Byrnes v. Faulkner, Dawkins and Sullivan

• Decision Date: 04 April 1977
• Docket Number: Nos. 267,D,673,s. 267
• Citation: 550 F.2d 1303
• Court: U.S. Court of Appeals — Second Circuit
• Parties: Fed. Sec. L. Rep. P 95,891 Thomas J. BYRNES and Francis R. Santangelo, Plaintiffs-Appellants, v. FAULKNER, DAWKINS & SULLIVAN and Singer & Mackie, Inc., Defendants-Appellees. FAULKNER, DAWKINS & SULLIVAN, Counterclaim-Plaintiff, Appellee, Appellant, v. Thomas J. BYRNES and Francis R. Santangelo, Counterclaim-Defendants, Appellants, Appellees, and Tobey & Kirk, Counterclaim-Defendant-Appellee. ockets 76-7259, 76-7276.

Page 1303

550 F.2d 1303

Fed. Sec. L. Rep. P 95,891

Thomas J. BYRNES and Francis R. Santangelo, Plaintiffs-Appellants, v. FAULKNER, DAWKINS & SULLIVAN and Singer & Mackie, Inc.,

Defendants-Appellees.

FAULKNER, DAWKINS & SULLIVAN, Counterclaim-Plaintiff, Appellee, Appellant, v. Thomas J. BYRNES and Francis R. Santangelo, Counterclaim-Defendants, Appellants, Appellees, and Tobey & Kirk, Counterclaim-Defendant-Appellee.

Nos. 267, 673, Dockets 76-7259, 76-7276.

United States Court of Appeals, Second Circuit.

Argued Dec. 8, 1976.

Decided March 1, 1977.

As Amended April 4, 1977.

Reginald Leo Duff, New York City (Carro, Spanbock, Londin, Rodman & Fass, New York City, of counsel), for plaintiffs-appellants.

I. Michael Bayda, New York City (Norman Trabulus, Jacobs, Persinger & Parker, New York City, of counsel), for defendant-appellee Faulkner, Dawkins & Sullivan.

Before MEDINA, HAYS ^* and OAKES, Circuit Judges.

OAKES, Circuit Judge:

These appeals are by would-be sellers of stock from decisions granting one buyer judgment on its "second affirmative defense" to the sellers' suit for breach of contract and dismissing claims against a secondary buyer for lack of subject matter jurisdiction. The first buyer cross-appeals from a dismissal of its counterclaims for punitive damages and lost profits it would have obtained on a resale of part of the shares agreed to be sold. The principal issue on appeal is whether the United States District Court for the Southern District of New York, Henry F. Werker, Judge, correctly upheld the affirmative defense of the appellee-buyer, a broker-dealer, that the contract for sale of stock was unenforceable because the written "comparison" sent to it by appellant sellers' agent constituted a prospectus as defined in Section 2(10) of the Securities Act of 1933 (the 1933 Act), 15 U.S.C. § 77b(10), did not contain the information required of a prospectus by Section 10 of that Act, 15 U.S.C. § 77j, and was therefore unlawful under Section 5(b)(1), 15 U.S.C. § 77e(b)(1). 413 F.Supp. 453, 459-64 (S.D.N.Y.1976). We affirm the judgments.

Facts

Insofar as here relevant, the facts were stipulated below and are not in dispute. Byrnes, Santangelo, and their associates (hereinafter sellers or appellants) were the owners of 148,000 shares of stock of White Shield Corp. on and after September 6, 1968. This stock had been acquired from certain officers or directors of White Shield. It was not registered under the 1933 Act and therefore could not readily be sold, but appellants had acquired the right to include the stock in a registration statement filed at some future time under the Act.

In 1971 White Shield filed several registration statements under the Act. Appellants' stock was included in one that was a so-called "shelf registration" or "shelf secondary," that is, a registration statement filed on behalf of certain named owners of theretofore unregistered shares who, the statement indicates, could then sell the stock in the open market "from time to time," generally through member firms of the National Association of Securities Dealers, Inc. (NASD). The prospectus offering for sale appellants' shares and those of some 25 other selling shareholders bears the same date that the registration statement gained final Securities and Exchange Commission (SEC) approval or "became effective": June 7, 1971. Just before June 7, appellants arranged with Tobey & Kirk, a securities broker-dealer registered with the SEC and a member firm of the NASD, to sell their stock when the registration statement became effective, and appellants delivered to Tobey & Kirk copies of a preliminary or "red herring" prospectus.

On June 7, 1971, Tobey & Kirk agreed to sell to Faulkner, Dawkins & Sullivan (hereinafter Faulkner, buyer, or appellee), at a price of $14 per share, 44,000 shares of the White Shield stock owned by appellants and included in the White Shield registration statement. At that time Faulkner was a "market-maker" ¹ in White Shield stock and regularly entered bid and asked quotations in the "Pink Sheets" of the National Quotation Bureau, Inc., and in NASDAQ, the automated quotation system of the NASD. On or about June 7, 1971, Faulkner sent a written "comparison" or confirmation of the purchase to Tobey & Kirk, showing that Faulkner was a market-maker in White Shield stock, and Tobey & Kirk on the same day sent a written comparison of the sale to Faulkner. This latter comparison did not show that the stock was part of a registered distribution, and it was not preceded or accompanied by a prospectus.

Only with delivery of the stock certificates themselves on June 15, 1971, did Tobey & Kirk deliver a prospectus to Faulkner. At that time Faulkner rejected the securities and informed Tobey & Kirk that the transaction was illegal. ² The prospectus identified the selling shareholders and said that both they and the participating members of the NASD who rendered assistance to them in connection with the sale "may be deemed to be underwriters as that term is defined in the (1933 Act)."

In respect to the counterclaim here in suit, on June 7, 1971, following the agreement with Tobey & Kirk, Faulkner agreed to sell to Singer & Mackie, Inc., a broker-dealer, 15,000 shares of White Shield at 14 1/8 per share for a markup of $1,875, the amount sought as compensatory damages by Faulkner in the counterclaim. That trade was cancelled without penalty when Faulkner rejected the securities proffered by Tobey & Kirk.

Appellants subsequently resold the rejected White Shield stock in the open market for considerably less than the $14 per share purchase price of the June 7, 1971, agreement. They then brought suit in the Supreme Court of New York County, alleging breach of contract and repudiation without just cause. In that suit Faulkner's answer asserted nine affirmative defenses, three alleging violations of the 1933 Act, three alleging violations of the Securities and Exchange Act of 1934, and three, relating primarily to the amount of damages, invoking state law or NASD regulations relative to resales. Appellants then filed an action in the United States District Court, seeking a declaratory judgment that the federal defenses to the state court suit were insufficient as a matter of law, but seeking no damages; the parties agreed to stay the state action pending the federal court decision. In federal court Faulkner reasserted the same nine defenses it had asserted in state court and added three counterclaims, the first for a declaratory judgment of the sufficiency of the defenses, the second charging a violation of SEC Rule 10b-6 and seeking compensatory and punitive damages, and the third charging a violation of Rule 10b-5 and seeking the identical compensatory and punitive damages. An opinion of then District Judge Murray I. Gurfein, reported at 362 F.Supp. 864 (S.D.N.Y.1973), dismissed the federal action brought by appellants for lack of subject matter jurisdiction but found that federal jurisdiction did exist over the counterclaims asserted by Faulkner under Section 17 of the 1933 Act, 15 U.S.C. § 77q, and Section 10 of the Securities Exchange Act of 1934, 15 U.S.C. § 78j. ³ So finding, Judge Gurfein granted appellants leave to answer the counterclaims and to assert as their own counterclaims the breach of contract claims that formed the basis for the original suit; the judge did so on the basis that they were cognizable in federal court as compulsory counterclaims under Fed.R.Civ.P. 13(a), a conclusion not challenged here. Thus, in the peculiar procedural posture of this case, appellants' "counterclaims" really restate their original claims as plaintiffs in federal court. The action was then heard by Judge Werker, who issued the substantive judgment appealed from here, following upon an agreed statement of certain facts and affidavits supporting cross motions for summary judgment.

The Affirmative Defense

Faulker's "second affirmative defense," on which it prevailed by summary judgment below, was that its contract with appellants should not be enforced because Section 5(b)(1) of the 1933 Act, 15 U.S.C. § 77e(b)(1), was violated. The violation was a result, the defense runs, of Tobey & Kirk's omission to disclose the information that the Act requires to be in a prospectus when Tobey & Kirk sent its "comparison" to Faulkner. Section 5(b)(1) makes it "unlawful for any person, directly or indirectly to make use of any means . . . of . . . communication in interstate commerce . . . to carry or transmit any prospectus relating to any security with respect to which a registration statement has been filed . . . unless such prospectus meets the requirements of (Section 10 of the Act, 15 U.S.C. § 77j)." Section 10 essentially requires the prospectus, or selling circular, to contain or be accompanied by a document that includes the information found in the registration statement itself. It is conceded that Tobey & Kirk's comparison did not satisfy the requirements of Section 10.

Appellants' first response is based upon their reading of Section 2(10) of the 1933 Act, 15 U.S.C. § 77b(10), which states, however, that " unless the context otherwise requires . . . (t)he term 'prospectus' means any prospectus, notice, circular, advertisement, letter, or communication . . . which offers any security for sale or confirms the sale of any security . . ." (emphasis added). Appellants admit, as they must, that their comparison falls within the literal terms of Section 2(10), but they argue, relying on the caveat "unless the context otherwise requires," that a comparison should not be deemed a prospectus in the context of an interbroker confirmation. They do recognize, however, that the party seeking to avoid the explicit language of the statute has the burden of proof. Exchange National Bank v. Touche Ross & Co., 544 F.2d 1126, 1137-1138 (2d Cir. 1976).

Appellants direct us to the history of Section 2(10), pointing out that its...