Eason v. General Motors Acceptance Corporation, 72-1722.

• Decision Date: 28 December 1973
• Docket Number: No. 72-1722.,72-1722.
• Citation: 490 F.2d 654
• Parties: Willard D. EASON et al., Plaintiffs-Appellants, v. GENERAL MOTORS ACCEPTANCE CORPORATION and Dave Waite Pontiac, Inc., Defendants-Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

490 F.2d 654 (1973)

Willard D. EASON et al., Plaintiffs-Appellants, v. GENERAL MOTORS ACCEPTANCE CORPORATION and Dave Waite Pontiac, Inc., Defendants-Appellees.

No. 72-1722.

United States Court of Appeals, Seventh Circuit.

Argued October 19, 1973.

Decided December 28, 1973.

Certiorari Denied April 22, 1974.

James E. Hughes, James K. Sommer, Indianapolis, Ind., for plaintiffs-appellants.

David B. Hughes, Alan W. Boyd, James M. Secrest, Indianapolis, Ind., for defendants-appellees.

Before KILEY and STEVENS, Circuit Judges, and WYZANSKI,^* Senior District Judge.

Certiorari Denied April 22, 1974. See 94 S.Ct. 1979.

STEVENS, Circuit Judge.

Plaintiffs are shareholders of a corporation which purchased a car leasing business from one of the defendants. In connection with the transaction, the corporate purchaser issued 7,000 shares of its stock to the seller, and the plaintiffs individually guaranteed certain liabilities assumed by the purchaser. Plaintiffs accuse both defendants of fraud and seek relief under § 10(b) of the Securities Exchange Act of 1934,¹ 48 Stat. 891, 15 USC § 78j(b), and Securities and Exchange Commission Rule 10b-5.² The question presented is whether their claim is foreclosed by the so-called "Birnbaum rule" which limits private relief for a violation of Rule 10b-5 to persons who were either purchasers or sellers of a security.

The appeal is from an order dismissing plaintiffs' third amended complaint and denying leave to file a fourth. The essential facts are quite simple. Prior to October 31, 1969, one of the defendants (Dave Waite Pontiac, Inc.) operated a Pontiac dealership and also an automobile leasing division. Purchases of cars for the leasing business were financed by General Motors Acceptance Corporation, the second defendant. Bank Service Corporation, a company in which the plaintiffs owned stock, entered into an agreement to purchase the leasing business. As consideration for the business, Bank Service issued 7,000 shares of its stock to Waite and assumed the liabilities of the leasing business, including notes payable to GMAC, and the individual plaintiffs delivered a guarantee of those notes, as well as a guarantee of future liabilities, to GMAC.

The leasing business failed; Bank Service became insolvent and defaulted on the notes.³ GMAC then brought suit in a state court to recover on the guarantees. Plaintiffs countered with this federal action, accusing both defendants of fraud and seeking rescission of the guarantees.

Plaintiffs seek to avoid Birnbaum's purchaser-seller limitation on private relief under Rule 10b-5 in various ways. They contend that their guarantees were securities which they sold to GMAC; that the underlying notes are securities which they are being forced to purchase; that they were indirect sellers of the 7,000 shares of corporate stock; and, in all events, that the Birnbaum limitation should be disavowed in this circuit. Since it would not be necessary to consider stretching the definitions of "purchasers," "sellers," and "securities" if there were no Birnbaum rule, we think it appropriate to examine the viability of that rule first. For purposes of decision, therefore, we assume that the only purchase or sale of a security involved in the transaction was the transfer of 7,000 shares of stock from Bank Service to Waite, and we reject the suggestion that plaintiffs should be characterized as "sellers" of that stock. The question which is thus presented is whether, notwithstanding the fact that they were neither purchasers nor sellers of a security, plaintiffs may obtain relief under Rule 10b-5. In answering that question, we first note that a violation of Rule 10b-5 has been alleged and then consider whether any remedy is available to these plaintiffs.

I.

For present purposes it is conceded that material misstatements and omissions attributable to both GMAC and Waite have been adequately alleged. The 7,000 shares of Bank Service stock were unquestionably "securities" within the meaning of Rule 10b-5. It is also settled that the issuance and delivery of such shares constituted a "sale,"⁴ and further, that even though the alleged fraud related to the value of the assets acquired, rather than the value of the security delivered, the deception was "in connection with" the sale of a security.⁵ Finally, "the fact that the transaction was not conducted through a securities exchange or an organized over-the-counter market is irrelevant to the coverage of § 10(b)." Superintendent of Insurance v. Bankers Life & Casualty Co., 404 U.S. 6, 10, 92 S.Ct. 165, 168, 30 L.Ed.2d 128. In short, defendants do not challenge the conclusion that a violation of Rule 10b-5 has been alleged. Nor would they dispute a federal court's jurisdiction to entertain an appropriate claim by the corporation, Bank Service.⁶ The disputed question is whether plaintiffs, as individual shareholders of Bank Service and guarantors of its indebtedness to GMAC, may assert a Rule 10b-5 claim.

II.

The question of plaintiffs' right to relief has three aspects: (a) whether they have "standing," (b) whether they are protected by the rule, and (c) whether overriding considerations of policy should defeat their claim.

A.

Neither the statute nor Rule 10b-5 expressly authorizes a private remedy. Nevertheless, in a 1946 decision which is now universally followed, Judge Kirkpatrick held that a civil action could be maintained by a member of the class "for whose special benefit the statute was enacted."⁷ The Birnbaum case, decided six years later,⁸ has been read as holding that only the purchaser or the seller of a security may maintain such an action; this purchaser-seller limitation has been frequently described as a "standing requirement."

This "standing requirement" may be interpreted in two quite different ways. On the one hand, it may signify that only purchasers or sellers of securities have legal rights that are protected by Rule 10b-5. In this sense, the analysis of the plaintiff's status — that is to say, his relationship to defendant's violation of Rule 10b-5 — really determines whether the plaintiff is a person who has suffered a legal wrong.⁹

On the other hand, as the term "standing" is more properly used, it assumes that the plaintiff is a member of the class protected by the rule at issue, and addresses the question whether he has a sufficient interest in a real controversy with the defendant to entitle him to invoke the jurisdiction of a federal court. Thus, for example, although a taxpayer, in common with the rest of the citizenry, may be protected by the rule he invokes, he may lack standing to litigate an issue because of the "case" or "controversy" limitation on the exercise of federal judicial power. Frothingham v. Mellon, 262 U.S. 447, 43 S.Ct. 597, 67 L.Ed. 1078. In this sense, the requirement that the plaintiff must have "standing" raises a jurisdictional question under Article III of the United States Constitution.¹⁰

The Birnbaum rule has been interpreted as a standing requirement in this constitutional and jurisdictional sense.¹¹ We are satisfied that such an interpretation of Birnbaum is unwarranted and we have no doubt that the plaintiffs' interest in the controversy before us is sufficient to satisfy the requirements of Article III. Indeed, the parties with a vital stake in the outcome of the dispute are the individual plaintiffs on the one hand and GMAC on the other. One or the other will suffer a loss of approximately $300,000 — the balance allegedly due on the loans made by GMAC to which plaintiffs' guarantees apply. This dispute may certainly be regarded as a "case" or "controversy" between these parties within the meaning of Article III.

In the Birnbaum case itself Judge Hand made no reference to the Constitution and did not mention the word "standing." The decision in that case turned on the court's evaluation of the kind of conduct which was forbidden by Rule 10b-5. The court concluded that the rule was "directed solely at that type of manipulative or fraudulent practice usually associated with the sale or purchase of securities . . ." 193 F.2d at 464. Since the rule at that time was thought to relate only to public sales of securities, the prohibition of that type of activity was quite reasonably understood as intended to afford "protection only to the defrauded purchaser or seller." Ibid. As conceived by its author, the purchaser-seller limitation was thus a description of the court's understanding of the class of persons protected by Rule 10b-5.

Instead of stating the issue in terms of standing, we think it is more useful to ask whether the plaintiffs were members of the class for whose special benefit Rule 10b-5 was adopted. This is the inquiry which is suggested in Judge Kirkpatrick's opinion which originally articulated the basis for finding an implied private remedy under Rule 10b-5.¹²

B.

Judge Hand's formulation of the "Birnbaum rule" in 1952 was an identification of the persons to whom Rule 10b-5 "extended protection." Protection against the type of fraudulent practice usually associated with the sale or purchase of securities appropriately extended "only to the defrauded purchaser or seller." In the last two decades, however, the rule has been interpreted to encompass additional types of misconduct and to extend protection to a variety of persons not included within the traditional definition of either purchaser or seller. Thus, issuers,¹³ trust beneficiaries,¹⁴ merging corporations,¹⁵ minority shareholders in short form mergers,¹⁶ parties to incomplete transactions,¹⁷ offerees,¹⁸ and others¹⁹ have been treated as though they were sellers and thereby accorded the protection of the rule. The course of judicial decision since 1952, when Birnbaum was decided, has actually recognized that the class of protected persons is broader than merely purchasers and sellers.

The language of Rule 10b-5 itself describes any act or practice which operates as...