Schlick v. Penn-Dixie Cement Corp.

• Decision Date: 31 October 1974
• Docket Number: No. 1009,PENN-DIXIE,D,1009
• Parties: Fed. Sec. L. Rep. P 94,853 John SCHLICK, Plaintiff-Appellant, v.CEMENT CORPORATION et al., Defendants-Appellees. ocket 73-2677.
• Court: U.S. Court of Appeals — Second Circuit

Page 374

507 F.2d 374

Fed. Sec. L. Rep. P 94,853

John SCHLICK, Plaintiff-Appellant, v. PENN-DIXIE CEMENT CORPORATION et al., Defendants-Appellees.

No. 1009, Docket 73-2677.

United States Court of Appeals, Second Circuit.

Argued Aug. 13, 1974.

Decided Oct. 31, 1974.

Jeffrey L. Zivyak and Ira W. Berman, New York City, for plaintiff-appellant.

Marc P. Cherno, New York City (Joseph H. Einstein, Alan J. Russo, New York City, of counsel), for defendants-appellees.

Amicus Brief filed by S.E.C. (Lawrence E. Nerheim, Gen. Counsel, Walter North, Associate Gen. Counsel, Frederic T. Spindel, Sp. Counsel, Frederick B. Wade, Atty., Securities and Exchange Commission, Washington, D.C.).

Before OAKES, Circuit Judge, and FRANKEL and KELLEHER, District judges. ^*

OAKES, Circuit Judge:

This appeal is from a judgment dismissing a complaint for failure to state a claim upon which relief may be granted under Fed.R.Civ.P. 12(b)(6). The action is one for damages for alleged violations of the federal securities laws, ¹ brought by a minority shareholder ² of Continental Steel Corporation (Continental), an Indiana corporation listed on the New York Stock Exchange (NYSE). The alleged violations arose in connection with a merger of Continental into a wholly owned subsidiary of defendant Penn-Dixie Cement Corporation (Penn-Dixie), also listed on the NYSE.

The dismissed complaint alleges that between October, 1967, and October, 1969, Penn-Dixie acquired 1,111,514 shares or approximately 52.9 per cent of the outstanding common stock of Continental. Having thus acquired voting control over Continental, Penn-Dixie instituted management control over the corporation by placing six of its directors and officers on Continental's nine member board of directors. Appellant claims that Penn-Dixie then exercised its control of Continental so as to defraud Continental shareholders.

Generally, Penn-Dixie is said to have manipulated and depressed the market value of Continental stock in relation to that of Penn-Dixie by utilizing Continental's assets for the benefit of Penn-Dixie and to have caused Continental to enter into a merger agreement providing for an unfair exchange ratio based upon manipulated and artificial stock values of the merging parties. On March 14, 1973, the boards of directors of both companies unanimously approved an agreement of merger ³ by which Continental shareholders would receive in exchange for each share of Continental one and one-half shares of Penn-Dixie common stock and a warrant ⁴ to purchase an additional share of Penn-Dixie. In connection with the merger the complaint further alleges that Penn-Dixie issued a materially defective proxy statement which failed to disclose the manner in which Penn-Dixie had inflated the value of its shares at the expense of Continental. Damages claimed are in an indeterminate amount set at no less than $10 per Continental share, representing the difference in value between the value of the Continental shares in the actual merger and what they would have been worth but for the manipulations of Penn-Dixie.

On the basis of these general obligations, the complaint contains four claims of relief, in separate counts. The first alleges a violation of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. 78j(b) (1970), and Rule 10b-5 promulgated thereunder, 17 C.F.R. 240.-10b-5 (1974); count two claims a violation of the proxy solicitation provision of Section 14(a) of the Securities Exchange Act of 1934, 15 U.S.C. 78n(a) (1970), and Rule 14a-9 thereunder, 17 C.F.R. 240.14a-9 (1974); the third and fourth counts of the complaint are common law counts based upon fraud and unfairness, each of which is pendent to the federal claims. Thus the whole complaint must fail unless one of the federal counts is viable. United Mine Workers v. Gibbs, 383 U.S. 715, 86 S.Ct. 1130, 16 L.Ed.2d 218 (1966).

The district court found that the proxy count of the complaint was defective in that it failed to present 'any allegation of injury which was caused by the proxy violations, aside from that claimed to flow from the unequal ratios.' Schlick v. Penn-Dixie Cement Corp., No. 73, Civ. 1467 (S.D.N.Y., decided Sept. 26, 1973). In effect, the district court seemed to be saying that the appellant failed to show that the appellees' misstatements or omissions contributed to the kind of injury which the federal securities laws were intended to redress. ⁵

In reaching this conclusion, the district court relied heavily on the fact that the allegedly false and misleading proxy statement did not cause Continental minority stockholders any harm other than that caused by the unfair exchange ratio. They were not misled about their rights so as to have failed to take protective action in the form of seeking injunctive relief; rather, the court below continued, appellant chose to bring this action for damages before the merger was finalized. Nor did the complaint allege that other rights such as appraisal rights were lost as a result of appellees' action. ⁶ On such a showing, the district court regarded the appellant's proxy claim as one based upon what was alleged merely to be an unfair merger. While conceding this might well state a cause of action under state law, Judge Metzner rejected the argument that a federal claim could be maintained. ⁷

The dismissal by the court below of appellant's 10b-5 count was based first upon what the district court said was a concession by the appellant that if his 'basic claim under the proxy rules cannot be sustained, the 10b claim must also fall for want of the necessary causal connection' and secondly upon a determination that the count was defective because it contained 'only conclusory allegations without any specific allegations of fraud or deception as required to support a 10(b) claim.' Segal v. Gordon, 467 F.2d 602, 607 (2d Cir. 1972); O'Neill v. Maytag, 339 F.2d 764, 767-768 (2d Cir. 1964). ⁸ We disagree with the district court on its dismissal as to each of the federal act claims and hence reverse, for reasons stated below.

I. THE RULE 10b-5 CLAIM.

A. The sufficiency of the complaint. We go first to the 10b-5 count of the complaint. That count does allege generally 'the engagement in a course of business which operated as a fraud and deceit on the purchasers and holders of Continental stock.' If that were all that were alleged, it would fall within this court's rule that 'mere conclusory allegations to the effect that defendant's conduct was fraudulent or in violation of Rule 10b-5 are insufficient.' Segal v. Gordon, 467 F.2d at 607, quoting Shemtob v. Shearson, Hammill & Co., 448 F.2d 442, 444 (2d Cir. 1971), and O'Neill v. Maytag, supra. But here the complaint contains more than conclusory allegations. Paragraph 15 specifically alleges that Continental bank accounts were utilized by Penn-Dixie as compensating balances for Penn-Dixie's own borrowings and for Penn-Dixie's benefit without compensation or benefit to Continental, thereby depriving Continental of its ability to use its own capital to expand its business and thereby obtaining a more favorable merger exchange ratio. The same paragraph specifically alleges that Continental funds were utilized by Penn-Dixie to engage in a real estate venture in Florida with a 'special customer' of Penn-Dixie, for the benefit of Penn-Dixie and without compensation to Continental for the use of its funds. The complaint alleges the charging of excessive intercompany costs to Continental, thus reducing Continental's income and increasing that of Penn-Dixie. It alleges an accounting change, valuing certain Continental inventories on a last-in, first-out basis rather than average cost as had been done prior to 1971, thereby incurring a $595,000 special income charge reducing Continental's earnings for the year ending December 31, 1972, the year prior to merger. The complaint also alleges an over-inflation of Penn-Dixie assets by including in Penn-Dixie book value the sum of $21,425,000 which was the excess of cost over related net assets attributed to Penn-Dixie's purchase of the common stock of Continental. ⁹ Finally, it alleges that the appellees caused the Continental pension fund to purchase common stock of Penn-Dixie on the market in order to create a higher price for the shares of Penn-Dixie, which higher price was utilized to obtain an exchange ratio more favorable to Penn-Dixie. While all of these allegations are stated on information and belief, and there are cases holding that allegations of fraud based on information and belief usually do not satisfy the degree of particularity required by Fed.R.Civ.P. 9(b), Lee v. Alabama, 364 F.2d 945 (5th Cir. 1966); Duane v. Altenburg, 297 F.2d 515, 518 (7th Cir. 1962), the particularity requirement may be satisfied if, as here, the allegations are accompanied by a statement of the facts upon which the belief is founded. Id.; 5 C. Wright & A. Miller, Federal Practice and Procedure: Civil 1298, at 416 (1969). Wright and Miller point out that the rule relating to information and belief may be relaxed as to matters peculiarly within the opposing party's knowledge, as where the complaining stockholders in a derivative suit have little information about the manner in which the corporation's internal affairs are conducted and hence are rarely able to provide details as to the alleged fraud. Id. In any event, Rule 9 must be construed in conjunction with Rule 8, id.; Carroll v. First National Bank of Lincolnwood, 413 F.2d 353 (7th Cir. 1969), cert. denied, 396 U.S. 1003, 90 S.Ct. 552, 24 L.Ed.2d 494 (1970), and a complainant is not required to plead evidence. Brady v. Games, 76 U.S.App.D.C. 47, 128 F.2d 754, 755 (1942); Collins v. Rukin, 342 F.Supp. 1282, 1292 (D.Mass.1972). We consider Rule 9 sufficiently complied with here.

B. The nature of the fraud. It is well to put to rest, in the light of Judge Metzner's holding, a slow-to-die contention advanced by appellees principally in...