Atchley v. Qonaar Corp.

• Citation: 704 F.2d 355
• Decision Date: 01 April 1983
• Docket Number: No. 82-1696,82-1696
• Parties: Fed. Sec. L. Rep. P 99,155 Richard ATCHLEY, et al., Plaintiffs-Appellants, v. QONAAR CORPORATION, et al., Defendants-Appellees.
• Court: United States Courts of Appeals. United States Court of Appeals (7th Circuit)

Page 355

704 F.2d 355

Fed. Sec. L. Rep. P 99,155

Richard ATCHLEY, et al., Plaintiffs-Appellants, v. QONAAR CORPORATION, et al., Defendants-Appellees.

No. 82-1696.

United States Court of Appeals, Seventh Circuit.

Argued Dec. 3, 1982.

Decided April 1, 1983.

Abraham N. Goldman, Chicago, Ill., for plaintiffs-appellants.

Michael Silverman, Kwiatt & Silverman Ltd., Chicago, Ill., for defendants-appellees.

Before CUMMINGS, Chief Judge, CUDAHY, Circuit Judge, and TIMBERS, Senior Circuit Judge. ^*

CUMMINGS, Chief Judge.

In February 1982, the three named plaintiffs, Richard and Donna Atchley and Joyce Guine, filed a second amended complaint on Until 1981, defendant Qonaar was a publicly held corporation with its stock traded over the counter. On September 11, 1981, defendant Kroehler Mfg. Co.'s wholly-owned subsidiary, defendant KFM, Inc., made a tender offer of $37 per share to purchase all outstanding Qonaar stock, the tender offer running until October 16, 1981. The tender offer disclosed that Qonaar's directors, officers, and principal stockholders would tender their 134,506 shares of the 352,200 outstanding Qonaar shares in response to the offer and that the offer was conditioned upon the tender of at least a total of 282,000 shares, viz., their 134,506 shares plus an additional 147,494 shares. The complaint alleged that 98% of all publicly held shares were tendered, and on October 31, 1981, Qonaar and KFM, Inc. were merged pursuant to Delaware's short-form merger procedure.

behalf of themselves and all shareholders of Qonaar Corporation, a Delaware corporation whose principal place of business was in the Northern District of Illinois. Jurisdiction was predicated upon Section 10(b) of the Securities Exchange Act of 1934 (15 U.S.C. Sec. 78j) and Section 14 of the Williams Act (15 U.S.C. Sec. 78n). Plaintiffs alleged the following:

Plaintiff Richard Atchley and his wife, plaintiff Donna Atchley, purchased 350 and 150 shares respectively of Qonaar stock in the summer of 1981. Plaintiff Joyce Guine also purchased 100 Qonaar shares but sold them in October 1981 in response to KFM, Inc.'s tender offer. According to the second amended complaint, the Atchleys' shares were tendered to KFM, Inc. on December 28, 1981, by Dean Witter Reynolds, Inc., a well-known securities house, "without direction and in violation of all express direction to agents and employees of Dean Witter" which held the Atchleys' shares in "self directed I.R.A. account[s]" (Second Amended Compt. p 3).

Defendant John J. Harvey was allegedly a controlling shareholder in Kroehler, while defendants Robert Rittmaster and Mathew Young were officers, directors and major stockholders of Qonaar. Rittmaster was formerly president of Qonaar but was named president of Kroehler after the merger.

Count I of the second amended complaint is based on Section 10(b) of the Securities Exchange Act of 1934 (15 U.S.C. Sec. 78j) and SEC Rule 10b-5 thereunder. According to that Count Qonaar had enjoyed "astounding profit and sales growth" from 1978 through 1980 and expected to continue such profitability in view of its dominant position in the markets for parking meters and mass transit coin collection devices (Second Amended Compt. p 9). The defendants were charged with a scheme to acquire 200,000 Qonaar shares by a tender offer after deliberately depressing Qonaar's earnings. The plaintiffs assert that during the first ten months of 1981 defendants took a series of eight actions ¹ to reduce Qonaar revenues, increase its expenses, accelerate its depreciation and reduce its assets. As a result of their actions, the tender offer materials and solicitations mailed to Qonaar shareholders in 1981 showed income of 50cents per share for the first six months of 1981, whereas the annual profits per share had been $1 in 1978, $2.50 in 1979, and over $5 in 1980. Because of the dissemination of the "artificially low statement of income enjoyed by Qonaar in 1981," 98% of Qonaar's publicly held shares were tendered to KFM, Inc. at $37 per share, whereas their true value was up to $200 (Second Amended Compt. paragraphs 15, 16, 17, 18).

Further, plaintiffs alleged that defendants knew the artificially low value would materially affect investment decisions and alleged that plaintiff Guine relied on the low statement of Qonaar's earnings contained in its tender offer solicitations in selling her 100 shares of Qonaar stock to KFM, Inc. in the fall of 1981. Plaintiffs claimed that the "artificial depression or sabotage of Qonaar income, communicated to the * * * shareholders * * * in connection with the tender offer * * * constituted a manipulative and a deceptive device and contrivance" in violation of Section 10(b) Count II realleged the actions taken by defendants in Count I and added that defendants omitted five additional facts in their tender offer in violation of Section 14(e) of the Williams Act (15 U.S.C. Sec. 78n(e)). ³ This Count also sought $20,000,000 in damages for Qonaar shareholders.

and Rule 10b-5. The individual plaintiffs and the class suffered economic injury in excess of $20,000,000. ²

Finally, the second amended complaint contained six class action allegations, stating that the individual plaintiffs were typical of the class of Qonaar shareholders because they were not privy to the defendants' alleged scheme of understating the true value of Qonaar securities in order to acquire the outstanding Qonaar stock at $37 per share.

Late in February 1982, defendants filed a motion to dismiss the second amended complaint or for summary judgment in their favor. On March 29, the district court filed a memorandum opinion and order granting defendants' motion to dismiss (App. A-11 to A-20). After citing several cases from this Circuit and the Second Circuit, Judge Kocoras concluded that the plaintiffs had standing to sue, a conclusion no longer contested by defendants. However, he determined that the series of acts alleged in both Counts as taken by defendants to reduce Qonaar revenues, increase its expenses, accelerate its depreciation and reduce its assets involved at most a breach of fiduciary duty, justifying dismissal of both Counts under Santa Fe Indus., Inc. v. Green, 430 U.S. 462, 97 S.Ct. 1292, 51 L.Ed.2d 480. In reliance on Part IV of Santa Fe, id. at 477-480, 97 S.Ct. at 1303-1304, the court found there was no federal cause of action here because breach of fiduciary duty or corporate mismanagement claims were traditionally relegated to state law. A remedy existed in this case under Delaware law, which supplied minority shareholders with a cause of action in its Court of Chancery to recover the fair value of shares allegedly undervalued in a short-form merger. The district judge also ruled that Richard and Donna Atchleys' claims under both Counts I and II should be dismissed because, by virtue of his position as president of Qonaar's Mass Transit Division from April to October 16, 1981, ⁴ he had access to records from which he could determine whether the tender offer material included misrepresentations and misstatements. Since the "sum total of the information available to Atchley was sufficient to alert any reasonable person to misstatements or omissions" (App. A-17), the court presumed that Atchley would have conveyed such information to his wife. Therefore Judge Kocoras thought the Atchleys had not established that they reasonably relied on information provided by defendants and that they exercised due diligence in examining information otherwise available to them.

Consequently, the second amended complaint was dismissed, resulting in this appeal. On careful analysis, we conclude that the second amended complaint was not based solely on a breach of fiduciary duties or corporate mismanagement and reverse and remand.

Adequacy of Securities Exchange Act Count

Judge Kocoras granted the motion of defendants to dismiss the second amended In Count I, plaintiffs rely upon Section 10(b) of the Securities Exchange Act of 1934 (15 U.S.C. Sec. 78j). In pertinent part, Section 10(b) forbids persons to employ in connection with the sale of any security "any manipulative or deceptive device or contrivance" in contravention of the SEC's rules and regulations. In conjunction with Section 10(b) they also rely upon SEC Rule 10b-5, 17 C.F.R. Sec. 240.10b-5, which provides as follows:

                complaint rather than granting them summary judgment in accordance with the alternative prayer of their supporting memorandum.  Accordingly, the district court and we must take the allegations of the second amended complaint as true.   Cruz v. Beto, 405 U.S. 319, 322, 92 S.Ct. 1079, 1081-1082, 31 L.Ed.2d 263 (per curiam);  Mitchell v. Archibald & Kendall, Inc., 573 F.2d 429, 432 (7th Cir.1978)
                

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,

(a) To employ any device, scheme, or artifice to defraud,

(b) 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

(c) 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.

Judge Kocoras ruled that Count I failed to state a claim under either Section 10(b) or Rule 10b-5 on the ground that Count I only alleged a "breach of fiduciary duty owed by defendants to minority shareholders of the target company," corporate mismanagement, or impure motives (App. A-16). It is true that under Santa Fe Indus., Inc., supra, plaintiffs' claims would not be cognizable under these provisions if they only involved a breach of fiduciary duty or corporate mismanagement. It is also true that a party cannot " 'bootstrap' such a claim...