Frigitemp Corp. v. Financial Dynamics Fund, Inc.

• Decision Date: 14 October 1975
• Docket Number: No. 963,D,963
• Parties: Fed. Sec. L. Rep. P 95,323 FRIGITEMP CORP. et al., Plaintiffs-Appellants, v. FINANCIAL DYNAMICS FUND, INC., et al., Defendants-Appellees. ocket 75-7030.
• Court: U.S. Court of Appeals — Second Circuit

Page 275

524 F.2d 275

Fed. Sec. L. Rep. P 95,323

FRIGITEMP CORP. et al., Plaintiffs-Appellants, v. FINANCIAL DYNAMICS FUND, INC., et al., Defendants-Appellees.

No. 963, Docket 75-7030.

United States Court of Appeals, Second Circuit.

Argued June 18, 1975.

Decided Oct. 14, 1975.

Gerald D. Fischer, New York City (Blackman, Lefrak, Feld & Fischer and Lloyd D. Feld, New York City, of counsel), for plaintiffs-appellants.

Michael C. Devine, New York City (Butowsky, Schwenke & Devine, New York City, of counsel), for defendants-appellees Financial Dynamics Fund, Inc., Financial Industrial Fund, Inc. and Financial Venture Fund, Inc. Barry H. Garfinkel, New York City (Skadden, Arps, Slate, Meagher & Flom, New York City, and Ireland, Stapelton, Pryor & Holmes, P. C., Denver, Colo., of counsel), for defendants-appellees Financial Programs, Inc., Robert E. Anton and John M. Butler.

Before GIBBONS, ^* GURFEIN and MESKILL, Circuit Judges.

GURFEIN, Circuit Judge:

This is an appeal from a judgment of the United States District Court for the Southern District of New York, Charles H. Tenney, Judge, dismissing the complaint pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure for failure to state a claim upon which relief can be granted. Plaintiff Frigitemp Corp. (Frigitemp) is a New York corporation. The four individual plaintiffs, Gerald Lee, Gerald Ross, Henry Gutman and Leon Guttman were stockholders of Frigitemp. Defendants Financial Dynamics Fund, Inc. (FDF), Financial Industrial Fund, Inc. (FIF) and Financial Venture Fund, Inc. (FVF) (collectively called "the Funds") are publicly owned, open end investment companies, commonly known as mutual funds, located in Colorado. They are managed by defendant Financial Programs, Inc. The individual defendants named in the complaint, Robert Anton and John M. Butler, were officers and employees of the defendant corporations. Jurisdiction is asserted on diversity of citizenship, 28 U.S.C. § 1332, Section 27 of the Securities Exchange Act of 1934, 15 U.S.C. § 78aa, and Section 22 of the Securities Act of 1933, 15 U.S.C. § 77v.

The essential facts pleaded, which we must take to be true are as follows. Frigitemp had an initial public offering in January 1969. The individual appellants owned more than a majority of the outstanding shares of common stock after the offering. On August 29, 1969, FVF purchased from Frigitemp in a private placement $1,000,000 principal amount of a 5% convertible subordinated debenture due 1984 and warrants to purchase 50,000 shares of Frigitemp's common stock until September 12, 1972 at prices between $17 and $19 per share, for one million dollars. In negotiating for the private placement the defendants allegedly received "material, confidential and 'inside' information concerning the business and affairs of Frigitemp."

As a condition of the private placement, the individual plaintiffs were required by the purchaser of the debenture to contribute 100,000 shares of common stock to the capital of Frigitemp.

By the time of the private placement, the three Funds had already purchased a substantial number of Frigitemp shares on the over-the-counter market but failed to disclose that fact to the plaintiffs. The Funds continued to buy shares in the over-the-counter market thereafter without having disclosed their intention to do so. Between March 1969 and March 1970, the three Funds bought an aggregate of 142,100 shares of Frigitemp common stock on the market, thus acquiring all but a small part of the shares in public hands. As a result of the purchases by the Funds the market price of Frigitemp common rose from $15.25 to $37 per share.

In February and March 1970, FVF and FDF sold about 18,000 shares for a profit of $130,000, allegedly on the basis of the "inside" information they received before August 29, 1969. In 1971 the Funds sold the balance, about 123,000 shares, and "depressed the price of the stock to $8 per share, thereby causing substantial damages to the remaining shareholders of Frigitemp." ¹

It is also alleged that a class action has been brought against two of the individual appellants and Frigitemp by persons who purchased Frigitemp stock and incurred losses. This complaint alleges that these losses were the direct result of the appellees' "misuse of . . . 'inside' information" and their "wrongful manipulation of the market price of the common stock of Frigitemp." There is no allegation, however, setting forth any fact supporting the charge of "manipulation." See Fed.R.Civ.P. 9(b). All that is alleged is that large purchases were made. We treat the gravamen of the complaint as the alleged use of confidential information and the making of large purchases by the Funds without disclosure of this fact to appellants.

The essence of the complaint is that the defendants failed to disclose, when negotiating the private placement and the condition that the individual appellants contribute 100,000 shares to the capital of Frigitemp, that they already owned a substantial amount of Frigitemp common and intended to purchase most of the public float on the basis of the "inside" information they were receiving.

There is no allegation that Frigitemp would not have sold the debenture if it had known these "facts." There is an allegation, however, that the individual appellants would not have contributed their 100,000 shares if they had known.

Four claims for relief are stated, two on behalf of Frigitemp, and two on behalf of the individual appellants. Judge Tenney dismissed all the claims. We affirm.

Claim # 1

Frigitemp seeks to recover a profit of $130,000 which defendants realized from the purchase and sale of Frigitemp common on the theory that under the facts alleged the defendants committed common law fraud and deceit. Judge Tenney dismissed the Frigitemp common law claim on the ground that Frigitemp was not a defrauded party. Appellants contend that Frigitemp, as a corporate entity, may recover profits made by the defendants through their trading in its shares on the basis of confidential and inside information freely given to the defendants during the negotiations for the purchase of the $1,000,000 debenture. Appellant founds its claim upon the theory that the appellees breached a "duty of trust owed to it."

Frigitemp relies upon Diamond v. Oreamuno, 24 N.Y.2d 494, 301 N.Y.S.2d 78, 248 N.E.2d 910 (1969), for its theory of common law fiduciary duty. There the New York Court of Appeals did sustain a complaint by a corporation seeking recovery from its officers and directors of profits derived from the use of corporate inside information, without an allegation that the corporation was itself damaged. But the theory of the Oreamuno case was that there had been a breach of a fiduciary duty, the officers and directors being treated as agents or trustees. On familiar principles of equity a fiduciary may be required to account to his cestui for profits made through his use of confidential information belonging to the cestui. See Byrne v. Barrett, 268 N.Y. 199, 197 N.E. 217 (1935); Restatement (Second) of Agency § 388, comment c (1958). Chief Judge Fuld made this clear by analogizing the suit in Oreamuno to the federal statutory remedy of Section 16(b) of the Securities Exchange Act, 15 U.S.C. § 78p(b), 24 N.Y.2d at 500-01, 301 N.Y.S.2d at 82-84, 248 N.E.2d at 913-14, which is based on breach of fiduciary duty. See American Standard, Inc. v. Crane Co., 510 F.2d 1043, 1060-61 (2 Cir. 1974).

The appellees here were never officers or directors or even employees of Frigitemp. ² See Brophy v. Cities Service Co., 31 Del.Ch. 241, 70 A.2d 5 (1949) (sustaining a derivative suit seeking to recover from an employee of a corporation the profits he allegedly made through use of confidential information).

In contending that the Oreamuno case supports recovery even against persons not in the corporate employ appellant cites Schein v. Chasen, 478 F.2d 817 (2 Cir. 1973), vacated on other grounds, 416 U.S. 386, 94 S.Ct. 1741, 40 L.Ed.2d 215 (1974). The majority of the panel there went no further than to hold, against the vigorous dissent of Judge (now Chief Judge) Irving R. Kaufman, that a co-venturer of the director who breaches his duty may be "subject to the same liabilities as those of the director himself for the misuse of corporate information." 478 F.2d at 822. ³ The predicate for liability was the breach of a fiduciary duty to the corporation. Thus, an underwriter who manages a public distribution of a corporation's shares is a fiduciary of the corporation and may not profit from corporate information obtained in its capacity as underwriter. Shapiro v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 353 F.Supp. 264 (S.D.N.Y.1972), aff'd, 495 F.2d 228 (2 Cir. 1974). ⁴

The authorities cited by appellant do not go beyond breaches of fiduciary duty. There is no reason to believe that the state courts of New York are likely to go further.

The information supplied by Frigitemp was information that Frigitemp, which was not in registration, was required to disclose to a person about to lend it $1,000,000, or, in the language of securities law, about to buy its debenture. Given the duty to disclose and the need for the loan, the corporate officer who gave the information in order to get the loan was not violating his fiduciary duty. Nor was the buyer of the debenture culpable as a co-venturer of a faithless trustee. The dealings were at arm's length. The corporate officer had the right to make the inside information available. The other party had the right to request it. We need not determine whether the buyer owed a duty to market traders to refrain from buying or selling the shares of Frigitemp based on such information, since such persons are not plaintiffs in this action. Our inquiry is limited to whether the corporation, the seller of the debenture, has a claim for relief.

We hold merely that appellees were under no fiduciary duty to the...