Fridrich v. Bradford, 74-1902

Citation542 F.2d 307
Decision Date15 September 1976
Docket NumberNo. 74-1902,74-1902
PartiesFed. Sec. L. Rep. P 95,723 Jerry D. FRIDRICH, et al., Plaintiffs-Appellees, v. J. C. BRADFORD, et al., Defendants-Appellants.
CourtUnited States Courts of Appeals. United States Court of Appeals (6th Circuit)

Ames Davis, Waller, Landsen, Dortch & Davis, Justin P. Wilson, William Waller, William Waller, Jr., Nashville, Tenn., for defendants-appellants.

Gilbert S. Merritt, Gullett, Steele, Sanford, Robinson & Merritt, Nashville, Tenn., James C. Burns, Jr., Shelbyville, Tenn., for plaintiffs-appellees.

Before CELEBREZZE, PECK and ENGEL, Circuit Judges.

ENGEL, Circuit Judge.

On April 27, 1972 J. C. Bradford, Jr. purchased 1,225 shares of common stock of Old Line Life Insurance Company (Old Line). The shares were purchased on inside information Bradford, Jr. had received on a tip from his father. The shares were purchased on the over-the-counter market from J. C. Bradford and Co., a Nashville brokerage firm of which Bradford, Jr. and his father are managing partners. Subsequent to the purchase, Old Line stock increased in value and on July 27, 1972, Bradford, Jr. sold the 1,225 shares, reaping a profit of $13,000 on the transaction.

The Securities and Exchange Commission investigated Bradford, Jr.'s stock transaction. As a result of a consent decree entered into between the Commission and Bradford, Jr., he was required to disgorge the entire $13,000 profit, was permanently enjoined from any further violation of § 10(b) of the Securities Exchange Act of 1934 1 and Rule 10b-5, 2 and was suspended from performing any business activities as a broker-dealer for twenty working days.

Thereafter plaintiffs filed this civil action, alleging that Bradford, Jr.'s trading activities violated Rule 10b-5. By the judgment of the district court appealed from here, Bradford, Jr. has been rendered jointly and severally liable to plaintiffs for the sum of $361,186.75. He has been held liable, although plaintiffs never sold their stock to him or his associates, nor did they sell on the same day or even in the same month in which he bought. There was no proof that Bradford, Jr.'s trading activities had any impact upon the market price of Old Line stock or upon plaintiffs' decision to trade in it. As we read the district court judgment, Bradford, Jr.'s liability would have been the same even though he had purchased only five shares of Old Line and made a profit of less than $53.00.

While Bradford, Jr. is only one of five defendants in this appeal, we have focused on his liability at the outset in order to illustrate the "Draconian liability" 3 to which persons who trade on inside information may be subjected to under the district court's interpretation of Rule 10b-5. Because we conclude that under the circumstances of this case imposition of civil liability constitutes an unwarranted extension of the judicially created private cause of action under Rule 10b-5, we reverse the judgment of the district court.

I.

Of the five defendants named 4 in the district court action, the dominant figure was James C. Bradford (Bradford). In 1961, Bradford put together a syndicate to purchase a controlling block of Old Line stock, which the syndicate continued to own through 1972. After the purchase, Bradford became a director of Old Line and upon his retirement as a director, was succeeded by Bradford, Jr., who remained a director until August 1972. Approximately once a year Bradford was visited in Nashville by Forrest Guynn, president of Old Line, who gave Bradford a personal report on the affairs of the company. After the 1961 purchase, Bradford & Co. became the principal market-maker of the stock. 5

Prior to 1972, Old Line was considered a prime target for merger or takeover in the insurance industry and Bradford, because of his relationship with Old Line, was often approached by companies interested in a takeover.

In October, 1971, Gordon E. Crosby, chairman of U. S. Life Corporation (USLIFE), a New York based insurance company, contacted Bradford concerning the possible acquisition of Old Line by USLIFE. Crosby was advised by Bradford that no offer would be considered unless it involved an offer of at least $50 per share for Old Line stock. Since Old Line had a market price of only $24 per share at that time, Crosby did not pursue the negotiations.

On April 19, 1972 Crosby telephoned Bradford and stated that he was then in a position to work out a deal at better than $50 per share of Old Line stock. Crosby, in effect, proposed an acquisition on the basis of one share of USLIFE stock for one share of Old Line. In a letter of April 21, 1972, Crosby agreed to negotiate the acquisition only with Bradford and agreed to pay Bradford a finder's fee equivalent to 1% of the fair market value of the USLIFE stock exchanged for the Old Line stock. On April 19, 1972 the closing bid price for Old Line stock was $33 per share and the closing price for USLIFE on the New York Stock Exchange was $61 per share.

On April 21, 1972, after his conversations with Crosby, Bradford caused to be purchased for the account of his wife 2,000 shares of common stock of Old Line, at an average price of about $34 per share. Between April 21 and April 26, Bradford made several purchases totalling 5400 shares of Old Line for the account of Life Stock Research Co. (Life Stock) at an average price of about $36 per share. On April 27, 1972, after hearing of Bradford's conversations with Crosby, Bradford, Jr. purchased 1,225 shares of common stock of Old Line at $37 per share. Prior to their April, 1972 purchases, the Bradfords had made only one purchase of Old Line stock in the past eight years, that in 1969.

On May 15, 1972 Bradford called Crosby and told him that he had spoken to Forrest Guynn, chief executive officer of Old Line. Bradford reported that Guynn was interested in having serious negotiations concerning the merger. Because Old Line was going to declare a 20% stock dividend, the ratio of exchange would have to be changed to 8/10 of a share of USLIFE per one share of Old Line, but Bradford saw this as presenting no problem.

Negotiations toward the merger continued in June, 1972. Bradford's finder's fee agreement granting him the right to receive 1% of the fair market value of the USLIFE stock exchanged was signed on June 26. Crosby of USLIFE and Guynn of Old Line met on June 28-29 and issued a press release on June 29 in which the terms of the acquisition offer were stated, 6 without mention, however, of the finder's fee. The June 29, 1972 press release was the first public announcement of the proposed merger. On July 7, 1972, Guynn, with the authorization of Old Line's Board of Directors, agreed in principle to the merger of Old Line and USLIFE. On July 11 a press release announcing the agreement in principle was issued and this was delivered to stockholders on July 14. Because of problems concerning SEC approval of the merger, the proposed date of the merger, September, 1972, had to be delayed. 7 Also, because the SEC would not approve Bradford's finder's fee without a hearing, Bradford waived his fee in return for an increase in the exchange rate on the stock from 0.8 to 0.808 of the USLIFE stock per share of Old Line. After an investigation of several months, the SEC approved the merger on November 20, 1972 and on December 28, 1972, after approval by Old Line's stockholders, the merger became effective.

Bradford and Co. was the principal market maker in Old Line stock throughout 1972, purchasing 169,054 shares and selling 170,685 shares, for which it was paid commissions in the amount of $103,214. Approximately $75,000 of this profit was a result of trading activity in Old Line during the months of April through December, 1972.

On July 31, 1972, Bradford, Jr. sold the 1,225 shares of Old Line stock he had purchased in April 1972 at a profit of $13,000. On August 24, 1972, Life Stock sold the 5400 shares purchased for it in April, realizing a profit of approximately $103,000 on the transaction. The 2,000 shares Bradford had purchased for his wife were not sold prior to the merger, but on the last business day prior to the merger there was an unrealized appreciation in the value of those shares amounting to approximately $74,000 based upon the bid price of Old Line stock on that date. 8

Two of the plaintiffs (Fridrich and Kim) bought stock in Old Line in May, 1972 and sold the stock in June at a slight profit. 9 The stock was purchased from a broker, Ken Schoen, and was sold on his advice. These transactions did not involve Bradford or any of his associates. The other plaintiffs (the Woosley family) purchased their stock from Bradford & Co. in 1967 but sold in June, 1972, through Schoen and on his advice. Schoen testified he would not have advised clients to sell their stock had he been aware that Bradford and Old Line were negotiating an agreement with USLIFE to effect a merger. Schoen did not have any information concerning the proposed merger until mid-July, 1972. He did not advise the plaintiffs to repurchase Old Line stock.

Meanwhile the SEC commenced an investigation of the transaction. Hearings were held before the Commission in early November, 1972 and on November 10, 1972, the SEC filed a Rule 10b-5 enforcement action against Bradford, Bradford, Jr., Life Stock, Bradford & Co. and Bradford & Co., Inc. in the United States District Court for the Southern District of New York. 10 The action was terminated by the filing of a stipulation of settlement and the entry of a consent judgment on June 1, 1973. That judgment permanently enjoined the defendants from directly or indirectly violating Section 10(b) in connection with the purchase or sale of securities issued or to be issued by Old Line. It further ordered that a fund created by a November 27, 1972 escrow agreement should be held and dispersed to such persons as should file their claims under the terms thereof. 11 Those entitled to file...

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