O'NEILL v. Maytag

• Decision Date: 29 December 1964
• Docket Number: Docket 29008.,No. 125,125
• Citation: 339 F.2d 764
• Parties: Robert J. O'NEILL, Plaintiff-Appellant, v. Lewis B. MAYTAG, Jr., Dudley Swim, Pan American World Airways, Inc., G. T. Baker, A. G. McNeese, Jr., Alton Ochsner, David Packard, G. Robert Truex, Jr., Albert C. Wedemeyer, G. R. Woody, and National Airlines, Incorporated, Defendants-Appellees.
• Court: U.S. Court of Appeals — Second Circuit

339 F.2d 764 (1964)

Robert J. O'NEILL, Plaintiff-Appellant, v. Lewis B. MAYTAG, Jr., Dudley Swim, Pan American World Airways, Inc., G. T. Baker, A. G. McNeese, Jr., Alton Ochsner, David Packard, G. Robert Truex, Jr., Albert C. Wedemeyer, G. R. Woody, and National Airlines, Incorporated, Defendants-Appellees.

No. 125, Docket 29008.

United States Court of Appeals Second Circuit.

Argued October 30, 1964.

Decided December 29, 1964.

Stanley L. Kaufman, New York City, (Shephard S. Miller and Kaufman, Taylor & Kimmel, New York City, on the brief), for plaintiff-appellant.

William Piel, Jr., New York City (David S. Henkel, John E. Donnelly and Sullivan & Cromwell, New York City on the brief), for defendants-appellees.

Philip A. Loomis, Jr., Gen. Counsel, David Ferber, Sol., John A. Dudley, Sp. Counsel, Michael Joseph, Atty., Securities and Exchange Commission, Washington, D. C., for Securities and Exchange Commission, amicus curiæ.

Before LUMBARD, Chief Judge, and HAYS and MARSHALL, Circuit Judges.

LUMBARD, Chief Judge:

This appeal presents questions of the existence and scope of private remedies under federal law for alleged violation of the provisions of two federal regulatory statutes: § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j (b) (1958), and § 409(b) of the Federal Aviation Act, 49 U.S.C. § 1379(b). Plaintiff, a shareholder of National Airlines, brought a derivative action in the District Court for the Southern District of New York on behalf of National against a number of its directors and officers and against Pan American World Airways, Inc. He alleged violation of both statutes and of the common law duty of the officers and directors.¹ Jurisdiction for the three theories is based respectively on § 27 of the Securities Exchange Act, 15 U.S.C. § 78aa; the general provision for federal question jurisdiction, 28 U.S.C. § 1331; and on the principle of pendent jurisdiction.

On motions by eight of the nine individual defendants, Judge McLean held that the complaint failed to state a cause of action under either statutory provision and that there was therefore no subject matter jurisdiction with respect to them.² Accordingly, he held that the court also lacked jurisdiction over the state law claim against them. We agree that no cause of action under § 10(b) or § 409(b) is stated against these defendants, and we affirm the judgment of the district court.³

The transaction complained of under each theory is an exchange of stock between Pan American and National, which is alleged to have been at a ratio unfavorable to National. In 1958 National issued 400,000 shares of its common stock to a trustee for the benefit of Pan American; Pan American in return issued 400,000 of its own shares to a trustee for the benefit of National. This cross-ownership was found by the Civil Aeronautics Board not to be in the public interest, and the Board ordered the companies either to sell or to re-exchange the stock. 31 C.A.B. 198 (1960).

In compliance with the CAB directive, there was an initial exchange of 46,400 shares at a one-to-one ratio early in 1963 and then, later in the same year, a second exchange in which National exchanged 353,600 shares of Pan American for 390,000 shares of National.⁴

Plaintiff concedes that the exchange of the 46,400 shares was fair in view of the then prevailing market values. But he alleges that 353,600 shares of Pan American given up by National in the second exchange were then worth $12,906,400 while the 390,000 shares of its own stock which it received in return were worth only $11,115,000, the value in each instance being based on New York Stock Exchange quotations. In plaintiff's view, the individual defendants caused National to pay this premium because they wished to eliminate the threat which the block of shares held by Pan American, approximately 21 per cent of the outstanding shares, posed to their control of National; the defendants in effect used approximately $1,800,000 of National's assets to purchase a more favorable control position for themselves.

I. Section 10(b) and Rule 10b-5

The allegations obviously state a claim under state law. But, there being no diversity, this state law claim is of no value to plaintiff in a federal district court unless there is also a parallel federal claim of sufficient plausibility at least to survive the opening round of pleadings and motions. Plaintiff's first theory under federal law is that the second exchange of stock violated § 10(b) of the Securities Exchange Act and, more particularly, Rule 10b-5 promulgated thereunder. 17 C.F.R. § 240.10b-5.

Section 10(b) of the Act provides:

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

* * * * *

"(b) to use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors."

Rule 10b-5 expands on the statutory language:

"It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, 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."

There can be no serious claim of deceit, withheld information or misstatement of material fact in this case. Decision thus depends on whether the statute and rule impose duties beyond that of honest disclosure.

Between principal and agent and among corporate officers, directors and shareholders, state law has created duties which exist independently of the sale of stock. While the essence of these duties in some circumstances is honest disclosure, the allegations in the instant case are typical of situations in which deception may be immaterial to a breach of duties imposed under common law principles. The question posed by this case is whether it is sufficient for an action under Rule 10b-5 to allege a breach of one of these general fiduciary duties where the breach does not involve deception. We think that it is not: At least where the duty allegedly breached is only the general duty existing among corporate officers, directors and shareholders, no cause of action is stated under Rule 10b-5 unless there is an allegation of facts amounting to deception.

Our conclusion follows from our view of the purpose of § 10(b): "That section was directed solely at that type of misrepresentation or fraudulent practice usually associated with the sale or purchase of securities rather than at fraudulent mismanagement of corporate affairs." Birnbaum v. Newport Steel Corp., 193 F.2d 461, 464 (2 Cir.), cert. denied, 343 U.S. 956, 72 S.Ct. 1051, 96 L.Ed. 1356 (1952). There may be difficulties in drawing this line where, as is alleged here, securities transactions are part of an internal struggle for corporate control. But these difficulties do not justify our treating the section, or the rule, as a mandate to inquire into every allegation of breach of fiduciary duty respecting the issuance or sale of corporate securities.

We have reached this conclusion despite the contrary position taken by the Securities and Exchange Commission in this case. The Commission has urged that a claim under Rule 10b-5 is stated by allegations that a corporation's "controlling directors caused it to acquire a large block of its own stock at an excessive price for the purpose of removing the threat to the directors' control represented by the stock." Brief of the Securities and Exchange Commission. The Commission's view may be supported to some extent by the broad dictum in McClure v. Borne Chemical Co., 292 F. 2d 824 (3 Cir.), cert. denied, 368 U.S. 939, 82 S.Ct. 382, 7 L.Ed.2d 339 (1961), although the posture of the case as it came to the Third Circuit — an appeal from an order refusing to require the plaintiff to post security — meant that the question of the scope of Rule 10b-5 was not directly involved.⁵ If such is the import of McClure, however, it seems to stand alone among judicial decisions; a reading of the facts of the cases cited as support by the plaintiff and the Commission reveals that in each, with the possible exception of McClure, the element of deception clearly was present.

There is, of course, no reason why the acts of an agent or corporate officer may not violate both his common law duty and the duty imposed by Rule 10b-5. In Ruckle v. Roto American Corp., 339 F. 2d 24 (2 Cir. 1964), the plaintiff alleged that the defendants, who comprised a majority of the board of directors, secured the board's approval of issuance of securities at an arbitrary value by withholding the most recent financial statements of the corporation. We held that the district court erred in dismissing the complaint; there was a clear allegation of deception in connection with the sale of securities, and the fact that the alleged deception occurred within the corporate structure did not by itself avoid liability under Rule 10b-5.

In addition, deception may take the form of nonverbal acts: In Cochran v. Channing Corp., 211 F.Supp. 239 (S.D. N.Y.1962), it consisted of reducing dividends in order to drive down the price of the corporation's stock. And it need not be deception in any restricted common law...