Mallis v. Bankers Trust Company

United States Court of Appeals for the Second Circuit · 1980 · Corporations

615 F.2d 68 (2d Cir. 1980)

Updated August 22, 2026

CorporationsSecurities fraudCommon law fraudNegligent misrepresentationRule 10b-5scienterrecklessnessdue diligence

Facts

Bankers Trust held as collateral 40,384 conditional shares of Equity National issued to Kates and subject under an Escrow Agreement to recall if Take Two failed to meet earnings requirements; Take Two in fact suffered a 1970 loss, and Equity National repeatedly demanded return of the shares. In March 1972, Arnold and Fowler arranged for Mallis and Kupferman to provide funds for Arnold's purchase of the shares from Kates, with the shares to be held by plaintiffs as collateral and plaintiffs to receive repayment plus a $50,000 profit. At the closing at Bankers Trust, Silverman produced the certificates, which bore a legend referring to the Escrow Agreement; the evidence disputed whether Silverman affirmatively represented that the shares were unencumbered except for lack of registration and how much he knew about the Escrow Agreement and related correspondence in his file. The shares later proved worthless, and plaintiffs sought to recover from Bankers Trust under Rule 10b-5 and New York tort theories.

Issue

Whether the district court erred in its treatment of plaintiffs' Rule 10b-5 claim by allowing unrelated in pari delicto-type defenses and by charging plaintiffs with a due diligence burden, and whether it also erred under New York law by charging due diligence as a separate element of fraud and refusing to submit negligent misrepresentation to the jury.

Rule

In a Rule 10b-5 action, after Ernst & Ernst v. Hochfelder, a plaintiff's burden is not to prove due care but simply to negate recklessness when the defendant puts that in issue. Under New York law, fraud requires misrepresentation of material fact, falsity, scienter, reliance, and damages, and does not recognize a separate due-diligence element, though justifiable reliance may fail where the truth was available by ordinary intelligence and the matter was not peculiarly within the defendant's knowledge. New York negligent misrepresentation lies where false information is directly supplied with knowledge it will be acted on, relied on to the plaintiff's detriment, and the parties are connected by a relation of duty arising out of contract or otherwise; the court predicted that New York would find such a duty where, consistent with Restatement § 552, business information is supplied for the guidance of a known buyer who justifiably relies.

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One of 10 multiple-choice questions for this case. Pick an answer to see why.

In Chicago, Lena Ortiz accepted a pledge of startup shares as collateral for a short-term advance to Devon Pike. Before closing, counsel for the transfer agent allegedly told Lena's banker that the shares were unrestricted, but the certificates themselves referred to a separate agreement. Lena later sued under Rule 10b-5 after the shares proved worthless.

If the defendant places Lena's own conduct in issue, which jury instruction best states Lena's burden regarding her conduct under Rule 10b-5?

Explanation. The majority held that, after Ernst & Ernst, a Rule 10b-5 plaintiff does not bear a negligence-style burden to establish due care or due diligence. When the defendant puts plaintiff conduct in issue, the plaintiff's burden is simply to negate recklessness.