proceedings, we turn directly to the legal questions presented. They are essentially whether defendants violated Section 10(b) and Rule 10b-5 and, if so, whether they are liable in damages to plaintiffs ior such violations. The district court held as a matter of pleading that both questions must be answered in the affirmative. We agree.

Our starting point is the statute and the implementing rule. Section 10(b) of the 1934 Act in relevant part makes it unlawful for any person, directly or indirectly, by the use of any facility of any national securities exchange “[t]o use or employ, in connection with the purchase or sale of any security . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission [SEC] may prescribe as necessary or appropriate in the public interest or for the protection of investors.” One such prescription is Rule 10b-5 which provides in relevant part that “in connection with the purchase or sale of any security”, it shall be unlawful for any person, directly or indirectly, by the use of any facility of any national securities exchange “(a) [t]o employ any device, scheme, or artifice to defraud, (b) [t]o make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or (c) [t]o engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person 11

As we have stated time and again, the purpose behind Section 10(b) and Rule 10b-5 is to protect the investing public and to secure fair dealing in the securities markets by promoting full disclosure of inside information so that an informed judgment can be made by all investors who trade in such markets. E. g., Crane Co. v. Westinghouse Air Brake Co., 419 F.2d 787, 793 (2 Cir. 1969), cert. denied, 400 U.S. 822 (1970); SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 848 (2 Cir. 1968), cert. denied sub nom. Kline v. SEC, 394 U.S. 976 (1969). We recently held in Radiation Dynamics, Inc. v. Goldmuntz, 464 F.2d 876, 890 (2 Cir. 1972), that “[t]he essential purpose of Rule 10b-5 . is to prevent corporate insiders and their tippees from taking unfair advantage of the uninformed outsiders.”

Moreover, in applying the anti-fraud provisions of the securities laws to the facts of this case, it is important to bear in mind that “Congress intended securities legislation enacted for the purpose of avoiding frauds to be construed ‘not technically and restrictively, but flexibly to effectuate its remedial purposes.’ ” Affiliated Ute Citizens v. United States, 406 U.S. 128, 151 (1972), quoting from SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 195 (1963). This policy of flexible, nontechnical construction of the securities laws has provided the underpinning for the results in recent cases involving specific violations of the antifraud provisions of the securities laws. E. g., Superintendent of Insurance v. Bankers Life & Casualty Co., 404 U.S. 6, 12 (1971); SEC v. Glen-Arden Commodities, Inc., 493 F.2d 1027, 1033-34 (2 Cir. 1974); International Controls Corp. v. Vesco, 490 F.2d 1334, 1345 (2 Cir. 1974). See Chris-Craft Industries, Inc. v. Piper Aircraft Corp., 480 F.2d 341, 357, 363 (2 Cir.), cert. denied, 414 U.S. 910 (1973).

Here, upon the question of whether Section 10(b) and Rule 10b-5 were violated, the critical facts — admitted for purposes of this appeal — are that Merrill Lynch, a prospective managing underwriter of a Douglas debenture issue, and some of the officers, directors and employees of Merrill Lynch, divulged to certain of ’ its customers, the selling defendants, material adverse inside information regarding Douglas’ earnings; the selling defendants, without disclosing to the investing public this inside information, sold Douglas common stock on a national securities exchange; and as a result of such trading Merrill Lynch and the individual defendants received commissions and other compensation, the selling defendants minimized their losses, but the investing public comprised of uninformed outsiders, including plaintiffs, who purchased Douglas stock during the same period sustained substantial losses.

Our holding that such conduct on the part of all defendants violated Section 10(b) and Rule 10b-5 is based chiefly on our decision in SEC v. Texas Gulf Sul-phur Co., swpra,, where we stated that

“anyone in possession of material inside information must either disclose it to the investing public, or, if he is disabled from disclosing it . . ., must abstain from trading in or recommending the securities concerned while such inside information remains undisclosed.” 401 F.2d at 848.

Defendants argue, however, that Texas Gulf is inapplicable here because, first, that was an SEC injunction action and not a private damage action and, second, Rule 10b-5 does not impose upon these defendants a duty to disclose the material inside information in question to these plaintiffs who did not purchase the actual stock sold by defendants.

Although Texas Gulf was an SEC injunction action, the strong public policy considerations behind our “disclose or abstain” rule there are equally applicable here. In short, whether invoked in an SEC injunction action or in a private damage action, “the Rule is based in policy on the justifiable expectation of the securities marketplace that all investors trading on impersonal exchanges have relatively equal access to material information . . . .” SEC v. Texas Gulf Sulphur Co., supra, 401 F.2d at 848. See Crane Co. v. Westinghouse Air Brake Co., supra, 419 F.2d at 796. Since one of the primary goals of the antifraud provisions of the securities laws would be frustrated if our “disclose or abstain” rule enunciated in Texas Gulf were to be limited to SEC injunction actions and held inapplicable to private damage actions, we reject such ground of distinction.

We also reject defendants’ second asserted ground for distinguishing Texas Gulf• — that our “disclose or abstain” rule is not applicable here because the only duty owed by defendants was to purchasers of the specific shares of Douglas stock sold by defendants and the transactions here involved were not face-to-face sales to plaintiffs. This argument totally misconstrues our Texas Gulf rule. 401 F.2d at 848. It also ignores the fact that these transactions occurred on an anonymous national securities exchange where as a practical matter it would be impossible to identify a particular defendant’s sale with a particular plaintiff’s purchase. And it would make a mockery of the “disclose or abstain” rule if we were to permit the fortuitous matching of buy and sell orders to determine whether a duty to disclose had been violated. See Painter, Inside Information: Growing Pains For The Development Of Federal Corporation Law Under Rule 10b-5, 65 Colum.L.Rev. 1361, 1372, 1377-78 (1965). On this very point, we stated in Radiation Dynamics, Inc. v. Goldmuntz, supra, that our “disclose or abstain” rule enunciated in Texas Gulf “applies whether the securities are traded on a public stock exchange or sold through private placement.” 464 F.2d at 887. To hold that Section 10(b) and Rule 10b-5 impose a duty to disclose material inside information only in face-to-face transactions or to the actual purchasers or sellers on an anonymous public stock exchange, would be to frustrate a major purpose of the antifraud provisions of the securities laws: to insure the integrity and efficiency of the securities markets. Chris-Craft Industries, Inc. v. Piper Aircraft Corp., supra, 480 F.2d at 357. We decline defendants’ invitation to sanction a result which Section 10(b) and Rule 10b-5 clearly were intended to foreclose. See Astor v. Texas Gulf Sul-phur Co., 306 F.Supp. 1333, 1340-42 (S.D.N.Y.1969). We hold that defendants owed a duty — for the breach of which they may be held liable in this private action for damages — not only to the purchasers of the actual shares sold by defendants (in the unlikely event they can be identified) but to all persons who during the same period purchased Douglas stock in the open market without knowledge of the material inside information which was in the possession of defendants.

We find untenable the contentions of the respective defendants that, upon the issue of whether they violated the anti-fraud provisions of the securities laws, a distinction should be drawn between their roles as non-trading “tippers” and trading “tippees”.

With respect to Merrill Lynch and the individual defendants (the non-trading “tippers”), their divulging of confidential material inside information to their customers who sold Douglas stock on the basis of such information clearly violated Section 10(b) and Rule 10b-5. In SEC v. Texas Gulf Sulphur Co., supra, 401 F.2d at 852, 856, we held that two “tippers” violáted the antifraud provisions of the securities laws by disclosing material inside information to individuals who subsequently entered into transactions on the basis of that information, and we remanded to the district court for determination of an appropriate remedy. Upon remand, the district court held one of these “tippers” liable for “tipping” and awarded appropriate relief. SEC v. Texas Gulf Sulphur Co., 312 F.Supp. 77, 95 (S.D.N.Y.1970), modified on other grounds, 446 F.2d 1301, 1307-08 (2 Cir.), cert. denied, 404 U.S. 1005 (1971). We find Texas Gulf controlling with respect to the liability of the non-trading “tippers” here.

With respect to the selling defendants (the trading “tippees”), Texas Gulf strongly suggests that the same duty to “abstain or disclose” should be imposed upon them. Although the issue of “tip-pee” liability was not squarely before us in Texas Gulf, we did say:

“As Darke’s ‘tippees’ are not defendants in this action, we need not decide whether, if they acted with actual or constructive knowledge that the material information was undisclosed, their conduct is as equally violative of the Rule as the conduct of their insider source, though we note that it certainly could be equally reprehensible.” 401 F.2d at 852-53.

In Ross v. Licht, 263 F.Supp. 395, 410 (S.D.N.Y.1967), the court observed, “If [defendants] were not insiders, they would seem to have been ‘tippees’ . and subject to the same duty as insiders.” See Radiation Dynamics, Inc. v. Goldmuntz, supra, 464 F.2d at 887, 890; Cady Roberts & Co., 40 S.E.C. 907, 912-13 (1961). Cf. Kuehnert v. Texstar Corp., 412 F.2d 700, 702-05 (5 Cir. 1969). We are not persuaded by the selling defendants’ argument that as tippees they were not able to make effective public disclosure of information about a company with which they were not associated; for the duty imposed is not a naked one to disclose, but a duty to abstain from trading unless they do disclose. Since upon the admitted facts before us the selling defendants knew or should have known of the confidential corporate source of the revised earnings information and they knew of its nonpublic nature, they were under a duty not to trade in Douglas stock without publicly disclosing such information.

In short, for the reasons set forth above, we hold that all defendants violated Section 10(b) and Rule 10b-5.

III.

We turn next to the remaining major legal question presented: assuming that defendants did violate the anti-fraud provisions of the securities laws by trading in or recommending trading in Douglas common stock (as we have held above), whether they are liable in a private action for damages to plaintiffs who during the same period purchased Douglas stock in the open market without knowledge of the material inside information which was in the possession of defendants.

The essential argument of defendants on this question is that, even if they did violate Section 10(b) and Rule 10b-5, their conduct did not “cause” damage to plaintiffs; that it was Douglas’ precarious financial condition, not defendants’ securities law violations, which precipitated the sudden, substantial drop in the market price of Douglas stock and hence the losses sustained by plaintiffs; that, since plaintiffs had no prior or contemporaneous knowledge of defendants’ actions, they would have purchased Douglas stock regardless of defendants’ securities law violations; and that, since defendants’ sales were unrelated to plaintiffs’ purchases and all transactions took place on anonymous public stock exchanges, there is lacking the requisite connection between defendants’ alleged violations and the alleged losses sustained by plaintiffs.

The short, and we believe conclusive, answer to defendants’ assertion that their conduct did not “cause” damage to plaintiffs is the “causation in fact” holding by the Supreme Court in Affiliated Ute Citizens v. United States, 406 U.S. 128, 153-54 (1972), upon the authority of which we conclude that the requisite element of causation in fact has been established here by the uncon-troverted facts that defendants traded in or recommended trading in Douglas stock without disclosing material inside information which plaintiffs as reasonable investors might have considered important in making their decision to purchase Douglas stock.

In order more fully to deal with the arguments which have been vigorously urged upon us by defendants’ counsel, however, we believe it may be helpful to back up a bit from our conclusion based on Affiliated Ute and particularly to indicate briefly the decisional law regarding the requisite element of causation that preceded the Supreme Court’s opinion in that case.

We consistently have held that causation is a necessary element of a private action for damages under Rule 10b-5. E. g., Chasins v. Smith, Barney & Co., 438 F.2d 1167, 1172 (2 Cir. 1970); Crane Co. v. Westinghouse Air Brake Co., 419 F.2d 787, 797 (2 Cir. 1969), cert. denied, 400 U.S. 822 (1970). Indeed, we have refused “to facilitate outsiders’ proof of insiders’ fraud” by “reading out of [Rule 10b-5] so basic an element of tort law as the principle of causation in fact.” List v. Fashion Park, Inc., 340 F.2d 457, 463 (2 Cir.), cert. denied, 382 U.S. 811 (1965). This is consistent with “the basic concept that causation must be proved else defendants could be held liable to all the world.” Globus v. Law Research Service, Inc., 418 F.2d 1276, 1292 (2 Cir. 1969), cert. denied, 397 U.S. 913 (1970). And we have recognized that the aim of Rule 10b-5 “is to qualify, as between insiders and outsiders, the doctrine of caveat emptor — not to establish a scheme of investors’ insurance.” List v. Fashion Park, Inc., supra, 340 F.2d at 463.

As one branch of their absence of causation argument, defendants contend that there was no privity between themselves and plaintiffs. We hold here, as we have held before, that privity between plaintiffs and defendants is not a requisite element of a Rule 10b-5 cause of action for damages. For example, we have upheld Rule 10b-5 claims for relief where there have been no direct transactions between plaintiffs and defendants. Crane Co. v. Westinghouse Air Brake Co., supra, 419 F.2d at 796-98; Heit v. Weitzen, 402 F.2d 909, 913 (2 Cir. 1968), cert. denied, 395 U.S. 903 (1969). See Astor v. Texas Gulf Sulphur Co., 306 F.Supp. 1333, 1341-42 (S.D.N.Y.1969). As the Tenth Circuit stated in Mitchell v. Texas Gulf Sulphur Co., 446 F.2d 90, 101 (10 Cir.), cert. denied, 404 U.S. 1004 (1971), “[p]erhaps the first step is to realize that the common law requirement of privity has all but vanished from 10b-5 proceedings while the distinguishable ‘connection’ element is retained.” And we recognized in Globus v. Law Research Service, Inc., supra, 418 F.2d at 1291, that “[b]efore there may be a violation of the securities acts there need not be present all of the same elements essential to a common law fraud. . . . ” See Ruder, Texas Gulf Sulphur — The Second Round: Privity and State of Mind in Rule 10b-5 Purchase and Sale Cases, 63 Nw.U.L.Rev. 423, 432-33 (1968). In short, causation as an element of a Rule 10b-5 cause of action can be established notwithstanding lack of privity.

As a further refinement of their absence of casuation argument, defendants contend that, even if privity between plaintiffs and defendants is not required, it is still necessary to show a “connection” between defendants’ nondisclosure conduct and plaintiffs’ purchase of Douglas stock — in the sense that the former induced the latter — before a Rule 10b-5 claim can be established. It is true that prior to the Supreme Court decision in Affiliated Ute the so-called connection requirement was stated in terms of causation and reliance. For example, we have noted that the reason for the reqúirement of reliance “is to certify that the conduct of the defendant actually caused the plaintiff’s injury”, List v. Fashion Park, Inc., supra, 340 F.2d at 462, and we have held that “[t]o the extent that reliance is necessary for a finding of a 10b-5 violation in a non-disclosure case . . .,

the test is properly one of tort ‘causation in fact.’ ” Chasins v. Smith, Barney & Co., supra, 438 F.2d at 1172. See Crane Co. v. Westinghouse Air Brake Co., supra, 419 F.2d at 797. Cf. SEC v. Texas Gulf Sulphur Co., supra, 401 F.2d at 860. While the concepts of reliance and causation have been used interchangeably in the context of a Rule 10b-5 claim, the proper test to determine whether causation in fact has been established in a non-disclosure case is “whether the plaintiff would have been influenced to act differently than he did act if the defendant had disclosed to him the undisclosed fact.” List v. Fashion Park, Inc., supra, 340 F.2d at 463. See Chasins v. Smith, Barney & Co., supra, 438 F.2d at 1172. Cf. Chris-Craft Industries, Inc. v. Piper Aircraft Corp., 480 F.2d 341, 373-75 (2 Cir.), cert. denied, 414 U.S. 910 (1973).

Even on the basis of the pre-Affiliat-ed Ute decisions discussed above, therefore, we would reject defendants’ essential causation argument, namely, that, absent an allegation that plaintiffs’ purchase of Douglas stock was induced by defendants’ non-disclosure of material inside information, the requisite element of causation is lacking. On the contrary, the Rule 10b-5 causation in fact requirement is satisfied by plaintiffs’ allegation that they would not have purchased Douglas stock if they had known of the information withheld by defendants.

As must be apparent from our discussion above, we believe that the Supreme Court’s decision in Affiliated Ute— which we regard as controlling on the issue of causation in the instant case — is a logical sequel to our prior decisions in such cases as List, Heit, Globus, Crane, and Chasins. Moreover, Affiliated Ute specifically applied to a Rule 10b-5 damage action the causation in fact standard enunciated by Mr. Justice Harlan in Mills v. Electric Auto-Lite Co., 396 U.S. 375, 385 (1970), where, in a case involving a cognate provision of the 1934 Act (Section 14(a)), the Court approved dispensing with any requirement of proof of reliance as a prerequisite to recovery in a private damage action. See note 12, supra.

In Affiliated Ute, members of a large class of holders of stock deposited in a bank alleged that two employees of the bank in arranging for sales of this stock had failed to disclose to plaintiffs facts regarding the bank’s and the employees’ positions as market makers and facts regarding the true value of the stock, in violation of Rule 10b-5. The Supreme Court, in reversing the Court of Appeals which had held that there could be no recovery under Section 10(b) and Rule 10b-5 without a showing of reliance, stated:

“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. . . . This obligation to disclose and this withholding of a material fact establish the requisite element of causation in fact.” 406 U.S. at 153-54. (citations omitted) (emphasis added).

As applied to the instant case, this holding in Affiliated Ute surely warrants our conclusion that the requisite element of causation in fact has been established by the admitted withholding by defendants of material inside information which they were under an obligation to disclose, such information being clearly material in the sense that plaintiffs as reasonable investors might have considered it important in making their decision to purchase Douglas stock.

Defendants argue that the Affiliated Ute rule of causation in fact should be confined to the facts of that case which involved face-to-face transactions. We disagree. That rule is dependent not upon the character of the transaction— face-to-face versus national securities exchange — but rather upon whether the defendant is obligated to disclose thei inside information. Here, as we have held above, defendants were under a duty to the investing public, including plaintiffs, not to trade in or to recommend trading in Douglas stock without publicly disclosing the revised earnings information which was in their possession. They breached that duty. Causation in fact therefore has been established.

Our holding that causation in fact has been established despite the fact that all transactions took place on a national securities exchange is consistent with the underlying purpose of Section 10(b) and Rule 10b-5 “to prevent inequitable and unfair practices and to insure fairness in securities transactions generally, whether conducted' face-to-face, over the counter, or on the exchanges. The Act and the Rule apply to the transactions here, all of which were consummated on exchanges.” SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 847-48 (2 Cir. 1968), cert, denied sub nom. Kline v. SEC, 394 U.S. 976 (1969) (citations omitted).

For the reasons set forth above, we hold that defendants are liable in this private action for damages to plaintiffs who, during the same period that defendants traded in or recommended trading in Douglas common stock, purchased Douglas stock in the open market without knowledge of the material inside information which was in the possession of defendants.

IY.

Finally, having held that all defendants violated Section 10(b) and Rule 10b-5 and that they are liable to plaintiffs in this private action for damages, we leave to the district court the appropriate form of relief to be granted, including the proper measure of damages. This comports with the procedure followed in other cases where appellate courts have determined issues of liability for violations of the securities laws. Mills v. Electric Auto-Lite Co., 396 U.S. 375, 386-89 (1970); J. I. Case v. Borak, 377 U.S. 426, 433-35 (1964); Chris-Craft Industries, Inc. v. Piper Aircraft Corp., 480 F.2d 341, 379-80 (2 Cir.), cert. denied, 414 U.S. 910 (1973); Crane Co. v. Westinghouse Air Brake Co., 419 F.2d 787, 803-04 (2 Cir. 1969), cert. denied, 400 U.S. 822 (1970).

In the instant case there are especially compelling reasons for following this procedure. Since the appeal comes to us from an interlocutory order denying defendants’ motion for judgment on the pleadings, there was no issue before the district court and of course no adjudication below on the form of relief to be granted. Among the questions to be determined which will have an important bearing on the form of relief is whether the action is to be maintained as a class action and, if so, the parameters of the class; as to this, the district court understandably was unable to make a determination on the facts presented by the pleadings. 353 F.Supp. at 280. See note 10, supra,. Another closely related question bearing upon the relief to be granted as to which the district court had insufficient data upon which to make a determination, 353 F.Supp. at 279-80, is just when Douglas’ news release regarding its revised earnings forecast on the morning of June 24, 1966 became effectively disseminated, especially in the light of SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 854 n. 18 (2 Cir. 1968), cert. denied sub nom. Kline v. SEC, 394 U.S. 976 (1969). Other questions bearing upon the appropriate form of relief which must await trial include the extent of the selling defendants’ trading in Douglas stock, whether such trading effectively impaired the integrity of the market, what compensation if any was paid by the selling defendants to Merrill Lynch for the inside information, what profits or other benefits were realized by defendants, what expenses were incurred and what losses were sustained by plaintiffs, and what should be the difference, if any, in the extent of liability imposed on the individual defendants and the selling defendants, respectively. Moreover, we do not foreclose the possibility that an analysis by the district court of the nature and character of the Rule 10b-5 violations committed may require limiting the extent of liability imposed on either class of defendants.

In leaving to the district court the fashioning of appropriate relief, including the proper measure of damages, we are not unmindful of the arguments pressed upon us by all defendants that the resulting judgment for damages may be very substantial in amount — in the words of defendants’ counsel, a “Draconian liability”. This is an additional reason for leaving to the district court the appropriate form of relief to be granted — a determination that can best be made after an evidentiary hearing and on the basis of appropriate findings of fact.

In short, we decide today only those legal questions properly before us on this appeal from the interlocutory order denying defendants’ motion for judgment on the pleadings. We leave all other issues to the district court, including the fashioning of appropriate relief.

Affirmed.

      . Jurisdiction is grounded upon Section 27 of the 1934 Act, 15 U.S.C. § 78aa (1970), and Section 22(a) of the 1933 Act, 15 U.S.C. § 77v(a) (1970), Both acts give to the district courts jurisdiction over all actions brought to enforce any liability or duty created by the respective acts “irrespective of the amount in controversy or the citizenship of the parties.” Ill Loss, Securities Regulation 2005 (2d ed. 1961), citing Deckert v. Independence Shares Corp., 311 U.S. 282, 289 (1940), and Wilko v. Swan, 346 U.S. 427, 431 (1953).
      Section 27 of the 1934 Act, moreover, is unique in that it gives exclusive jurisdiction to the district courts of violations of that act or the rules and regulations thereunder, whereas the state courts are given concurrent jurisdiction over private actions under the other federal securities acts. III Loss, supra, at 2005.

      . 2A Moore, Federal Practice f 12.08 (2d ed. 1972).
      This is so despite defendants’ assertion of a Rule 12(b)(6) defense of failure to state a claim upon which relief can be granted in their Rule 12(c) motion, as permitted by Rule 12 (h) (2). 5 Wright & Miller, Federal Practice and Procedure: Civil § 1367, at 688-89 (1969).

      . Douglas’ fiscal year begins December 1 and ends November 30.

      . Of the twelve “individual defendants”, referred to in the district court opinion and in the briefs as “employees” of Merrill Lynch, five were salesmen in the New York institutional sales office of Merrill Lynch (i. e. defendants Lee W. Idleman, Lawrence Zick-lin, James A. McCarthy, Elias A. Lazor and Chester T. Smith, Jr.).
      The other seven individual defendants were vice presidents of Merrill Lynch (i. e. defendants Wintlirop Lenz, Julius II. Sedlmayer, Gillette K. Martin, Dean S. Woodman, Edward N. McMillan, Phillip P. Bilbao and Norman H. Heindel, Jr.).
      Of the latter, three were directors of Merrill Lynch (i. e. Lenz,-Sedlmayer and McMillan).
      Each of the vice presidents occupied positions of special significance in the Merrill Lynch organization in the context of the issues in this case. Lenz was chairman of Merrill Lynch’s executive committee and was in charge of underwriting; Sedlmayer was director of the underwriting division; Martin was head of the corporate buying department of the underwriting division; Woodman was in charge of the west coast underwriting office; McMillan was director of the institutional and equity sales division; Bilbao was manager of the institutional sales department and municipal sales division; and Heindel was manager of the New York institutional sales office.

      . This information, sometimes described as “nonpublic information”, is referred to in this opinion as “inside information”.

      . On the morning of June 24, Douglas issued a press release which reported that its earnings for the first six months of its 1966 fiscal year, i. e. through May 31, were 12 cents per share and that it expected that its earnings for the full 1966 fiscal year would be nominal, if any.

      . The subject matter of Douglas’ press release of June 24 appeared in articles in the New York Times on June 25 and in the AVall Street Journal on June 27.

      . The following is a table of prices of Douglas common stock on the NYSE during the relevant period:

        Bate Volume Closing High, Low Price

      June 21 .... 66,200 90 86 86%
      June 22____ 66,500 90% 87% 87%
      June 23 .... 261,500 88% 77% 78%
      June 24 .... 211,100 77 74% 76
      June 25 SATURDAY
      June 26 SUNDAY
      June 27 .... 121,300 74% 69 69
      June 28 .... 135,300 70 66% 68%
      June 29 .... 102,200 69% 64% 64%
      June 30 .... 180,900 65% 61 63%
      July 1 .... 100,400 64% 61 61%

      . Based on substantially the same transactions alleged in the complaint in the instant action, the SEO brought administrative proceedings to determine whether certain of the defendants herein had violated the antifraud provisions of the securities laws in connection with the trading of Douglas common stock during the period June 17-June 24, 1966. The upshot of these proceedings was that the SEC accepted the offer of settlement of Merrill Lynch and its employees pursuant to which, for purposes of the administrative proceedings, they consented to findings that they had violated the antifraud provisions, including Section 10(b) and Rule 10b-5. The SEC suspended Merrill Lynch’s New York institutional sales office for 15 days and imposed other administrative sanctions on certain of the individual defendants. Merrill Lynch, Pierce, Fenner & Smith, Inc., Securities Exchange Act Release No. 8459 (1968).
      AVith respect to the selling defendants, the SEC in a separate decision, Investors Management Co., Inc., Securities Exchange Act Release No. 9267 (1971), affirmed the initial decision of the hearing examiner who, after a lengthy hearing, found that all of the selling defendants had violated the antifraud provisions, including Section 10(b) and Rule 10b-5, and ordered that they be censured.

      . Plaintiffs’ motion for a class action determination was denied because it was impossible on the facts presented by the pleadings to determine the parameters of the class; but leave was granted to renew the motion when sufficient facts could be presented. 353 F.Supp. at 280. Since a class action determination was not made, we are not presented with those issues discussed in Eisen v. Carlisle & Jac-quelin, 479 F.2d 1005 (2 Cir.), vacated and remanded,-- U.S.- (1974).
      The district court denied without comment defendants’ motion insofar as it applied to plaintiffs’ claims asserted under Section 15(c) (1) of the 1934 Act or Section 17 (a) of the the 1933 Act, since neither side had briefed those issues. They are not before us on this appeal.

      . Judge Tenney’s Section 1292(b) certification reads as follows:
      “The undersigned is of the opinion that this order involves a controlling question of law as to which there is substantial ground for difference of opinion, i. e., whether one who allegedly receives material non-public adverse information about a company, and thereafter sells stock in the company on a national securities exchange without disclosing said information, is civilly liable, regardless of the amount sold, to all persons who during the same period purchased securities in the same company in the open market without knowledge of the adverse information, and the Court is further of the opinion that an immediate appeal from this order may materially advance the ultimate determination of the litigation.”

      . While the antifraud provisions here involved are Section 10(b) and Rule 10b-5, many of the controlling principles applicable thereto have been enunciated in cases arising under other provisions of the 1934 Act. E. g., Mills v. Electric Auto-Lite Co., 396 U.S. 375 (1970) (§ 14(a)); J. I. Case Co. v. Borak, 377 U.S. 426 (1964) (§ 14(a)) ; Chris-Craft Industries, Inc. v. Piper Aircraft Corp., supra (§ 14(e)). The standard of causation in fact (dispensing with any requirement of proof of reliance as a prequisite to recovery) as stated by Mr. Justice Harlan in Mills, 396 U.S. at 385, has been held applicable by the Supreme Court to a Rule 10b-5 damage action in XJte, 406 U.S. at 153-54. In Chris-Craft, 480 F.2d at 362, we noted that “the underlying proscription of § 14(e) is virtually identical to that of Rule 10b-5”, and we stated that “[i]n determining whether § 14(e) violations were committed in the instant case, we shall follow the principles developed under Rule 10b-5 regarding the elements of such violations.” Accord, Gulf & Western Industries, Inc. v. Great Atlantic & Pacific Tea Company, Inc., 476 F.2d 687, 695-96 (2 Cir. 1973) (§ 14(e)). See 1 Bromberg, Securities Law: Fraud — SEC Rule 10b-5 § 4.7, it 86-86.1 (Supp.1972-73).

      . We further noted in Texas Gulf the Congressional purpose to be implemented by Rule 10b-5:
      “The core of Rule 10b-5 is the implementation of the Congressional purpose that, all investors should have equal access to the rewards of participation in securities transactions. It was the intent of Congress that all mefhbers of the investing public should be subject to identical market risks [And] inequities based upon unequal access to knowledge should not be shrugged off as inevitable in our way of life, or, in view of the congressional concern in the area, remain uncorrected.” 401 F.2d at 851-52.

      . As the author recognizes, “Since in any active market disclosure to a particular individual is not feasible, the duty to disclose, if such a duty exists, must be owed to all members of that ill-defined class of stockholders who, with the benefit of inside information, would alter their intention to [buy].” Painter, 65 Colum.L.Rev. at 1378.

      . While defendants urged upon the district court the absence of other elements of a Rule 10b-5 cause of action — e. g., standing, materiality and scienter, 353 F.Supp. at 270-73, their chief emphasis on this appeal is directed at the asserted absence of causation and reliance and the absence of privity between plaintiffs and defendants.

      . The similarity between certain arguments made here and some discussed above under part II of this opinion is recognized. The issue here is the existence of the essential elements of a private action for damages — whether these plaintiffs may recover damages — while the issue under part II was whether violations of Section 10(b) and Rule 10b-5 had been established. We shall assume familiarity here with our discussion of similar arguments above.

      . Following our remand in Texas Gulf, supra, 401 F.2d at 804, the district court ruled on motions for summary judgment by certain defendants in a related shareholders’ action. Astor v. Texas Gulf Sulphur Co., 306 F.Supp. 1333 (S.D.N.Y.1969). Shareholders of Texas Gulf had brought a Rule 10b-5 action against defendants who had purchased Texas Gulf stock on the basis of material inside information during the same period that plaintiffs had sold. Plaintiffs alleged that they would not have sold their stock had they known of the undisclosed information. No privity existed between plaintiff-sellers and defendant-buyers. Defendants bad made no affirmative misrepresentations. The transactions were executed on an essentially anonymous market. 306 F.Supp. at 1341. On the basis of these facts, the court, applying the List test, found that plaintiffs’ complaint stated a claim for relief under Rule 10b-5 and accordingly denied defendants' motions for summary judgment. Id. at 1342.

      . Defendants argue that, rather than the instant private action for damages, there are adequate sanctions against those who violate Section 10(b) and Rule 10b-5 in the form of administrative and injunctive proceedings which can be brought by the SEC. See note 9, supra. The short answer is that such proceedings and the private action for damages are not mutually exclusive remedies. As we recently stated in Chris-Craft Industries, Inc. v. Piper Aircraft Corp., supra, 480 F.2d at 356:
      “the Supreme Court, as well as other federal courts including our own, have recognized that vigorous enforcement of the federal securities laws, jiarticularly the anti-fraud provisions, can be accomplished effectively only when implemented by private damage actions. In J. I. Case Co. v. Borak, 377 U.S. 426 (1964), the Supreme Court emphasized that private actions provide ‘a necessary supplement to Commission action’ and that ‘the possibility of civil damages or injunctive relief serves as a most effective weapon in the enforcement’ of the securities laws. 377 U.S. at 432. See Fischman v. Raytheon Mfg. Co., 188 F.2d 783 (2 Cir. 1951); Speed v. Transamerioa Corp., 235 F.2d 369 (3 Cir. 1956).”
      In like vein, defendants contend that the recovery of illegal profits resulting from an insider’s misuse of corporate information should be left to derivative stockholders actions as in Schein v. Chasen, 478 F.2d 817 (2 Cir. 1973), remanded on other grounds sub nom. Lehman Bros. v. Schein, - U.S. - (1974), and Diamond v. Oreamuno, 24 N.Y.2d 494, 248 N.E.2d 910, 301 N.Y.S.2d 78 (1969). What we said above regarding the role of the private action for damages in the overall program for vigorous enforcement of the federal securities laws applies with equal force here. Moreover, derivative actions for such relief are not uniformly available in all states.


source: Caselaw Access Project

author: MURRAH, Circuit Judge.

license: Public Domain

text:
    UNITED STATES of America, Plaintiff-Appellee, v. Earl JOHNSON, a/k/a Floyd D. Sanders, Defendant-Appellant.
    No. 73-1435.
    United States Court of Appeals, Tenth Circuit.
    Submitted Nov. 14, 1973.
    Decided April 4, 1974.

      George W. Materi, Sh.awnee Mission, Kan. (George W. Earnshaw, Shawnee Mission, Kan., on the brief), for defendant-appellant.
    Monti Belot, Asst. U. S. Atty., Topeka, Kan. (Robert J. Roth, U. S. Atty., District of Kansas, and Glen S. Kelly, Asst. U. S. Atty. (Trial Attorney), with him on the brief), for plaintiff-appellee.
    Before MURRAH, SETH ’ and DOYLE, Circuit Judges.
   MURRAH, Circuit Judge.

Earl Johnson appeals from a judgment of conviction after a jury trial on a charge of selling heroin in violation of 21 U.S.C. § 841(a)(1). He first plead lack of specific intent, and entrapment by a bonus or “contingent fee” informer (see, e. g., Maestas v. United States, 341 F.2d 493 (10th Cir. 1965)) who was not available at trial.

The jury was told:

Once the defense of entrapment is raised, the burden is on the government to prove beyond a reasonable doubt that the defendant was not entrapped.

If then the jury should find beyond a reasonable doubt from the evidence in the case that before anything at all occurred with respect to the alleged offense involved that the defendant was ready and willing to commit the crime charged whenever opportunity was afforded, and that law enforcement officers or their agents, including informers, did no more than offer the opportunity, then the jury should find that the defendant was not a.victim of entrapment.

On the other hand, if the evidence in the case should leave you with a reasonable doubt whether the defendant had the previous intent or purpose to commit the offense charged, and did so only because he was induced or persuaded by the law enforcement officers or their agents, including informers, then it is your duty to acquit him. No objections were made to these instructions and they therefore became the law of the case.

The government’s case was based on testimony by a narcotics agent that a paid informer had called his office to make arrangements for the agent to be introduced to Johnson and to purchase-heroih from him. Pursuant to the arrangement, the agent went to the informer’s house, was admitted by the informer, and escorted to a room where he negotiated with Johnson. Johnson delivered two packages to the agent, which were later proven to contain heroin, and received payment for them. The agent also testified that he inquired about the possibility of purchasing additional drugs in the future and that Johnson indicated a willingness to accommodate him. On cross-examination, the agent testified that he did not know how the heroin came into Johnson’s possession and conceded that the informer was either an addict or an ex-addict.

' In support of his defense of lack of specific intent, and entrapment, Johnson testified that he came from another city to collect a debt owed by the government informer; that the informer told him he had no money, but could acquire some with Johnson’s assistance by the sale of “fake” heroin, and that the informer supplied the two packages which were delivered to the government agent. Johnson also contends that he had no prior involvement in the sale of drugs and that the informer was motivated to “frame” him due to the involvement of both men with the same girlfriend.

If, as Johnson testified, the informer provided the heroin which was sold to the undercover agent, we think the government would have been perilously close to what Justice Rhenquist conceived in United States v. Russell, 411 U.S. 423, 93 S.Ct. 1637, 36 L.Ed.2d 366 (1973), as conduct so outrageous as to violate standards of due process. 3 However, absent any positive proof of the origin of the narcotics in question, we must focus on the issue of Johnson’s intent and predisposition.

Johnson testified that he was ready and willing to participate in the sale of only a fake powder. If the jury believed this testimony, in the context of the undisputed facts of the sale, Johnson would have been entitled to a verdict of acquittal for the lack of the necessary knowledge and intent to sell a controlled substance as required by 21 U.S.C. § 841(a). The case was submitted on Johnson’s uncontradieted testimony to that effect but, by its verdict, the jury obviously chose to disbelieve him, as it was entitled to do. United States v. Saka, 339 F.2d 541, 543 (3d Cir. 1964). Cf. Masciale v. United States, 356 U.S. 386, 388, 78 S.Ct. 827, 2 L.Ed.2d 859 (1958); United States v. Workopich, 479 F.2d 1142 (5th Cir. 1973). Having disbelieved Johnson’s testimony, the jury had sufficient evidence, including Johnson’s offer to make future sales, to enable them to believe beyond a reasonable doubt that Johnson was “ready and willing” to sell heroin. This being so, we cannot say he was entrapped as a matter of law. See Martinez v. United States, 373 F.2d 810 (10th Cir. 1967).

Johnson’s second contention on appeal is.that he was denied his Sixth Amendment right to confrontation of witnesses due to the absence at trial of the informer. The facts are that, at Johnson’s request, the government agreed at the outset of the trial not to call the informer, since defense counsel had been unable to interview him. However, later in the trial, Johnson sought to call the informer, had the government issue a subpoena for him, received a continuance, and now complains, because the informer could not be found, that appellant is denied his Sixth Amendment right. This contention is wholly without merit. When defense counsel finally requested a subpoena, the government properly issued it and made a “reasonable effort” to locate the informer. United States v. Pollard, 483 F.2d 929 (8th Cir. 1973); United States v. Hayes, 477 F.2d 868 (10th Cir. 1973); United States v. Jenkins, 470 F.2d 1061, 1063 (9th Cir. 1972). It is indeed unfortunate that we are deprived of the testimony of the informer, who might have shed light on the critical fact of the origin of the heroin and on Johnson’s testimony that he thought he was selling only a fake powder. But having failed to exercise due diligence to secure the informer’s presence, Johnson cannot now complain of his absence.

Johnson’s final contention, and the ground for our reversal of his conviction, is that prejudicial evidence was admitted, over objection, concerning the circumstances of his arrest. On direct examination defense counsel asked Johnson:

Have you ever been involved or convicted of . pled guilty to anything to do with dangerous drugs? Johnson responded:
I have nowhere on my record of any indication or anything to do with drugs, anyplace.

Seeming to respond to this line of questioning, counsel for the government elicited testimony from Johnson and the narcotics agent about heroin found in the bedroom of the house where Johnson was visiting a female companion when he was arrested three months after the offense charged in this case. The government did not establish Johnson’s knowledge of the existence of the heroin at the time of his arrest or that he was in any way in possession or control of the premises. Nor is there any evidence of a sale of drugs or any other unlawful act by Johnson when he was taken into custody. Instead, the government contends that defense counsel “opened the door” to this inquiry, which, as the trial judge pointed out, would otherwise have been “clearly inadmissible.”

Federal courts have referred to the hostility based on the “general odium” of narcotics use and have approached that subject with concern for its potential to prejudice the jury. See United States v. Kearney, 136 U.S.App.D.C. 328, 420 F.2d 170, 174 (1969); cf. United States v. Coppola, 479 F.2d 1153, 1162 (10th Cir. 1973); United States v. Puco, 453 F.2d 539, 542, n. 9 (2d Cir. 1971). Mindful of that concern, our reading of Johnson’s response to this attorney’s question indicates that while he may have “opened up” the subject of his criminal record in relation to dangerous drugs, his response should not be construed to permit the government to submit the uncommonly remote and highly prejudicial evidence that heroin was found in the bedroom of a house where he was a guest when he was arrested. We think this evidence clearly lacked enough substantial relevance to outweigh its prejudicial effect and we hold that its admission was an abuse of discretion. See United States v. Phillips, 401 F.2d 301, 306 (7th Cir. 1968). See also Martin v. United States, 404 F.2d 640, 642-643 (10th Cir. 1968); United States v. Krulewitch, 145 F.2d 76, 80 (2d Cir. 1944).

Reversed.

      . Rule 51 Fed.R.Crim.P.; Warden v. United States, 391 F.2d 747 (10th Cir. 1968). In these circumstances we have no occasion to consider whether these instructions conform to the prevailing law of this circuit prior to United States v. Russell, 411 U.S. 423, 93 S.Ct. 1637, 36 L.Ed.2d 366 (1973).

      . Federal courts have shown grave concern over the government practice of providing narcotics to those who are, in turn, arrested for possessing or selling them. See United States v. Bueno, 447 F.2d 903 (5th Cir. 1971) , and cases cited; United States v. Dillet, 265 F.Supp. 980 (S.D.N.Y.1966). Cf. United States v. Workopich, 479 F.2d 1142, 1144 (5th Cir. 1973); United States v. Abbadessa, 470 F.2d 1333, 1336 (10th Cir. 1972) .

      . The government began to elicit Johnson’s testimony, concerning the heroin found at the time of his arrest, by the following exchange :
      Q. Now, you stated also on direct examination, I believe, that you never used or sold heroin or had anything to do with it or any kind of drugs.
      A. I don’t.
      Although Johnson’s answer was not precisely responsive to the question (which was not directed toward his current habits concerning heroin), the government did not pursue the matter. Cf. Bronston v. United States, 409 Ü.S. 352, 93 S.Ct. 595, 34 L.Ed.2d 568 (1973). The government does not now argue, and we do not conclude, that this exchange “opened up” the inquiry in question.

      . The trial judge observed that the inquiry was “entirely proper after the defendant got on the stand and testified he never had anything to do with heroin and never had [sic], so, the defendant opened it up. That is the reason the court let it in, otherwise it would have been clearly inadmissible.”

      . In United States v. Jose Perez and Vivian Perez, 493 F.2d 1339 (10th Cir., filed March 18, 1974), this court held that the defendants had not “opened the door” to testimony which was found to be erroneously admitted in “violation of the right of confrontation as well as the hearsay rule.” The conviction, nevertheless, was affirmed since there was sufficient independent evidence to lead the court to believe “that the errors were harmless beyond a reasonable doubt.” We are faced with a different factual situation here, since Johnson, unlike the defendants in Perez, contends that he lacked the specific intent to sell heroin. The very essence of our case is the jury’s evaluation of Johnson’s credibility, and the admission of the tainted evidence under these circumstances can by no means be considered harmless.


author: HAYS, Circuit Judge: MOORE, Circuit Judge,

text:
    ESTATE of James L. THOMSON et al., Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Appellee. ESTATE of Adelaide L. THOMSON et al., Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.
    No. 10, Docket 73-1170.
    United States Court of Appeals, Second Circuit.
    Argued Oct. 29, 1973.
    Decided March 27, 1974.
    John M. Donahue, Hartford, Conn. (Richard W. Torneo, Robinson, Robinson & Cole, Hartford, Conn., on the brief), for appellants.
    Richard Farber, Washington, D. C. (Scott P. Crampton, Ernest J. Brown,

      Loring W. Post, Tax Div., Dept, of Justice, Washington, D. C., on the brief), for appellee.
    Before MOORE, HAYS and FEIN-BERG, Circuit Judges.
   HAYS, Circuit Judge:

These are consolidated appeals from determinations by the Tax Court of deficiencies in the estate tax of the estate of James L. Thomson, who died on July 23, 1966, and of the estate of Adelaide L. Thomson, his wife, who died on March 14, 1968.

The appeal of the estate of Adelaide L. Thomson is based upon the claim of deficiency arising out of an increase in the value of a marital deduction trust with respect to which Mrs. Thomson had a power of appointment. The claimed increase in the value of the marital deduction trust arises only out of the addition to the husband’s estate of the unreported accumulated income in the husband’s taxable estate.

The pertinent facts have been established by stipulation.

On June 4, 1928, James L. Thomson created a trust for the benefit of his son, A. Lindsay Thomson, and his daughter, Jean Thomson. The City Bank and Trust Company of Hartford, of which appellant Hartford National Bank and Trust Company is the successor, was the designated trustee. The corpus of the trust consisted of securities then having a market value of $31,237. The trust instrument directed that income be accumulated and added to principal during Thomson’s lifetime unless Thomson directed that the income payments be made to either or both of the beneficiaries, the power to make such direction being expressly reserved by the donor. Thomson never exercised his power to distribute trust income; accordingly, all installments of income were added to principal.

In accordance with the terms of the trust instrument at the decedent’s death, the trust assets, then valued at $222,-235.77, were distributed in equal shares to the beneficiaries.

The deficiency determined by the Tax Court arises from the failure to include in the taxable estate of the decedent Thomson, in accordance with section 2036(a) of the Internal Revenue Code of 1954, the accumulations of income added to the corpus of the trust.

Section 2036(a) provides, in relevant part, as follows:

“General rule. — The value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer . by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death—
“(1) the possession or enjoyment of, or the right to the income from, the property, or
“(2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom.”

Application of section 2036(a) is limited by section 2036(b):

“Limitation on application of general rule. — -This section shall not apply to a transfer made before March 4, 1931 . . .

The appellants’ position is that the “transfer” of assets into the trust was complete when the trust was created in 1928 and that the post-1931 income accumulations are not transfers of assets within the meaning of section 2036(a).

We reject this position and affirm the decision of the Tax Court.

• It is not necessary to repeat here the history of section 2036(a) and its predecessor sections. Succinct statements of the events leading up to and following the enactments of sections 2036(a) and (b) are included in the opinion of the Tax Court in this case, 58 T.C. 880, and in this court’s opinion in Commissioner of Internal Revenue v. Estate of Canfield, 306 F.2d 1 (2d Cir. 1962). A detailed history of section 2036(a) is found in Commissioner of Internal Revenue v. Estate of Church, 335 U.S. 632, 634-640, 69 S.Ct. 322, 337, 93 L.Ed. 288 (1949). It is sufficient for present purposes to state that the substance of section 2036 (a) was adopted in order to counteract the effect of May v. Heiner, 281 U.S. 238, 50 S.Ct. 286, 74 L.Ed. 826 (1930), which held that transfers of property to a trust were not to be included in the taxable estate of the grantor even though he retained a life estate or the power to appoint a beneficiary.

Under Hassett v. Welch, 303 U.S. 303, 58 S.Ct. 559, 82 L.Ed. 858 (1938), the legislation reversing May v. Heiner was held to be prospective in effect, that is, it controlled only transfers made after the date of the adoption of the legislation, to wit, March 3,1931.

When, in Commissioner of Internal Revenue v. Estate of Church, 335 U.S. 632, 69 S.Ct. 322, 337, 93 L.Ed. 288 (1949), the Supreme Court overruled May v. Heiner, it became necessary again to amend the Code in order to protect the expectations of persons who had relied on May v. Heiner by not surrendering life estates created by pre-1931 trusts. S.Rep.No.831, 81st Cong., 1st Sess. (1949), U.S.Code Cong.Service, p. 2172. Accordingly the substance of the present section 2036(b) was enacted.

Appellants seek to persuade us that the accumulations which were added to the principal of the trust after March 3, 1931, were “transferred” to the trust when the trust was set up in 1928 because, as appellants argue, the income was “internally generated” and not added from external sources. But even if we were inclined, and we are not, to classify. income received by the trust over the years after 1931 as “transferred” to the trust at the time of its establishment, we would be prevented from doing so by the clear authority of United States v. O’Malley, 383 U.S. 627, 86 S.Ct. 1123, 16 L.Ed.2d 145 (1966).

In O’Malley the trust instruments provided that annual income from five irrevocable trusts established by the set-tlor was to be distributed to named income beneficiaries, unless the trustees exercised discretion given by the instrument to accumulate income. The Court held that the entire corpus of the trust was includible in gross estate, that both the original transfer into trust and subsequent settlor-directed accumulations were “transfers” as that term is used in section 811(c) (1) (B) (ii) of the 1939 Code (the current section 2036(a)(2)).

Under O’Malley, “transfer”, as the term is used in section 2036(a) — and, under our analysis, as it is used in section 2036(b) — includes the post-1931 accumulations of income in the Thomson trusts. In O’Malley, the Supreme Court held that the decedent transferred income accumulations to trust principal because he had

“exercised his retained power to distribute or accumulate income, choosing to do the latter and thereby adding to the principal of the trusts. With respect to each addition to trust principal from accumulated income, Fabrice [the decedent] had clearly made a ‘transfer’ as required by [section 2036(a)(2)].” 383 U.S. at 632-633, 86 S.Ct. at 1126-1127.

In the instant case, the Thomsons retained the power to distribute income to the beneficiaries or to accumulate it in principal. They chose to do the latter. The Thomsons had no less control of the disposition of income than Fabrice. It is of no importance that in the event of silence the Thomson trusts accumulated income while the Fabrice trust paid out to beneficiaries. And it is of no importance that the Thomson trusts were created prior to 1931, while the Fabrice trusts were created in 1937 and 1938, since the Commissioner seeks to include only post-1931 accumulations in the Thomsons’ gross estate.

Under the language itself of sections 2036(a) and (b), as well as the purposes of adoption of these statutes, these accumulations were transfers which took place after March 3, 1931, exactly as were the accumulations in O’Malley.

The Tax Court’s determinations of deficiencies in the estate taxes of the appellant estates are affirmed.

MOORE, Circuit Judge,

(dissenting):

I dissent.

In my opinion, Congress, by enacting Section 7(c) of the Technical Changes Act of 1949 (Act of October 25, 1949), Ch. 720, 63 Stat. 891, the predecessor to the current § 2036(b), 26 U.S.C. § 2036(b) (1970), intended to allow set-tlors of pre-1931 trusts to rest secure in the knowledge that the legal consequences that their trusts would incur would be determined with reference to 1931 law.

The purpose of that section was to prevent undue hardship to settlors who had written their instruments according to one legal principle only to find them about to be judged by another harsher one. It is certain that Congress intended to protect settlor-reserved life estates, for the duration of those estates, from the new theories of estate taxation announced in the Joint Resolution of Congress, issued on March 3, 1931. That pronouncement was prospective, but was made retroactive by Commissioner of Internal Revenue v. Estate of Church, 335 U.S. 632, 69 S.Ct. 322, 337, 93 L.Ed. 288 (1949).

It was for the purpose of countering the Church rule that this section was passed, and it seems somewhat strange to hold, as the majority does here, that there was no intent to extend similar protection to a far lesser settlor-reserved power, likewise threatened by Church.

In this case settlor-decedent, Thomson, set up a trust in 1928 for the benefit of his two children. The trust provided that the income of the corpus was to be accumulated unless the settlor exercised a reserved power to direct distribution on an annual basis, i. e., that the income be paid to either or both of the beneficiaries. Upon the death of the settlor when the power ended, the trust was to be split into two equal trusts which were to continue until the beneficiaries each reached the age of thirty when each would be given the principal from one of the two trusts. The settlor never exercised his power to pay out the income and, thus, in fact, all income was added to principal. The IRS sought to include the value of the income accumulated since March 3, 1931 [the date of the Joint Resolution of Congress passed in reaction to May v. Heiner, 281 U.S. 238, 50 S.Ct. 286, 74 L.Ed. 826 (1930)] within decedent’s estate and that of his spouse under § 2036(a) of the Act, 26 U.S.C. § 2036(a).

§ 2036(a) states:

The value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer . . ., by trust or otherwise, under which he has retained for his life . . . (1) the possession or enjoyment of, or the right to the income from, the property, or (2) the right ... to designate the persons who shall possess or enjoy the property or the income therefrom.

There is no contention that this section would not include the reserved power in question had the trust been entered into after March 3, 1931. The present controversy is based on § 2036(b) which excludes from the scope of § 2036(a) “all transfers made before March 4, 1931.”

The history of § 2036(b) is somewhat intricate, and therefore, although it has béen laid out with thoroughness elsewhere, and at the expense of some repetition of the majority’s opinion, some backdrop must be laid here.

May v. Heiner, supra,, was decided on the basis of § 402(c), Revenue Act of 1918, which made includible in a decedent’s estate all property:

. . . to the extent of any interest therein of which decedent has at any time made a transfer, or with respect to which he has at any time created a trust . . . intended to take effect in possession or enjoyment at or after his death ....

The May case, which involved a life estate, held that retained life interests, terminating as they must upon settlor’s death, were not reachable under § 402 (c) because the donee had received all he was to receive, the remainder interest, before the donor’s death.

The May case and its limitation of the gross estate, provoked Congress to provide a clarification. On March 3, 1931 the section in question was amended to include:

. . . a transfer under which the transferor has retained for his life or any period not ending before his death (1) the possession or enjoyment of, or the income from, the property or (2) the right to designate the persons who shall possess or enjoy the property or the income therefrom.

However, ’ it is clear that this legislation was intended and it was eventually held to apply only prospectively, Hassett v. Welch, 303 U.S. 303, 58 S.Ct. 559, 82 L.Ed. 858 (1938), so that the May rule continued to be applicable to interests retained under pre-1931 transfers.

In 1949, however, the Supreme Court did what Congress had not done. In Commissioner of Internal Revenue v. Estate of Church, 335 U.S. 632, 69 S.Ct. 322, 337, 93 L.Ed. 288 (1949) the May interpretation of what was meant by “intended to take effect in possession or enjoyment at or after . . . death . ” was overturned. The Church decision directly attacked the contention that to reverse May would upset previous expectations.

In view of the struggle of the Treasury in this tax field, the variant judicial and Tax Court opinions, our opinion in the Hallock case [Helver-ing v. Hallock, 309 U.S. 106, 60 S.Ct. 444, 84 L.Ed. 604], and others which followed, it is not easy to believe that taxpayers who executed trusts prior to the 1931 joint resolution felt secure in a belief that May v. Heiner gave them a vested interest in protection from estate taxes under trust transfers such as this one.

335 U.S. at 647, 69 S.Ct. at 330.

Congress did not agree and enacted the counterpart to what is currently § 2036(b) which prevented Church from reaching back of March 4, 1931 and sweeping the May rule away to extinction. The Senate Committee Report on thdt section quoted approvingly a passage, S.Rep.No.831, 81st Cong., 1st Sess. (1949) at p. 7, U.S.Code Cong.Service, at p. 2179, from Mr. Justice Reed’s dissent in Church:

In reliance upon a long-settled course of legislative and judicial construction, donors have made property arrangements that should not now be upset summarily with no stronger reasons for doing so than that former courts and the Congress did not interpret the legislation in the same way as this Court now does.

335 U.S. at 652-653, 69 S.Ct. at 338.

The Report continued:

In the joint resolution of March 3, 1931, Congress created a new estate tax rule with respect to transfers after March 3. It left unchanged the rule in effect for transfers before that date. It is the opinion of your committee that the old rule should have been continued in effect with respect to such transfers until changed by legislation. Since the rule has been changed by the Supreme Court in the Church opinion, your committee believes that the Congress should act to restore the estate tax law to what it was prior to the Church opinion.

S.Rep.No.831, 81st Cong., 1st Sess. (1949) at p. 7, U.S.Code Cong.Service, at p. 2180.

Since the Report does not specifically mention interests other than life estates, it should be noted that both the May and Church cases dealt with retained life estates. Therefore, it is not surprising that the range of retainable lesser powers were ignored in both decisions and in the Congressional Report. However, it is clear that both May and Church did intend to carry the whole range of reserved interests along with them on their conflicting paths, as did § 2036(a) and the Joint Resolution. Thus, it is likely that Congress, in its expressed intent to allow continued reliance on the pre-1931 law, meant to include the lesser powers as well.

The Appellee and the court below apparently concede this inclusive quality of § 2036(b). They did not seek to include either the corpus or the increments added to the corpus up to March 3, 1931. They, therefore, must be of the opinion that the power reserved by the settlor had no estate tax consequences at the time of the trust’s making. If this were not so, the corpus and the entire increment would be includible in decedent’s estate. This concession, in turn, must be based on the supposition that § 2036(b) protected not only retained life estates from the sweep of Church but also all other lesser retained life interests and powers. Appellee’s contention, however, is that each non-exercise of the power after March 3, 1931 would have the effect of swelling the corpus and therefore constituted an additional “transfer” for the purposes of § 2036(a), 'thereby including each increment in Appellants’ gross estate.

Appellants argue that Congress intended, by the passage of § 2036(b) to exclude the increments which arise from principals which are themselves excludible. This is based on the reasoning that if what was reserved had no estate tax consequences at the time of its reservation ; and since Congress, by § 2036(b) as shown by the Senate Report on the bill, supra, intended draftsmen of pre-1931 instruments of this nature to continue to rely on the applicability of pre-1931 law; a transfer complete when made should not be made open to new tax consequences without a clearly changed Congressional intent.

The difficulty in this case arises from the fact that settlor did not retain the maximum control that he could over his transferred property short of the freehold interest that would have included the property in his estate. Rather he retained what seemed at the time a very minor power — the ability for his life to pay the income to either or both of the remaindermen or in the alternative to accumulate it for the benefit of the same remaindermen. It seems unlikely that Congress intended to protect the maximum retained interest, and yet, even though the same rationale would apply, expose the lesser interests to the full rigors of the newly changed law.

In short, the settlor had parted with any and all interest of his own in the trust and the proceeds of the trust. He was not giving its income on an annual basis — he merely reserved the power to declare the recipients from a highly limited class. In their respective searches for the correct gloss for § 2036(b), the court below and the majority here placed great weight on United States v. O’Malley, 383 U.S. 627, 86 S.Ct. 1123, 16 L.Ed.2d 145 (1966). In that case the settlor of five post-1931 trusts reserved a power similar to that under consideration here. At issue was whether income accumulated by exercise of the power was includible in settlor’s estate under § 2036(a). It was held that this increment to the corpus had been transferred by the settlor and therefore was taxable to him. The majority see O’Malley as “clear authority” that income received by the trust over the years after 1931 was not “transferred” to the trust at the time of its establishment. The majority then submit that if “transfer” is to be interpreted one way in § 2036(a) iO’Malley}, it is reasonable to interpret it similarly in § 2036(b) [the present case]. However, to interpret “transfer” in the fashion suggested would be contrary to the very purpose of § 2036(b) —to allow pre-1931 settlors to rely on the law extant on the day before the Joint Resolution. The majority agree that pre-1931 law would have viewed the transfer as complete for estate tax purposes. They probably would agree that if the settlor retained a life estate and released part of it year by year to the remaindermen, he would not now suffer any adverse estate tax effects. Yet they argue that because the settlor gave away more, because he retained less control over his property, his estate must pay an increased tax. Further, I do not see O’Malley as such a clear precedent in the majority’s favor. O’Malley concerned the question of how much was transferred ; it did not face, and indeed it did not need to face, the question of when the transfer was made. Here it is the other half of the definition of transfer that must be considered. O’Malley is a reasonable decision in light of the policy expressed in § 2036(a). But here is faced a question of timing, not amount. Such a question could not have been raised in O’Malley as it dealt solely with post-1931 transfers. Indeed this question of timing is one that could only have relevance to a case arising under § 2036(b). Thus, it is with reference to the Congressional intent embodied in that section that the proper meaning of “transfer” in this instance must be determined.

Quite apart from O’Malley, of course, there is a certain conceptual congeniality in seeing a new fresh transfer each time interest accrues in the trust account. The majority state that even without O’Malley they are not inclined to view each added increment as part of the original transfer. However, within the narrow realm of the estate tax, there may be some merit to. such a conclusion. In Commissioner of Internal Revenue v. Canfield’s Estate, 306 F.2d 1 (2d Cir. 1962), decedent, in 1919, set up a trust, reserving to herself a life estate and making the remainder subject to a general testamentary power of appointment which she also retained. In 1942 she released the power of appointment. The Commissioner contended that she had transferred property to the takers in default in 1942 — property in which she had retained a life estate, and therefore the corpus should be taxable under § 2036(a). This court disagreed, holding that the transfer occurred when the legal title passed — 1919 according to 1919 law — and therefore the decedent’s estate should be allowed the protection of § 2036(b) with regards to the corpus. This was not a novel pronouncement. Commissioner of Internal Revenue v. Ridgeway’s Estate, 291 F.2d 257 (3rd Cir. 1961); Estate of Cuddihy, 32 T.C. 1171 (1959). To be sure Canfield is distinguishable on its facts from the case at hand but what is not so readily distinguishable is the willingness of this court in that case to consider a transaction under § 2036(b) in light of the law extant at the time of the transaction. Such a role is generally the proper one for the courts in the trusts and estates realm, for otherwise as was done in Church, we may destroy careful planning of taxpayers who relied on what was at the time of their planning established law. United States v. Byrum, 408 U.S. 125, 135, 92 S.Ct. 2382, 33 L.Ed.2d 238 (1972). Usually it is preferable to depend on Congress to weigh the pros and cons of retroactive change where there has been general reliance on prior law and where such reliance cannot readily be altered. In the current case the settlor made a transaction that was complete when made for estate tax purposes. Later judicial decisions conspired to unravel his transfer. Thus it would seem reasonable, in light of Congressional intent, and as interpreted by this court in Canfield, to look at the reserved power in the light of the law as it was in 1931 and tie up the parcel that Church had unravelled.

Accordingly, I would reverse the decision of the Tax Court.

      . With respect to the distribution of trust income, the trust instrument reads as follows:
      “The Trustee shall collect the rents, income and profits of said trust estate as the same accrue, shall pay out of said trust estate all lawful taxes and expenses chargeable against the same, and against the earnings thereof, including reasonable fees for its services as Trustee, and during the lifetime of the Donor shall add the net income remaining from time to time after the payment of such expenses to the principal of said trust, to be managed, invested, reinvested and treated in all respects as and for a part of said principal, unless the Donor shall from time to time instruct the trustee to make payments of or from said income to the beneficiaries, or either of them, during the donor’s lifetime; power to direct such earlier payment of income to the beneficiaries being expressly reserved by the donor.” [Emphasis supplied.]


author: PER CURIAM:

text:
    UNITED STATES of America, Plaintiff-Appellee, v. Juan MUNOZ-DELA ROSA, Defendant-Appellant.
    No. 73-2930.
    United States Court of Appeals, Ninth Circuit.
    April 8, 1974.
    Joseph B. Swan, Jr., (argued), Tom Karas, Samuel Alba, Federal Public Defenders, Phoenix, Ariz., for defendant-appellant.
    Thomas N. Crowe, Asst. U. S. Atty. (argued), Alice A. Wright, Asst. U. S. Atty., William C. Smitherman, U. S. Atty., Phoenix, Ariz., for plaintiff-appel-lee.
    Before KOELSCH and DUNIWAY, Circuit Judges, and THOMPSON, District Judge.

       Honorable Bruce R. Thompson, United States District Judge, District of Nevada, sitting by designation.

   OPINION

PER CURIAM:

Defendant-Appellant Munoz-Dela Rosa escaped from federal custody while serving a federal sentence imposed after conviction for illegal entry into the United States. He was indicted for the escape and, after apprehension, pleaded guilty. He was then sentenced by the District Judge.

“THE COURT: It is the further judgment of this Court that you be committed to the custody of the Attorney General or his authorized representative for a period of five years, on condition that you serve six months in a jail type institution, concurrent to the sentence you are presently serving, and the execution of the remainder of the sentence will be suspended, and you will be placed on non-supervisory probation, and be deported.
“(Translation.)
“THE COURT: Now, that means that once you are released, if you come back during the next five years after you start serving your second sentence, you could be kept in jail for the remainder of that five-year sentence, whatever is left of it.
“THE DEFENDANT: Yes, sir.”

This occurred after eleven o’clock a.m. on August 27, 1973. On the same day, the Judgment and Order of Probation was filed at 2:46 o’clock p.m., after being signed by the sentencing judge. It stated :

“IT IS ADJUDGED that the defendant is hereby committed to the custody of the Attorney General or his authorized representative for imprisonment for a period of five (5) years, on condition that the defendant be confined in a jail-type institution for a period of six (6) months, said sentence to run consecutively with sentence imposed on February 21, 1973, by U.S. Magistrate Raymond Terlizzi, in case No. 2-A-269 Tucson, execution of the remainder of the sentence of imprisonment is hereby suspended and the defendant placed on non-supervisory probation for such period.”

On September 4, 1973, defendant filed a Motion to Correct Judgment and Order of Probation. A hearing was held on September 10, 1973, with the defendant and counsel present. At the hearing, the Judge explained that he had made a mistake in the oral pronouncement ; that he intended to say “consecutive” not “concurrent;” that he never gave a concurrent sentence for escape; that “I misspoke myself.” Defense counsel, a Deputy Federal Defender in Arizona, agreed that from his experience in that Court, “I am willing to concede that you probably meant consecutive.”

Thus, we have a direct conflict between the sentence pronounced orally by the Court and the formal judgment filed a short time later pursuant to the requirements of Rule 32(b)(1) of the Federal Rules of Criminal Procedure.

The contention of the defendant is that the oral pronouncement of sentence always controls; that the sentence cannot be modified except as authorized by Rule 35, Federal Rules of Criminal Procedure; and that the written commitment must be corrected to conform with the oral pronouncement. The Government contends that a judge, in pronouncing sentence, may make a mistake in articulating the sentence which should be correctable under Rule 36, Federal Rules of Criminal Procedure, as a clerical error pr as an error made through oversight or omission.

It should be observed that the unique posture of the instant case presents a situation in which the defendant was not sentenced twice, that is to say, he was not before the Court a second time for resentencing. On the contrary, he was in Court the second time for hearing on a motion to correct the written commitment to conform with the oral pronouncement of sentence. The district judge simply denied the motion.

Thus, cases in which the defendant was returned to Court and resentenced are proeedurally distinguishable. See, for example, United States v. Benz, 282 U.S. 304, 307, 51 S.Ct. 113, 75 L.Ed. 354 (1931); Kennedy v. United States, 330 F.2d 26, 27 (9th Cir. 1964); Borum v. United States, 133 U.S.App.D.C. 147, 409 F.2d 433, 440 (1967). In these instances, the double jeopardy clause of the Fifth Amendment to the Constitution of the United States precludes recognition of an increased sentence when the defendant is returned to Court for resentencing.

Also, we are not here concerned with the applicability of precedents which have approved a corrected and increased sentence in instances where the original sentencing process was construed to be a continuing one, that is to say, the prisoner had not yet left the courtroom or was returned the same day. Rowley v. Welch, 72 App.D.C. 351, 114 F.2d 499 (1940); DeMaggio v. Coxe, 70 F.2d 840 (2nd Cir. 1934); Nichols v. United States, 106 F. 672 (8th Cir. 1901).

This Court has permitted the written commitment to control the oral articulation of a legal sentence only in cases where the oral pronouncement was ambiguous and the written judgment was relied upon to clarify the ambiguity. Boyd v. Archer, 42 F.2d 43 (9th Cir. 1930); Payne v. Madigan, 274 F.2d 702, (9th Cir. 1960) aff. 366 U.S. 761, 81 S. Ct. 1670, 6 L.Ed.2d 853. See also Young v. United States, 274 F.2d 698 (8th Cir. 1960).

We have noted that in the present case the defendant was not resentenced. From a procedural point of view, the two most similar precedents are United States v. Sacco, 367 F.2d 368 (2nd Cir. 1966), and Chandler v. United States, 468 F.2d 834 (5th Cir. 1972). In Sacco, the defendant was sentenced to seven years under a charge carrying a maximum penalty of five years and to five years under a charge carrying a maximum penalty of ten years, the sentences to run concurrently. Eight months later, he moved under Rule 35 to correct the illegal excessive sentence on the first count. The Government filed a counter-motion to transpose the sentences. The Court denied defendant’s motion and granted the Government’s motion. The sentencing judge stated that the sentences had been transposed through inadvertence and error. The Second Circuit reversed and said:

“We are of the opinion that a judge should not be permitted to increase a sentence clearly and explicitly imposed, after the prisoner has begun to serve it, even though the judge later recollects that he had intended at the time to decree a longer sentence for a conviction on a particular count but did not do so because he had inadvertently confused it with another count. This is not the case of an error in reporting or a purely clerical error or a judicial mistake corrected the same day or the imposition of a sentence of less than a mandatory minimum or similar flaws which present quite different problems. The possibility of abuses inherent in broad judicial power to increase sentences outweighs the possibility of windfalls to a few prisoners.”

In Chandler, supra, under the identical set of facts, the issue was raised by a post-judgment motion under 28 U.S.C. § 2255. Here again, the district court entered an amended judgment and commitment, apparently in the absence of the defendant, to conform the written judgment to the judge’s original intention. The Fifth Circuit reversed, saying, inter alia:

“Admittedly, the Government is requesting only that a narrow hole be bored in the double jeopardy clause. We will not, however, allow deeply entrenched constitutional rights to be made subject to claims of ‘inadvertent error’ and we must plug up the hole, however small, left open by the trial court’s auger. We cannot allow even judicial remembrances of things past to dim the constitutional incandescence of the Fifth Amendment.”

We realize that in the present case the district judge required defendant’s presence at the time of the hearing on the motion to correct the written judgment, but this fact does not materially distinguish this case from the cited precedents.

In cases where there is a direct conflict between an unambiguous oral pronouncement of sentence and the written judgment and commitment, this Court has uniformly held that the oral pronouncement, as correctly reported, must control. The only sentence that is legally cognizable is the actual oral pronouncement in the presence of the defendant. United States v. Jarratt, 471 F.2d 226 (9th Cir. 1972); United States v. Hicks, 455 F.2d 329 (9th Cir. 1972); Payne v. Madigan, supra. See also: Borum v. United States, supra, Sobell v. United States, 407 F.2d 180, 184 (2nd Cir. 1969); Rakes v. United States, 309 F.2d 686 (4th Cir. 1962).

All acknowledge that judges are human and may misstate their intention at the time of sentencing. The instant case presents very strong evidentiary support for a holding that the district judge did in fact “misspeak” himself at the time Appellant was sentenced. Yet the difficulties in formulating a principle to establish an exception to the well-established rules hereinabove stated have led us to the conclusion that the interests of justice, in the light of constitutional double jeopardy protections and the defendant’s right to be present at the time of sentencing (Rule 43, Federal Rules of Criminal Procedure), and to speak on his own behalf (Rule 32(a)(1), Federal Rules of Criminal Procedure), require strict adherence to the axiom that an unambiguous oral pronouncement of a legal sentence must control.

The order appealed from is reversed.