St. Louis Union Trust Co. v. Merrill Lynch, Pierce, Fenner & Smith Inc.

• Decision Date: 27 October 1977
• Docket Number: No. 76-1447,76-1447
• Citation: 562 F.2d 1040
• Parties: Fed. Sec. L. Rep. P 96,151 ST. LOUIS UNION TRUST COMPANY, a corporation, Kenneth H. Bitting, Jr., William C. Bitting and George C. Bitting, as Executors of the Last Will of Kenneth H. Bitting, Deceased, Plaintiffs-Appellees, v. MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED, a corporation, Donald T. Regan, Ned B. Ball and George L. Shinn, Defendants-Appellants.
• Court: U.S. Court of Appeals — Eighth Circuit

Page 1040

562 F.2d 1040

Fed. Sec. L. Rep. P 96,151

ST. LOUIS UNION TRUST COMPANY, a corporation, Kenneth H Bitting, Jr., William C. Bitting and George C Bitting, as Executors of the Last Will of Kenneth H. Bitting Deceased, Plaintiffs-Appellees, v. MERRILL LYNCH, PIERCE, FENNER & SMITH INCORPORATED, a corporation, Donald T. Regan, Ned B. Ball and George L. Shinn, Defendants-Appellants.

No. 76-1447.

United States Court of Appeals Eighth Circuit.

Submitted April 13, 1977.

Decided Aug. 26, 1977.

Rehearing and Rehearing En Banc Denied Oct. 27, 1977.

William P. Rogers (argued and made rebuttal), and Stanley Godofsky, James N. Benedict, New York City, Ernest L. Folk, III, Charlottesville, Va., James B. May and Roger J. Hawke, New York City, and John J. Cole, St. Louis, Mo., on brief and reply brief for defendants-appellants.

Veryl L. Riddle (argued), and Thomas C. Walsh, Daniel R. O'Neill and John J. Hennelly, Jr., St. Louis, Mo., on brief for plaintiffs-appellees.

Before HEANEY, ROSS and STEPHENSON, Circuit Judges.

ROSS, Circuit Judge.

This appeal raises substantial questions concerning the validity of an option held by Merrill Lynch, Pierce, Fenner & Smith, Inc. (hereinafter Merrill Lynch) to repurchase its own stock from a deceased shareholder's executors. The district court found violations of the securities fraud provisions of § 10(b) of the Securities Exchange Act of 1934 ¹ and Rule 10b-5 ² thereunder, as well as common law fraud and breach of fiduciary duty under state law. ³ St. Louis Union Trust Co. v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 412 F.Supp. 45 (E.D.Mo.1976). The district court awarded the plaintiffs $1,452,090 plus prejudgment interest in actual damages and $2,000,000 in punitive damages. Id. at 61-62. We hold that the plaintiffs were not entitled to relief on their federal and state claims as a matter of law. Accordingly, we reverse and order the complaint dismissed.

The plaintiffs are the executors of the Estate of Kenneth H. Bitting, a former officer, employee and stockholder of Merrill Lynch. The defendants are Merrill Lynch and three of its senior executives, Donald T. Regan, Ned B. Ball and George L. Shinn.

In 1947, Kenneth Bitting operated a stock brokerage partnership known as Bitting, Jones & Company in St. Louis, Missouri. In that year, the Bitting partnership merged into Merrill Lynch, which was then a national stock brokerage partnership, and became the St. Louis office of Merrill Lynch. Between 1947 and 1951, Bitting was an employee of the Merrill Lynch partnership. In 1951, he became a general partner of the firm.

In 1959, the Merrill Lynch partnership was dissolved and the business was incorporated. In return for their interests in the partnership, each partner, including Kenneth Bitting, received shares of common stock in Merrill Lynch. Bitting received 9,100 shares of voting stock and a $58,000 debenture in exchange for his partnership capital. In October 1959, Merrill Lynch split its stock on a three for one basis and Bitting became the owner of 27,300 shares of voting stock. Bitting had acquired all of his stock at a cost based on book value.

Under Merrill Lynch's original Certificate of Incorporation, all common stock, including that issued to Kenneth Bitting, was restricted against transfer. Under the terms of the Charter, Merrill Lynch was granted an option to purchase the holder's stock at an adjusted net book value price upon the occurrence of several specified contingencies, including the death of the holder. This transfer restriction was conspicuously noted on each stock certificate. Likewise the stockholder or his executors were given a right to "put" the stock to Merrill Lynch and it was then required to purchase that stock at book value.

In 1962, Bitting retired from the company. At that time, in accordance with company policy, he exchanged his 27,300 shares of voting stock for over $400,000 in cash and 10,000 shares of nonvoting stock. Between 1962 and 1970, Bitting became the owner of 40,000 shares of nonvoting stock as a result of two additional stock splits.

On October 8, 1970, Kenneth Bitting died. Pursuant to its Charter, Merrill Lynch exercised its option to purchase the 40,000 shares at a price of $26.597 per share, the net book value as of October 30, 1970. The option was exercised by the company on November 18, 1970. ⁴ The total price was $1,063,880. Thereafter the corporation offered Bitting's widow an opportunity to purchase 10,000 shares of nonvoting stock at the same price, which she accepted. Some other widows had been given similar options.

Between 1959 and 1971, Merrill Lynch was a privately held company. On April 12, 1971, the company publicly announced that it was "going public" that it was going to make its shares available to the public. On June 23, 1971, following registration with the SEC and a three for one stock split, four million shares of the company's stock were offered to the public at a price of $28 per share. The offering price per share was approximately three times the price which was paid to the Bitting executors in accordance with the terms of the stock restriction contained in Merrill Lynch's Certificate of Incorporation.

The plaintiffs' complaint is grounded on allegations that the decision to go public in the spring of 1971 was made by a tightly knit group of insiders within the company's management hierarchy before the company purchased the Bitting stock. ⁵ The plaintiffs say that their stock was purchased in furtherance of a fraudulent scheme on the part of the inside group to enhance the price at which the company's stock was to be offered to the public and to maintain and preserve their control of company management after public ownership.

After a nonjury trial, the court substantially adopted the plaintiffs' theory of the case. The court held that the option was unenforceable under Delaware law and was fraudulently exercised by the defendants to the detriment of the plaintiffs in order to increase the per share earnings of Merrill Lynch stock prior to the public offering and to maintain management control.

I. The Enforceability of the Stock Restriction.

We first address the issue of whether the stock restriction was enforceable under Delaware law ⁶ when the stock option was exercised in November 1970. ⁷ The district court held that the option was not enforceable at that time. We disagree and hold that the restriction was enforceable under § 202(c) (1) of the Delaware General Corporation Law.

Article VI, Section 1(a) of the Merrill Lynch Certificate of Incorporation, the provision under which Kenneth Bitting's stock was called, provides in pertinent part as follows:

* * * (I)n the event of the death * * * of any holder of common stock of the Corporation * * * , the Corporation shall have the right and option which shall be prior to any other right and option, to purchase the shares of common stock of the Corporation held by the deceased * * * for a period of ninety (90) days from the earlier of: (i) the date the Corporation receives from the legal representative of such holder written notice * * * of the death * * * of such holder, or (ii) the date the Corporation mails written notice * * * that the Corporation is on notice of such death * * *.

This restriction was noted conspicuously on each Merrill Lynch stock certificate and was indisputably assented to by Bitting when the stock was issued to him. There has been no contention, nor could there be on this record, that Bitting's assent was induced by fraud, deceit or any other improper motive.

The enforceability of the restriction rests on our construction of Section 202 of the Delaware General Corporation Law, which was in existence in November 1970 when the restriction was enforced. Section 202(a) carries the label "Restriction on transfer of securities" and reads as follows:

A written restriction on the transfer or registration of transfer of a security of a corporation, if permitted by this section and noted conspicuously on the security, may be enforced against the holder of the restricted security or any successor or transferee of the holder including an executor, administrator, trustee, guardian or other fiduciary entrusted with like responsibility for the person or estate of the holder.

Section 202(c) declares four types of restrictions valid without inquiry into the existence vel non of a lawful or reasonable purpose. Section 202(c)(1), the pertinent provision for our purposes, provides as follows:

(c) A restriction on the transfer of securities of a corporation is permitted by this section if it:

(1) Obligates the holder of the restricted securities to offer to the corporation or to any other holders of securities of the corporation or to any other person or to any combination of the foregoing, a prior opportunity, to be exercised within a reasonable time, to acquire the restricted securities; * * *.

This statute on its face validates the stock restriction at issue. The statute declares the enforceability of any restriction which "(o)bligates the holder of the restricted securities to offer to the corporation * * * a prior opportunity * * * to acquire the restricted securities * * *." That is precisely what Merrill Lynch's Charter required of Kenneth Bitting's estate in this case.

We have not found, and the parties have not cited to us, any reported Delaware decision construing § 202(c)(1). However, in DeVries v. Westgren, 119 Pittsburgh L.J. 61 and 109 (C.P. Allegheny County 1970), aff'd as modified, 446 Pa. 205, 287 A.2d 437 (1971), the court enforced a stock restriction requiring a shareholder to offer all of his common stock to the corporation upon the voluntary or involuntary termination of his employment under a Pennsylvania statute identical to § 202(c)(1). ⁸ The defendant shareholder was involuntarily terminated by the company and was sued by the other shareholders when he refused to surrender his shares pursuant to...