282 F.2d 195 (5th Cir. 1960), 18218, Hooper v. Mountain States Securities Corp.

Docket Nº:18218.
Citation:282 F.2d 195
Party Name:Perry O. HOOPER, as Trustee in Bankruptcy of Consolidated American Industrices, Inc., Appellant, v. MOUNTAIN STATES SECURITIES CORPORATION et al., Appellees.
Case Date:July 12, 1960
Court:United States Courts of Appeals, Court of Appeals for the Fifth Circuit

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282 F.2d 195 (5th Cir. 1960)

Perry O. HOOPER, as Trustee in Bankruptcy of Consolidated American Industrices, Inc., Appellant,



No. 18218.

United States Court of Appeals, Fifth Circuit.

July 12, 1960

Rehearing Denied Sept. 26, 1960.

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Albert W. Copeland, Montgomery, Ala. (Godbold, Hobbs & Copeland, Montgomery, Ala., of counsel), for appellant.

J. Asa Rountree, III, Birmingham, Ala., Jack Crenshaw, Montgomery, Ala., Jos. F. Johnston, James C. Barton, Birmingham, Ala., Thomas G. Meeker, Gen. Counsel, S.E.C., David Ferber, John A. Dudley, Attys., S.E.C., Washington, D.C. (Cabaniss & Johnston, Deramus, Fitts & Johnston, Birmingham, Ala., of counsel), for appellees.

Before RIVES, Chief Judge, and CAMERON and BROWN, Circuit Judges.

JOHN R. BROWN, Circuit Judge.

In this civil action seeking relief for violation of § 10(b) of the Securities Exchange Act, 15 U.S.C.A. § 78 er seq., 78j, and Rule X-10B-5 promulgated by the SEC, the principal question is whether a corporation misled by fraud in the issuance of its stock in return for spurious assets is a seller. Is the transaction a sale? The District Court on motion to dismiss the complaint thought not. With that conclusion, the efforts to secure extraterritorial service of process under 27 of the Act for the trial in Alabama over defendants residing in other states automatically fell. Some subsidiary question s exist. These include the right of the bankruptcy Trustee to sue for fraud perpetrated on the corporate bankrupt and also the problem of applicable statutes of limitation. Faced also is a question whether the scheme was so neatly executed that there was no 'seller' and no 'purchaser.' This is so, the argument runs, because although the issuing corporation parted with its shares, this was done through persons having no authority (hence not a 'seller') and the acquiring corporation was liquidated prior to receiving the

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stock (hence not a 'purchaser'). We hold the corporate issuer to be a seller and reverse.


The Fraudulent Scheme.

Because the basic issue is broadly presented, we may capsulate the facts alleged which, for this motion, are deemed established. In doing so, however, we would emphasize that the complaint more than satisfied the requirements of the Federal Rules. 1 In its fourteen pages and the annexed five exhibits making up another ten pages, it sets forth in detail reminiscent of common law pleading names, places, dates and specific transactions. The sufficiency of the allegations of fraud under F.R.Civ.P. 9, 28 U.S.C.A. is not challenged.

Plaintiff is the Trustee of Consolidated American Industries, Inc. The corporation had been under the domination of the somewhat renowned BenJack Cage, now a Brazilizn protected fugitive from Texas justice. On October 18, 1956, control of Consolidated passed into new hands located in Alabama. As a condition Cage was required to sever all connections with the affairs of Consolidated. This he formally did. But that is all, for he then became the central figure in a fraudulent scheme concocted with the other defendants to get Consolidated to issue 700, 000 shares of its stock (par value 1¢ but having a current trading value of $1.00). Ostensibly leaving Consolidated, Cage went to Cuba where on behalf of another Cage enterprise (I.C.T.) he orally agreed to buy shares in a Cuban insurance company. This called for a down payment of $5, 000 and an advance to the Cuban company of an additional $5, 000 as a demand loan. This $10, 000, although not then paid to the Cubans, cuts an important figure in this litigation. Winging his way back to Texas where he was then still a free man, Cage made another deal through a Corpus Christi trader to acquire oil exploration rights in Honduras.

The grand aim of Cage was to find a corporate vehicle through which these two contract rights could then be transferred to Consolidated in exchange for Consolidated stock which would thereafter be distributed in liquidation of the vehicle corporation. The Consolidated stock could then be disposed of by the individual distributees as regulation-free stock in ordinary over-the-counter operations. Here is where the defendant Mountain States Securities Corporation and the Denver individual defendants come in. This corporation in connivance with certain directors, stockholders and its counsel created Mid-Atlantic Development Company which was to serve as the vehicle corporation. The stock ownership of Mid-Atlantic was ultimately fixed at 4/7ths for Cage (or his nominees) and 3/7ths for the Denver group.

In the meantime, around November 15, 1956, in order to get I.C.T. to transfer to Mid-Atlantic the rights to the Cuban insurance company stock, Cage had to scrape up $10, 000 to comply with the initial Cuban deal. He did this by falsely representing to the new Alabama management of Consolidated then located in Montgomery, Alabama, that Consolidated already owned the Cuban insurance company stock, and that the Cuban company was in dire need of financing which, if not forthcoming from Consolidated, would result in loss of its investment. This took place by use of interstate long distance telephone facilities. This call was effective and Consolidated thereupon arranged for the $10, 000 to be sent to Cuba.

Mid-Atlantic, now the owner of the rights to procure the Cuban insurance company stock and the Honduran exploration

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rights, formally contracted to transfer these to Consolidated in exchange for 700, 000 shares of Consolidated stock. But as the new post-October Alabama management of Consolidated was not in on the deal, some way had to be found to get the Consolidated's New York City stock transfer agent to issue the 700, 000 shares to Mid-Atlantic. Here is where the Pennsylvania defendant, the former secretary of Consolidated, and the New York defendant, its former general counsel, come in. In December 1956 the former secretary falsely certified corporate resolutions purporting to approve as of October 18, 1956, the Mid-Atlantic transaction. The former general counsel falsely wrote a letter to the transfer agent concerning the Board of Directors' action in this transaction and stating his opinion that the issuance was exempt from SEC registration. At the time these actions were taken, each knew that he was no longer an officer of Consolidated, lacked authority to act in behalf of the corporation, and that the transaction was not as represented to the transfer agent. The transfer agent, acting pursuant to these corporate directions, issued the stock in Mid-Atlantic's name and delivered the certificate to the former general counsel who in turn gave it to Cage. Mid-Atlantic had already been dissolved and new stock was issued in the name of the distributees (or nominees) of Mid-Atlantic. Of the 700, 000 shares, over 400, 000 were then sold by the distributees to individual investors throughout the world.

Accepting these allegations as sufficient-- which they clearly were-- to charge a fraudulent scheme resulting in the issuance of its own stock, the District Court held that Consolidated was not a seller, and that there had been no sale. The complaint was dismissed for failure to state a claim under the statute and regulation, and in the absence of such a claim, no ground existed for extraterritorial service of process on the nonresident defendants. The District Judge faced the issue squarely and decided it just as forthrightly. Now the defendants naturally assert other grounds which support the result even though we might disagree with the district Court's stated reason. Following tit for tat, the Trustee joins them with like energy. This has resulted in considerable preoccupation with the nature of the rights to stock in the Cuban insurance company and the Honduran oil exploration transactions. Whether either one or both of these amounted to a sale of a security by Mid-Atlantic and therefore a 'purchase' by Consolidated, we need not decide since we are clear that Consolidated 'sold' its own stock and to be a seller is enough. One need not be both.


Issuing Corporation is a Seller.

Issuance of Stock is a Sale.

We need not repeat here the history now so well catalogued which traces the exercise by the SEC of the legislative power granted in § 10(b) 2 to

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promulgate regulation X-10B-5. 3 A significant purpose of X-10B-5 was to extend to sellers the same protection against fraudulent and other unlawful schemes afforded to those defrauded in the purchase of securities. 4 In a substantive way it is even more sweeping. It greatly expands the protection frequently so hemmed in by the traditional concepts of common law misrepresentation and deceit, the requirement of privity, proof of specific damage, inadequacy of the right of rescission or right to recover up to par value of stock of a much greater market value. To these difficulties would have to be added the geographic obstacle of suit in a common forum against multi-state defendants scattered as far as the fraudulent device required. 5 And along with the Second, Third and Ninth Circuits, 6 we now adopt, as we earlier foreshadowed, 7 the principles set forth in the trail-blazer decision of Kardon v. National Gypsum Co., E.D. Pa., 1946, 69 F.Supp. 512, that a violation of rule 10B-5 gives rise to a private right of action. And this private right of action arises where facilities of the mail or interstate communications are used in connection with the sale or purchase of securities even though the transaction is conducted directly between the buyer and seller and not through a securities exchange or an organized over-the-counter market. 8

The argument against allowing recovery to a corporation issuing its own stock in exchange for a consideration, cash or...

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