O'Brien v. Continental Illinois Nat. Bank and Trust Co. of Chicago

• Decision Date: 05 April 1979
• Docket Number: 78-1704,78-1117,78-1112,Nos. 78-1111,78-1115,s. 78-1111
• Citation: 593 F.2d 54
• Parties: Fed. Sec. L. Rep. P 96,780 Harold J. O'BRIEN et al., Plaintiffs-Appellants, v. CONTINENTAL ILLINOIS NATIONAL BANK AND TRUST COMPANY OF CHICAGO, a National Banking Association, Defendant-Appellee. to 78-1706 and 78-1708.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 54

593 F.2d 54

Fed. Sec. L. Rep. P 96,780

Harold J. O'BRIEN et al., Plaintiffs-Appellants, v. CONTINENTAL ILLINOIS NATIONAL BANK AND TRUST COMPANY OF CHICAGO, a National Banking Association, Defendant-Appellee.

Nos. 78-1111, 78-1112, 78-1115, 78-1117, 78-1704 to 78-1706

and 78-1708.

United States Court of Appeals Seventh Circuit.

Argued June 13, 1978.

Decided Feb. 23, 1979.

As Amended April 5, 1979

James S. Gordon, Chicago, Ill., for plaintiffs-appellants.

Bryson P. Burnham, Chicago, Ill., for defendant-appellee.

Before TONE and WOOD, Circuit Judges, and CAMPBELL, Senior District Judge. ^*

TONE, Circuit Judge.

The district court dismissed the federal securities law counts of the complaints in these six consolidated cases for failure to state a claim for relief under § 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. Subsequently the court dismissed pendent state law counts alleging breaches of fiduciary duty. Final judgments were entered for the defendants. We hold that the court was correct in dismissing the federal securities counts but reverse the judgments with directions to reinstate the pendent claims.

The facts pleaded in the several complaints are similar in all material respects. Plaintiffs are the respective trustees of nine separate union or employee pension trust funds. In each case, the plaintiffs entered into an agreement with the defendant, the Continental Illinois National Bank and Trust Company of Chicago, under which funds of the pension trust were turned over to the bank for investment. Although some of the agreements are characterized as trust agreements and the others as agency agreements, ¹ the rights and relationships of the parties were essentially the same in each case: Continental was given the responsibility of making such investments as in its sole discretion it saw fit, subject to a fiduciary duty of due care. Plaintiffs had power to terminate the agreements at will but no right to receive notice of, or to be consulted about, proposed investments and no right to veto investment decisions.

Acting pursuant to the agreements, Continental bought and sold for the benefit of each of the several trust accounts the common stock of Penn Central Company, Trans World Airlines, Inc., Lums, Inc., Boise Cascade Corporation, Management Assistance, Inc., and United States Freight Company, and bought subordinated debentures of Interway Corporation. Plaintiffs allege that at the time of these transactions Continental was a substantial creditor of these companies; that in some instances, Continental received information as a creditor that was not available to others; and that in other instances Continental's role as a creditor enabled it to affect dividend policies. It is alleged that Continental purchased the securities of these companies without disclosing to plaintiffs its conflicts of interest arising from its role as creditor, failed to disclose adverse inside information about the investment quality of the securities purchased, and in some instances delayed selling a company's stock in order to protect itself as a creditor of the company.

Plaintiffs further allege that if Continental had not withheld the information in question, they would have exercised their rights to terminate the trust or agency agreements and thereafter would not have purchased certain securities and would not have retained others. The withholding of information is asserted to have constituted deceptive practices in connection with the purchase and sale of securities within the meaning of § 10(b) and Rule 10b-5, giving rise to private claims for damages.

As noted above, plaintiffs also allege that Continental's conduct in failing to disclose the alleged adverse information and in purchasing and retaining the various securities for the benefit of the funds, constituted a common law breach of fiduciary duty and breach of contract. ² These state law claims were joined in the federal actions on the basis of pendent jurisdiction, except for a few instances in which jurisdiction was founded on diversity of citizenship. ³

Continental's original motions to dismiss the complaints in these cases were denied on May 10, 1974 by Judge McGarr. Local 734 Bakery Drivers Pension Fund Trust, et al. v. Continental Illinois National Bank and Trust Company of Chicago, CCH Fed.Sec.L.Rep. P 94,565 (N.D.Ill.1974). After the Supreme Court's decision in Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 95 S.Ct. 1917, 44 L.Ed.2d 539 (1975), Continental moved for reconsideration of Judge McGarr's ruling. While the motion was Sub judice the Supreme Court decided Santa Fe Industries v. Green, 430 U.S. 462, 97 S.Ct. 1292, 51 L.Ed.2d 480 (1977). On April 25, 1977, Judge Flaum, to whose calendar the cases had been reassigned, vacated the May 10, 1974 order and dismissed plaintiffs' 10b-5 claims. O'Brien v. Continental Illinois Bank and Trust Co., 431 F.Supp. 292 (N.D.Ill.1977). On November 28, 1977 the court entered a separate memorandum of decision dismissing the pendent state law claims. O'Brien v. Continental Illinois Bank and Trust Co., 443 F.Supp. 1131 (N.D.Ill. 1977). These appeals followed.

I. The Federal Securities Laws Counts

It is undisputed that Continental was vested with sole discretionary power, as trustee or agent under the various agreements, to make purchases and sales of securities with the funds entrusted to it. Plaintiffs were not entitled to receive notice of a contemplated purchase or sale, to participate in the investment decision, or to veto that decision when they learned of it. They did, however, have authority to terminate the agreements at will, and they eventually exercised that authority.

Plaintiffs thus could not and did not allege that they were induced to buy or sell securities by the nondisclosures. They alleged rather that they "were induced not to exercise their respective powers to terminate the . . . contractual relationships" with Continental (O'Brien, Hanley, Lipson, Brabec), that they "were induced to take no action with respect to the investment of the funds of the Pension Fund by Continental in (the subject) securities" (O'Donnell), or that "they had no knowledge that Continental was investing in the (securities) for their accounts" (Tenco). ⁴

A. The Retained Securities

The sales plaintiffs allege they would have made if they had received the information in question and revoked the trust or agency agreements, were never actually made. These retention claims are squarely within Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 95 S.Ct. 1917, 44 L.Ed.2d 539 (1975), in which the Court adopted the rule of Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2d Cir. 1952), that only purchasers and sellers of securities are entitled to maintain actions for violation of § 10(b) and Rule 10b-5. The Birnbaum rule does not allow a remedy under Rule 10b-5 to persons "who allege that they decided not to sell their shares because of . . . a failure to disclose unfavorable material." 421 U.S. at 737-738, 749, 754-755, 95 S.Ct. at 1926.

It is irrelevant that, as plaintiffs argue, they ultimately sold their securities. A plaintiff may not bring his retention claim within the Birnbaum rule by selling his securities before he sues. The failures to disclose were not "in connection with" the ultimate sales. Cf. O'Hashi v. Varit Industries, 536 F.2d 849, 852 (9th Cir.), Cert. denied, 429 U.S. 1004, 97 S.Ct. 538, 40 L.Ed.2d 616 (1976).

B. Purchased Securities

With respect to the purchases made by Continental, plaintiffs do not fit as neatly into the categories of persons to whom the Birnbaum rule denies the 10b-5 remedy. See Blue Chip Stamps, 421 U.S. at 737-738, 95 S.Ct. 1917.

Continental argues, however, that it and not plaintiffs purchased the stock and, therefore, the Blue Chip rule applies. Although some judges and commentators have interpreted Blue Chip as Continental does, ⁵ we are unable to say categorically that plaintiffs, on whose behalf Continental bought, were not in any sense purchasers of the securities. Nevertheless, we believe that considerations that helped to shape the decisions of the Supreme Court in Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 97 S.Ct. 1292, 51 L.Ed.2d 480 (1977), and Blue Chip as well, require the same result here, and that therefore a cause of action under § 10(b) and Rule 10b-5 is not to be implied in the circumstances of this case.

In the Santa Fe case the Court held that unfairness in the securities transaction in question, a short-term merger that squeezed out minority shareholders, was not enough to create a 10b-5 cause of action, and that in view of the language of § 10(b), deception or manipulation was a necessary element of a claim under that section. 430 U.S. at 474-477, 97 S.Ct. 1292. The Court went on to say, in Part IV of its opinion, that even if the language of the statute were not dispositive, there were "two additional considerations that weigh heavily against permitting a cause of action under Rule 10b-5 for the breach of corporate fiduciary duty alleged in this complaint." First, "a private cause of action under the antifraud provisions of the Securities Exchange Act should not be implied where it is 'unnecessary to ensure the fulfillment of Congress' purposes' in adopting the Act." 430 U.S. at 477, 97 S.Ct. at 1303, quoting from Piper v. Chris-Craft Industries, Inc., 430 U.S. 1, 41, 97 S.Ct. 926, 51 L.Ed.2d 124 (1977). The "fundamental purpose" of the Act was "implementing a philosophy of full disclosure." The Court was "reluctant to recognize a cause of action here to serve what is 'at best a subsidiary purpose' of the federal legislation." 430 U.S. at 478, 97 S.Ct. at 1303, quoting from Cort v. Ash, 422 U.S. 66, 80, 95 S.Ct. 2080, 45 L.Ed.2d 26 (1975). The second consideration relied on by the Court was that "the cause of action (is) one traditionally relegated to state law . . .," 430 U.S. at 478, 97 S.Ct. at...