Goodall v. Columbia Ventures, Inc., No. 73 Civ. 3688-LFM.

• Court: United States Courts of Appeals. United States Court of Appeals (5th Circuit)
• Citation: 374 F. Supp. 1324
• Docket Number: No. 73 Civ. 3688-LFM.
• Parties: McChesney GOODALL, Plaintiff, v. COLUMBIA VENTURES, INC., et al., Defendants.
• Decision Date: 29 April 1974

374 F. Supp. 1324

McChesney GOODALL, Plaintiff,
v.
COLUMBIA VENTURES, INC., et al., Defendants.

No. 73 Civ. 3688-LFM.

United States District Court, S. D. New York.

April 29, 1974.

374 F. Supp. 1325

COPYRIGHT MATERIAL OMITTED

374 F. Supp. 1326

Shearman & Sterling, New York City, for defendants; Danforth Newcomb, New York City, of counsel

White & Case, New York City, for plaintiff; Peter M. Collins and Ted Neuenschwander, New York City, of counsel.

374 F. Supp. 1327

OPINION

MacMAHON, District Judge.

Defendants move, pursuant to Rule 12(b)(6) and (c), Fed.R.Civ.P., for an order dismissing the first, second, fourth and fifth claims for relief alleged in plaintiff's complaint, or, in the alternative, for an order granting defendants judgment on the pleadings. Plaintiff cross-moves to dismiss the two counterclaims pleaded in defendants' amended answer for failure to state a claim upon which relief can be granted, pursuant to Rule 12(b)(6), Fed.R.Civ.P.

Plaintiff is the owner of 90,000 shares of common stock of Chemical Separations Corporation (Chem Seps), a Tennessee corporation, which produces machinery and processes for water purification. Defendant Columbia Ventures, Inc. (Columbia), a New York corporation, formerly known as Small Business Investment Company of New York, Inc., is a small business investment company, licensed by the Small Business Administration and registered with the Securities and Exchange Commission under the Investment Company Act of 1940, 15 U.S.C. § 80a-8. Columbia is the majority stockholder of Chem Seps. The individual defendants are (or were) directors of Chem Seps and are officers of Columbia.

The complaint alleges that plaintiff has been injured by two transactions allegedly engineered by Columbia, through its control of a majority of the Chem Seps' board of directors, including the individual defendants. The first transaction involved the sale to Columbia of all of Chem Seps' patents and patent rights, which comprise virtually all of its assets, in exchange for 8,000 shares of Chem Seps' $100 par value preferred stock owned by Columbia. The second transaction was the issuance of 1.1 million shares — 52% — of Chem Seps' then outstanding common stock, at 10¢ per share,¹ to Foster Wheeler Corporation (Foster Wheeler), allegedly controlled by the same parent company as Columbia.

Plaintiff claims damages of $500,000 and asserts that defendants have violated the Investment Company Act of 1940;² § 10(b) of the Securities Exchange Act of 1934³ and SEC Rule 10b-5 promulgated thereunder;⁴ § 48-816 of the Tennessee Corporation Code; §§ 107.1004(a) and 107.901(a) of the Small Business Administration Regulations;⁵ and the common law. Jurisdiction is based on § 27 of the Exchange Act,⁶ § 45 of the Investment Company Act,⁷ and the principles of pendent jurisdiction.

We turn, first, to defendants' motion.

Plaintiff's first claim asserts a violation of § 17(a) of the Investment Company Act, which prohibits certain transactions by persons affiliated with registered investment companies.⁸ Defendants

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contend that since plaintiff is not the owner of an interest in any investment company, including Columbia, he lacks standing under the Investment Company Act

There can be no doubt that the Investment Company Act supports a private right of action for damages.⁹ We must decide, however, whether that private right of action may be asserted by a plaintiff who has no ownership interest in an investment company. Plaintiff claims that he states a valid claim for relief under the Act because he has been injured as a result of defendants' violation of the Act.

The Investment Company Act of 1940 was enacted by congress to correct and prevent a variety of abuses in the management of investment companies.¹⁰ The legislation was intended by congress to benefit those persons who had ownership interests in investment companies.¹¹ The statute was not, however, designed to regulate the management of companies in which investment companies invested their funds or to protect the security holders of those companies.¹²

It is well established that where a private right of action is implied from a statute, a violation of the statute is actionable only by those within the class of persons the statute was designed to protect.¹³ Thus, the private right of action under the Investment Company Act should extend only to persons holding ownership interests in investment companies. Courts have generally denied standing to sue under the Investment Company Act to persons who lack such an ownership interest.¹⁴

In Independent Investor Protective League v. Securities and Exchange Comm'n, 495 F.2d 311 (2d Cir. 1974), and Herpich v. Wallace, 430 F.2d 792 (5th Cir. 1970), where plaintiffs claimed, as does plaintiff here, that an investment company was abusing its power as a controlling shareholder in plaintiffs' corporation to their injury, standing to sue was denied because the damage allegedly suffered by plaintiffs was outside the scope of interests protected by the Investment Company Act.¹⁵ The court, in Herpich, said "plaintiffs must look elsewhere than to the Investment Company Act for a remedy."¹⁶

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Similarly, plaintiff here has failed to demonstrate either that he is a member of the class congress intended to protect or that he has suffered a harm actionable under the statute, and, therefore, he lacks standing to assert a private right of action under the Investment Company Act and the first claim asserted in the complaint must be dismissed.

Turning to the second claim, defendants contend that plaintiff lacks standing to sue under § 10(b) of the Securities Act. They argue that since plaintiff is neither a purchaser nor a seller of securities, his standing to sue is barred by the rule of 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). Plaintiff contends that he states a valid § 10(b) claim because defendants violated § 10(b) by issuing false and misleading proxy materials which facilitated the fraudulent sales of Chem Seps' patents to Columbia and stock to Foster Wheeler and because he was damaged as a result of their actions. Birnbaum, plaintiff argues, requires only that a plaintiff be damaged by a fraud in connection with a purchase or sale of securities, not that plaintiff be a purchaser or seller himself.

Although Birnbaum has been widely criticized¹⁷ and its scope narrowed,¹⁸ it is still law in this circuit.¹⁹ It has been consistently held that Birnbaum limits the protection of § 10(b) and Rule 10b-5 "to those who actually purchase or sell securities to their loss in reliance upon the withholding or misrepresentation of material information or other manipulative or deceptive devices."²⁰ Certain exceptions to Birnbaum, however, have been developed. Thus, if the plaintiff is a forced seller, or seeks only injunctive relief, or brings his suit derivatively, Birnbaum is inapplicable.²¹ Where a plaintiff seeks to recover damages for a violation of § 10(b), however, Birnbaum still requires that he be either a purchaser or a seller of the securities involved.²²

Plaintiff does not claim that his suit comes within any of the recognized exceptions to Birnbaum. He contends, nonetheless, that Birnbaum requires only a causal connection between a purchase or sale of securities and a plaintiff's loss, and he cites Heyman v. Heyman, 356 F.Supp. 958 (S.D.N.Y.1973), to support this view.

In Heyman, plaintiff was one of the beneficiaries of a testamentary trust, which, pursuant to a stockholders' agreement, sold securities acquired from the decedent for less than their true value. The court held that although plaintiff was not technically the seller of the securities, the sale was made for her benefit

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and, therefore, the court "should not be loath to look behind the legal technicalities of a transaction in order to protect those whose interests the statute was designed to safeguard."²³ The court found that the standing requirements of Birnbaum were satisfied because the plaintiff was the party who stood to gain or lose by the sale and should therefore be considered the seller of the securities

We agree with the realistic approach of Heyman, but we think Heyman does not depart from the long-standing requirement of this circuit that a § 10(b) plaintiff must be a purchaser or seller of securities. Rather, the case stands for the proposition that in applying Birnbaum to the real world, courts should not exalt the form of transactions over their substance.²⁴

In any event, this case is clearly distinguishable from Heyman. In essence, plaintiff here seeks to recover damages from the defendants for their mismanagement of Chem Seps and breach of their fiduciary duty to shareholders of Chem Seps. Congress did not intend, and the Birnbaum rule has consistently been interpreted, to prevent the use of § 10(b) and Rule 10b-5 as vehicles for suits based on mere corporate mismanagement or breach of fiduciary duty.²⁵ Such claims are commonly cognizable under state law and are not magically transformed into § 10(b) actions merely because the alleged mismanagement or breach of fiduciary duty involved a sale of securities. Where, as here, plaintiff cannot allege that he is a purchaser or seller of securities, he has no standing to sue under § 10(b) or Rule 10b-5. Therefore, plaintiff's second claim must also be dismissed.

The fourth and fifth claims of the complaint are based upon alleged violations by the defendants of §§ 107.1004(a) and 107.901(a)²⁶ of the Small Business Administration (SBA) regulations. The defendants contend that there is no private right of action for violation of the SBA regulations and, therefore, that the fourth and fifth claims should be dismissed.

Neither the regulations themselves, nor the Small Business Investment Act expressly mandate a private right of action for violations....