Cohen v. Colvin, 66 Civ. 197.

• Decision Date: 15 March 1967
• Docket Number: No. 66 Civ. 197.,66 Civ. 197.
• Citation: 266 F. Supp. 677
• Parties: Michael COHEN, Plaintiff, v. Charles H. COLVIN et al., Defendants.
• Court: U.S. District Court — Southern District of New York

266 F. Supp. 677

Michael COHEN, Plaintiff, v. Charles H. COLVIN et al., Defendants.

No. 66 Civ. 197.

United States District Court S. D. New York.

March 15, 1967.

COPYRIGHT MATERIAL OMITTED

Louis Kipnis, New York City, for plaintiff.

Cleary, Gottlieb, Steen & Hamilton, New York City, William L. Lynch, Geo. Weisz, Allan R. Tessler, New York City, of counsel, for individual defendants.

Gasperini, Koch & Savage, New York City, for corporation defendant.

MEMORANDUM

TENNEY, District Judge.

Certain named defendants move pursuant to Rules 12(b) (1) and (6) of the Federal Rules of Civil Procedure for dismissal of plaintiff's complaint for lack of jurisdiction and for failure to state a claim upon which relief can be granted.¹

Plaintiff, a stockholder of the Fairchild Hiller Corporation (hereinafter referred to as "Fairchild"), brings this action individually and on behalf of all stockholders similarly situated, and on behalf of Fairchild, claiming a violation by the defendants of Sections 10(b) and 14(a) of the Securities Exchange Act of 1934 (48 Stat. 891 (1934), 15 U.S.C. § 78j (1964); 78 Stat. 569 (1964), as amended, 15 U.S.C. § 78n (1964)), and Rules 10b-5 and 14a-9 promulgated pursuant thereto (17 C.F.R. §§ 240.10b-5, 240.14a-9). Plaintiff invokes the jurisdiction of this Court solely under Section 27 of the Securities Exchange Act (48 Stat. 902 (1934), 15 U.S.C. § 78aa (1964)).

Plaintiff's complaint alleges that Fairchild is a Maryland corporation doing business in New York with its shares being traded on the New York Stock Exchange. Paragraph 5 of the complaint states that on June 30, 1965, Fairchild was authorized to issue 5,000,000 shares of common stock. Of this amount, approximately 3,000,000 shares were outstanding with a so-called "Insider Group" of directors holding approximately 10% of the outstanding shares, giving this group "effective working control" of Fairchild. Paragraph 6 alleges that the "Insider Group" dominated the management policies of Fairchild and controlled the board of directors. Paragraph 7 realleges the control of the "Insider Group" and states that this group can perpetuate itself through the proxy machinery of the corporation.

Paragraphs 8 and 9 contain the crux of plaintiff's claim that Section 10(b) and Rule 10b-5 have been violated. It is there recited that commencing in 1964, Fairchild decided to acquire shares of Republic Aviation Corporation (hereinafter referred to as "Republic") for the purpose of effecting a future amalgamation of the two companies. This decision was not made public. Plaintiff contends that the amalgamation would require Fairchild to sell 1,500,000 new shares of stock at a value of $15,000,000. It is further alleged that the defendants were duty bound not to compete with Fairchild in the acquisition of Republic shares and were prohibited from using this confidential information for their own benefit or disclosing it to others.

Paragraph 10 states that in 1964 Fairchild acquired 257,000 shares of Republic stock at a cost of approximately $3,690,000. At the same time that Fairchild was obtaining these shares, plaintiff contends that the defendants and their associates purchased 170,000 shares of Republic. The complaint alleges that Fairchild had sufficient resources to purchase the shares acquired by the defendants.

By reason of the Fairchild holdings in Republic, two of Fairchild's directors (two of the named defendants) became directors of Republic. These directors worked toward obtaining a purchase agreement and such agreement was reached on August 10, 1965. The agreement provided for the sale of selected Republic assets to Fairchild, with Fairchild to pay a certain amount of cash at the closing; in addition, Fairchild was to issue to Republic a one-half share of Fairchild common stock for each outstanding share of Republic. Plaintiff claims that Republic was obliged to ultimately distribute these shares to its shareholders, while defendants claim that this was only one of several alternatives available to Republic.

It is further alleged that 1,500,000 Fairchild shares were issued to Republic, which intended to distribute said shares to its stockholders, including Fairchild and the defendants, who were to be treated in the same manner as any other stockholder. It is plaintiff's contention that in this manner defendants were to acquire 85,000 shares of Fairchild stock which plaintiff claims have a market value of at least $850,000. According to plaintiff, the acquisition of Fairchild shares through Republic constituted a purchase by the defendants of Fairchild shares from Fairchild, and that defendants' actions in obtaining these shares amounted to violations of Section 10(b) and Rule 10b-5.

Plaintiff further alleges that the defendants prepared and circulated to the Fairchild shareholders a notice of special meeting, proxy statement and proxy, authorizing the persons named therein to vote in favor of the proposed acquisition of Republic assets. Plaintiff claims that said proxy statement was false and misleading in that it omitted certain material facts about the role of the defendants in the acquisition and that such omissions constituted violations of Section 14(a) and Rule 14a-9. The various claimed omissions will be fully set forth below.

Finally, plaintiff's complaint adds a cause of action under state law for defendants' violation of their fiduciary duties to the corporation. Plaintiff invokes the doctrine of pendent jurisdiction in order to sustain the Court's jurisdiction to determine this cause of action.

Section 10(b)² of the Securities Exchange Act and Rule 10b-5³ promulgated thereunder attempt to prohibit the use of certain manipulative or deceptive devices in connection with the purchase or sale of securities. In order to state a cause of action under these provisions, certain essential elements must be set forth in plaintiff's complaint. See Barnett v. Anaconda Co., 238 F.Supp. 766, 775 (S.D.N.Y.1965). After careful consideration, I have concluded that certain of these essential elements are missing, and, hence, plaintiff's cause of action under these provisions must be dismissed.

To begin with, these provisions require the plaintiff to be either a purchaser or a seller of a security. As stated by the Court in Birnbaum v. Newport Steel Corp., 193 F.2d 461, 464 (2d Cir.), cert. denied, 343 U.S. 956, 72 S.Ct. 1051, 96 L.Ed. 1356 (1952):

Section 10(b) * * * was directed solely at that type of misrepresentation or fraudulent practice usually associated with the sale or purchase of securities rather than at fraudulent mismanagement of corporate affairs, and that Rule X-10B-5 extended protection only to the defrauded purchaser or seller.

It is now clear that a corporation as a purchaser or seller of stock may assert a claim under Section 10(b) and Rule 10b-5. New Park Mining Co. v. Cranmer, 225 F.Supp. 261 (S.D.N.Y. 1963); Pettit v. American Stock Exch., 217 F.Supp. 21 (S.D.N.Y.1963). But a third person cannot assert claims based upon purchases or sales to which he was not a party. Birnbaum v. Newport Steel Corp., supra; New Park Mining Co. v. Cranmer, supra. In this case, Fairchild did not sell any of its stock to the defendant directors. Fairchild's only "sale"⁴ of stock was the transfer of 1,500,000 Fairchild shares to Republic pursuant to the amalgamation agreement between the two corporations. Pursuant to this agreement, Republic was given several options: (1) selling the 1,500,000 newly-acquired Fairchild shares to selected purchasers; (2) making a public distribution of said shares; and (3) distributing said shares to existing shareholders (including the defendant directors). (See exhibit B to Uhl affidavit at 27.) It would be straining logic for this Court to hold that Fairchild "sold" its stock to the defendants because Republic chose the third alternative and thereby the Fairchild stock eventually found its way into the hands of the defendants.

Similarly, Fairchild never purchased any shares of stock from the defendants. The only relevant purchase made by Fairchild was its purchase of 257,000 shares of Republic stock, and this purchase in no way involved the defendants. The defendants did make a stock purchase, but this purchase was of Republic shares, not Fairchild shares. Once again, it would be going quite far to state that the defendants "purchased" stock from Fairchild when they purchased Republic shares because the defendants' shares of Republic were later exchanged for shares of Fairchild pursuant to the amalgamation agreement.

In this connection, it should be noted that at the time the defendants purchased Republic stock, they could neither be sure that any amalgamation would take place nor could they have possibly known of the issuance of Fairchild shares to Republic stockholders as part of any amalgamation. The uncontested affidavit of Edward Uhl, President of Fairchild, makes it clear that the defendants' purchases of Republic stock were made months prior to the formulation of the plan of amalgamation which was finally adopted, and the manner in which Republic would distribute its newly-acquired Fairchild shares was not decided upon until long after the defendants purchased their Republic stock. Under such circumstances, the purchase by the defendants of Republic stock looked more like a risky business venture on their part rather than a calculated plan by the defendants to make unfair use of inside information and thus appropriate to themselves the benefits of the proposed amalgamation. A recent law review article discussing Section 10(b) has stated

"If the board of directors of two companies have agreed in principle to a merger on specified terms, certainly insiders should thereafter be precluded from trading. On the other hand, where negotiations have just commenced and the parties have established no operating guidelines, such as a favorable rate of exchange for the stock of one company, it can be

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