“Stone grows on one. Many of my insights are not his. But he is brave and honorable. He thinks straight. He fights for his principles, and I think he knows, in the way I hope to have known, the necessary limitations we must place on ourselves as a court.”
In the late 1890s and early 1900s, the Supreme Court decided a mere handful of cases affecting the securities markets. This was due in large part to the lack of a strong national regulatory presence in market regulation. When it faced such cases, the Court often used common law rules to make its decisions.
The development of common law rules -- rules made by courts that espoused general principles which would then be applied to other cases with similar facts -- were first developed by state courts. The federal court system did not have an independent source of common law rules. When a case arose where the law of several states might apply, federal courts would apply the state statutory law of the relevant jurisdiction.9
In 1909, the Supreme Court, in Strong v. Repide, gave impetus to the trend of using the common law of fraud to permit recovery by plaintiffs. Strong v. Repide was an insider trading case arising from the sale of stock in the Philippine Sugar Estates Development Company to one of the directors of the company. The defendant, while negotiating the purchase of the plaintiff's stock, was simultaneously negotiating the sale of the corporate land assets to the Philippine government.10
The defendant took extraordinary efforts to conceal the information about the negotiations, and was able to purchase the stock from the stockholder for about one-tenth of its actual value. In a decision written by Justice Peckham, the Supreme Court refused to follow either the then-accepted majority or minority rule, adopting instead a third approach. It held that, under the special facts of the case, "the law would indeed be impotent if the sale could not be set aside or the defendant case in damages for his fraud."11 This new rule meant that, although directors generally had no duty to disclose material facts when trading with shareholders, a duty might arise where there were special circumstances, such as concealment of the defendant-seller's identity (the corporate officer had used an agent go-between to avoid detection of his actions by the seller) and a failure to disclose significant facts that materially affected the price of the stock.
Although in Strong v. Repide, the Supreme Court developed and applied common law fraud principles to protect an innocent purchaser, in many other areas of financial regulation, deference to the accepted boundaries of state economic regulation meant that those cases often remained beyond the purview of national regulation. In 1911, antitrust law became an exception to that practice when the Supreme Court revisited the meaning of the federal Sherman Antitrust Act in Standard Oil Company v. United States.
For years, progressives had been attempting to stop the powerful misconduct of the company which had left a trail of ruined competitors in its wake. Standard Oil had grown its national monopoly by acquiring stock control of numerous refining companies, extracting preferential rail rates from shippers, and aggregating so vast a capital as to exclude others from the oil drilling, refining and retail markets. At issue was whether Standard Oil had violated the Sherman Act and should be dissolved. Justice White, writing for the majority, returned to common law principles in holding that, while Congress did not specify in the antitrust act a standard to judge which restraints under the Sherman Act were illegal, the statute “indubitably contemplating and requiring a standard” must have intended to employ the common law “standard of reason.”12 In these cases, the Supreme Court used the common law as a legitimate and principled tool for adjudicating economic disputes while protecting individual liberty of contract.
(9) See Swift v Tyson, 41 US 1 (1842), overruled in Erie Railroad v. Tompkins, 304 US 64 (1938). Where the national interest was so strong, the doctrine of federal preemption might apply as an exception to federal application of state common law rule. See Richard A. Epstein and Michael S. Greve, Federal Preemption: States’ Powers (National Interests, AIE Press: Washington, DC, 2007).
(10) Strong v. Repide, 213 US 419 (1909); Fair To All People: The SEC and the Regulation of Insider Trading – Pre-Securities Act Common Law Enforcement: “Special Facts or Special Circumstances.”.
(11) Strong v. Repide, 430.
(12) Standard Oil Company v United States, 221 US 1 (1911); see also Edward F. Mannino, Shaping America: The Supreme Court and American Society (The University of South Carolina Press: Columbia, 2009), 98-99.
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