ABRAM CHASINS, APPELLEE,

v.

SMITH, BARNEY & CO., INC., APPELLANT

LUMBARD, Chief Judge.

A petition for rehearing containing a suggestion that the action be reheard in banc having been filed herein by counsel for the appellant, and the panel having determined to withdraw its opinion, filed July 7, 1970, and to file a new opinion in substitution.

It is ordered that said petition be and it hereby is denied, LUMBARD, Chief Judge, MOORE and FRIENDLY, Circuit Judges, dissenting from such denial in an opinion by Judge FRIENDLY which follows, and FEINBERG, Circuit Judge, taking no part in the consideration or decision of this petition.

FRIENDLY, Circuit Judge, with whom LUMBARD, Chief Judge, and MOORE, Circuit Judge, join (dissenting from the denial of reconsideration in banc):

Although the narrowing of the opinion to the particular constellation of facts here presented substantially lessens its impact, we are nevertheless constrained to voice our dissent from the refusal to grant in banc reconsideration.

The transactions here in question were in securities traded on the “over-the-counter” market. Section 15(c) (1) of the Securities Exchange Act, which deals with this subject, provides:

No broker or dealer shall make use of the mails or of any means or instrumentality of interstate commerce to effect any transaction in, or to induce the purchase or sale of, any security (other than commercial paper, bankers’ acceptances, or commercial bills) otherwise than on a national securities exchange, by means of any manipulative, deceptive, or other fraudulent device or contrivance. The Commission shall, for the purposes of this subsection, by rules and regulations define such devices or contrivances as are manipulative, deceptive, or otherwise fraudulent.

Responsive to this Congressional direction, the SEC adopted Rule 15el-4, which provides in pertinent part:

The term “manipulative, deceptive, or other fraudulent device or contrivance,” as used in section 15(c) (1) of the Act, is hereby defined to include any act of any broker or dealer designed to effect with or for the account of a customer any transaction in, or to induce the purchase or sale by such customer of, any security (other than United States Tax Savings Notes, United States Defense Savings Stamps, or United States Defense Savings Bonds, Series E, F and G) unless such broker or dealer, at or before the completion of each such transaction, gives or sends to such customer written notification disclosing (1) whether he is acting as a broker for such customer, as a dealer for his own account, as a broker for some other person, or as a broker for both such customer and some other person; * * *

The district court initially found that the confirmations here, which disclosed that Smith Barney was selling “as principal for our own account,” were in full compliance with the rule. Although Rule 17a-9(f) defines “market-maker,” this is in a reporting requirement; it is conceded that in 1961 no rule of the SEC (other than, allegedly, the inevitable Rule 10b-5), the NASD or the New York Stock Exchange required disclosure of that fact to a customer. The complaint nowhere asserted that Smith Barney was under a duty to tell Mr. Chasins it was a “market-maker” in the three over-the-counter stocks that he bought. It alleged rather that defendant did not disclose the “best price” at which these and other securities could have been bought or sold in the open market, or the prices it had paid or received, and that plaintiff was deceived by Smith Barney’s failure to disclose “the material fact of its adverse interest, the extent of which is today still unknown to and not determinable by plaintiff.” The plaintiff, a noted musicologist, said nothing about market-making in his testimony. The closest he came to making the claim now sustained was that, despite his alleged inability to comprehend financial matters, he would have understood if told that the stock reflected by the confirmations was owned by the defendant, since “if you have a great picture, for example, and you know that the picture is going to be worth a lot more the next year or five years or ten, I don’t think you would be anxious to dispose of it.” Although this is hardly convincing, since great pictures are constantly being sold and bought under exactly such circumstances, Mr. Chasins had been plainly told of defendant’s ownership by the confirmation slips. In addition, the Smith Barney research report he had received on Tex-Star contained the legend in common use at the time:

We point out that in the course of our regular business we may be long or short of any of the above securities at any time,

and the prospectus he received of Welch Scientific Company disclosed that Smith Barney was one of the underwriters of that stock, which had only recently been placed on the market.1 All that the trial record contained about non-disclosure of market making was a statement by Delaney, a registered representative of Smith Barney, that he normally would bring this fact to the attention of clients if he knew it; that he did know Smith Barney was making a market in the three stocks; and that he couldn’t recall whether or not he had brought this to Mr. Chasins’ attention.

The issue of market making first assumed importance as a result of the opinion of the district judge. After finding against the plaintiff on all the contentions that had been advanced in the complaint and aired at the trial, he opined that information with respect to market-making “was material to the plaintiff in considering the price at which he purchased the securities, and to what extent the price was based on defendant’s own market activities,” and therefore plaintiff should recover his entire market loss. Smith Barney then made a motion pointing out there was no basis for the “therefore,” since on the judge’s theory the only recoverable damage would be any excessive price obtained as a result of Smith Barney’s being a market maker. On that issue it submitted proof by way of affidavit that the prices charged the plaintiff for the three stocks were entirely fair, indeed less than he would have paid if he had bought the stocks from a person acting solely as broker. It also submitted the opinion of the experienced manager of its trading department that

From the point of view of the knowledgeable investor, disclosure to him that he would be purchasing from a market maker would only have encouraged him in his decision to buy.

Unwilling to hear evidence on the issue first raised by its opinion, the district court took a new tack. It held, in seeming contradiction of the initial opinion, that the confirmations, in a form widely used, did not comply with Rule 15c-l-4 since they conveyed “the impression that defendant had purchased a block of the securities and was selling part of it to plaintiff at the then prevailing market prices, when, in fact, defendant was acting as a dealer for its own account.” We are unable to follow this, especially in light of the definition of “dealer” in § 3 (a) (5), and the court wisely does not base its decision upon it. Evidently lacking confidence in that holding, the judge then went on to conclude, without semblance of an evidentiary basis, that disclosure of market-making might have led Mr. Chasins not to purchase the stocks at all.

The conclusions on the materiality of disclosure of market making by the district court and in this court’s opinion are predicated on an essential misconception of the role of the market maker in over-the-counter transactions. When a reputable house like Smith Barney acts as one of several market makers, as was the case here, it serves a highly desirable purpose in reducing the spreads characteristic of over-the-counter trading. It has been widely recognized that the “best price” can be obtained by dealing directly with market makers, for one reason because a commission to an intermediary is avoided. See Thomson & McKinnon, CCH Fed.Sec.L.Rep. ¶ 77,572 (1968); Delaware Management Co., CCH Fed.Sec.L.Rep. ¶ 77,458 (1967); H. C. Keister & Co., CCH Fed.Sec.L.Rep. ¶ 77,414 (1966); Report of the SEC on the Public Policy Implications of Investment Company Growth, H.R.Rep.No.2337, 89th Cong.2d Sess., at 179 (1966). The district judge’s fears concerning the ability of a market maker to set an arbitrary price are inapplicable when as here there were several market makers, as Smith Barney pointed out in its post-trial motion and the SEC now confirms in its letter to us as amicus curiae. Moreover Smith Barney offered to prove that in fact Mr. Chasins bought at the lowest available price. So far as concerns the fears of ulterior motives voiced by the district judge and now by the court, the market maker, who buys as well as sells, is less likely to be interested in palming off a stock than a dealer with only a long position. Yet the confirmation here would plainly have been adequate for such a dealer, and we held only recently, in a case curiously not cited, that a dealer need not make the additional disclosure that it had originally acquired the stock for investment and not with a view towards distribution, something considerably more material than being one of several market makers, S. E. C. v. R. A. Holman & Co., 366 F. 2d 456, 457 (2 Cir., 1966). At the very least the materiality of market making to an investment decision was an issue on which Smith Barney was entitled to submit proofs. It never had had a fair opportunity to do this, although we read the court’s opinion as leaving this open to defendants in future cases.

The references in footnote 5 to the SEC’s Special Study of the Securities Markets, 85th Cong. 1st Sess., House Document No. 95, published nearly two years after plaintiff’s purchases, and the rules later adopted by the NASD and NYSE, slip opinions 3717 fn. 5, point in the opposite direction from the conclusions drawn from them. The Study developed the existence of problems calling for administrative action with prospective application, not for a retroactive sanction.2 *8 The NASD and NYSE rules, also adopted long after the transactions here at issue, require disclosure of mar ket making only in printed research reports and other published recommendations which could affect market prices for securities, not in individual advice to customers. As appears from the SEC’s amicus letter, the agency has the whole problem under active consideration and expects to promulgate a rule for prospective application. Although the opinion is now limited to the peculiar facts of this case, we fear it will encourage many suits by other speculators who have suffered losses. At minimum, Smith Barney is entitled to a new trial where the issues of materiality and reliance raised by the district court’s opinion can be fairly litigated.

. (a) 17 C.F.R. § 240.10b-5 provides as follows:

Rule 10b-5. Employment of Manipulative and Deceptive Devices.

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate eommerce, or of the mails, or of any facility of any national securities exchange

(1) to employ any device, scheme, or artifice to defraud,

(2) to 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

(3) to engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.

(b) 17 C.F.R. § 240.15cl-4 provides as follows :

Rule 15cl-4. Confirmation of Transactions.

. Chasins has also appealed a discovery ruling made in an order prior to trial by Judge Harold R. Tyler, Jr. in the district court. In light of our decision finding Smith, Barney to have violated Rule lob-5, we do not reach the question of whether this ruling constituted prejudicial error. . The four securities transactions involved in this appeal were sales of securities by Smith, Barney to Chasins in the over-the-counter market as follows:

Number of

Date Shares Company

7/19/61 200 Welch Scientific Company

7/19/61 200 Tex-Star Oil and Gas Corp. 7/19/61 200 Howard Johnson Company

8/22/61 200 Welch Scientific Company

Total cost of the securities to Chasins was $34,950; he subsequently sold these securities on June 28,1962 for $16,333.36.

There were other transactions involving the two parties that were questioned by Chasins in the district court; however, the decision regarding those transactions was not appealed except to the extent that Chasins appealed the decision that there was no breach of a common law fiduciary duty by Smith, Barney in handling Chasins’ account.

. Market maker has been defined by SEO Rule 17a-9(f) (1), 17 O.P.R. § 240.17a-9 (f) as follows:

(1) The term “market-maker” shall mean a dealer who, with respect to a particular security, holds himself out (by entering indications of interest in purchasing and selling in an inter-dealer quotations system or otherwise) as being willing to buy and sell for his own account on a continuous basis otherwise than on a national securities exchange.

See also Loeser, The Over the Counter Securities Market What It is and How It Operates, pp. 5-6 (1940) :

A dealer engages in “creating and maintaining a market” for securities. [It] “creates a market for a security when it is prepared both to buy and to sell that security at the prices it quotes, and it “maintains” such a market when it continues over a period to quote the prices at which it is ready both to buy and to sell. * * * In the language of finance the house is said to be “creating and maintaining a market” or, colloquially, “making a market.” * * * Id. at 5-6. See also Id. at 39-41.

. Indeed, soon after the Special Study of Securities Markets, H.R.Doc. No. 95, 88th Cong., 1st Sess., pt. 1 at 385, 386 (1963) recommended required disclosures in written advice of existing positions and market-making activities, the National Association of Securities Dealers adopted such a rule for its members in their advertisements, sales literature, and market letters. See CCH NASD Manual 1 2151, at 2016-17 (Sept. 1964). Cf. 2 CCH New York Stock Exchange Guide f 2474A. 10.

. That rule requires, inter alia, that a broker or dealer disclose when he is acting as a dealer for his own account. The confirmation slips simply notified Chasins that Smith, Barney had acted as the other principal in the particular transaction; this did not indicate whether it had acted as a dealer for its own account.

. See fn. 1(b), supra.

. The definition of a dealer is given in 15 U.S.C. § 78c(a)_ (5) as follows:

(5) The term “dealer” means any person engaged in the business of buying and selling securities for his own account, through a broker or otherwise, but does not include * * * any person insofar as he buys or sells securities for his own account, either individually or in some fiduciary capacity, but not as a part of a regular business.

Since Smith, Barney was making a market in the securities involved, it was part of its regular business to buy and sell the securities for its own account.

. Smith, Barney also challenges the decision on the ground that the issue of failure to disclose its market-making role being a violation of Rule 10b-5 was not presented until Judge Bonsai rendered his decision. Although the complaint did not specifically allege this as one of the violations of 10b-5, Chasins complained in general about nondisclosures and asserted that these nondisclosures violated the rule since they were nondisclosures of material facts. The pre-trial order was also broadly formulated, and the court, in discussion with trial counsel, indicated that he considered the fact of market making relevant to the issues presented in this case. This was sufficient to put Smith, Barney on notice that nondisclosure of its market-making role in these securities was an issue when Delaney, its representative, testified that at the time of the transactions in question he normally disclosed to clients the fact that Smith, Barney was making a market in securities he recommended. Under such circumstances, this issue was involved in the case, and the district court could properly dispose of it. See Rule 15(b), Federal Rules of Civil Procedure. Cf. Bucky v. Sebo, 208 F. 2d 304 (2d Cir. 1953).

. The Howard Johnson prospectus also revealed this, but the record is not clear whether plaintiff received this.

. The Study discusses the problem in two different contexts. In dealing with the quality of investment advice furnished by broker-dealers, it concludes that this area “lends itself to establishment of standards through statements of policy, covering such matters as * * * (b) required disclosures) in written advice of existing positions, intended positions and market-making activities, rather than general ‘hedge’ clauses as to possible present conflicting positions or transactions * * * ” Part I, p. 386. This goes far beyond market making; whatever its desirability for the future, the Study made no suggestion that such standards should apply to the past, and we held in the Holman, case, cited in the text, that failure to disclose an existing position, even one taken for investment and not for distribution, did not violate Rule 10b-5. The more specific discussion of market-making related to pricing, and suggested, Part II, p. 677, that the NASD and the Commission should “reexamine present requirements with a view to improving disclosures” including a broker-dealer’s soliciting a customer’s purchase of a security out of its own inventory. Nothing suggests that the group of experts who made the Special Study had any notion that these recommended changes were already covered by Rule 10b-5.