Hedden v. Marinelli

• Decision Date: 11 March 1992
• Docket Number: No. C 91 0906 RFP FSL.,C 91 0906 RFP FSL.
• Citation: 796 F. Supp. 432
• Court: U.S. District Court — Northern District of California
• Parties: William HEDDEN, an individual; Arnold Gendel, an individual; Plaintiffs, v. Gino A. MARINELLI, an individual; Marie Marinelli, an individual; Defendants. and all Related Cross-Actions.

796 F. Supp. 432

William HEDDEN, an individual; Arnold Gendel, an individual; Plaintiffs, v. Gino A. MARINELLI, an individual; Marie Marinelli, an individual; Defendants. and all Related Cross-Actions.

No. C 91 0906 RFP FSL.

United States District Court, N.D. California.

January 28, 1992.

Judgment, March 11, 1992.

Michael D. Stokes, Leboeuf Lamb Leiby & Macrae, San Francisco, Cal., for plaintiffs.

J. Bradley Russell, Wittman Fedynshyn & Roberts, San Diego, Cal., for defendants.

MEMORANDUM AND ORDER

PECKHAM, District Judge.

INTRODUCTION

This matter comes before the court on Defendants' Gino and Marie Marinelli's motion for summary judgment. Defendant Gino Marinelli seeks summary judgment on Plaintiffs' claims for violation of Sections 12(1) and 12(2) of the Securities Act of 1933 ("the 1933 Act"), Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934 ("the 1934 Act") and breach of contract. Defendant Marie Marinelli claims as a complete defense to all Plaintiffs' charges that she did not own any of the stock and should not, therefore, be a party to this case. Defendant Gino Marinelli further seeks summary judgment on his counterclaim for $60,000 owed from Plaintiff Gendel for stock which Gendel purchased from him.

BACKGROUND

This dispute concerns a sale of stock by Defendant Gino Marinelli to Plaintiffs Hedden and Gendel in 1990. Marinelli sold Plaintiffs stock which he acquired in the American Confectionery Corporation ("ACC") where he served as executive vice-president.

Marinelli acquired his position at ACC when, in 1987, ACC bought the assets of a chocolate company where Marinelli was a management employee. In order to retain the existing management of the purchased chocolate manufacturer, ACC invited Marinelli to remain in their employ and offered him 865,000 shares in ACC as part of his compensation for employment. Marinelli later became the executive vice-president of ACC, president of the ACC candy division and president of certain candy manufacturing enterprises held by ACC.

Sometime in 1990, Marinelli offered his stock in ACC for sale. Plaintiffs Hedden and Gendel were approached by ACC representative, Kirscher, and told that Marinelli wanted to distribute his large block of ACC stock. Marinelli claims he wanted to sell his ACC stock because he was resigning from all management positions with ACC. Plaintiffs, on the other hand, contend that at the time the stock transaction occurred, Marinelli still held all of the key management positions listed above and that it was not until later, on advice of counsel, that he "purported" to resign from his various positions. Plaintiffs further maintain that the resignations, when they occurred, were nothing more than "window dressing" since Marinelli retained control of the manufacturing operations of the corporation until the following year.

Letter agreements were entered into by Marinelli and Plaintiffs. The agreements recited that the stock sale was intended to conform with SEC Rule 144 which provides a safe harbor under certain conditions, exempting sellers from the registration requirements imposed by the 1933 Act. Forms 10-K and 10-Q containing financial data for ACC, were shown to Plaintiffs before the purchase. Plaintiffs were also shown pro forma financials containing financial projections for ACC which projected second quarter revenues for 1990 of over $1,000,000.

Plaintiffs Hedden and Gendel agreed to purchase the ACC stock. Plaintiff Hedden purchased 450,000 shares and Plaintiff Gendel bought 150,000 shares. It appears that Plaintiff Gendel was the CEO of ACC at the time he agreed to purchase the stock and Plaintiff Hedden was appointed to the board of directors of ACC sometime after the stock transfer. The financial projections contained in the pro formas were never achieved and, in fact, ACC experienced a revenue loss of $200,000 for the second quarter of 1990. Additionally, the value of ACC stock dropped and ACC filed for protection under Chapter 11 of the bankruptcy laws. ACC stock is apparently worthless at present.

After the plunge in ACC stock value, Plaintiffs filed the instant action against Gino and Marie Marinelli pursuant to Sections 12(1) and 12(2) of the 1933 Act and Section 10(b) of the 1934 Act. Plaintiffs seek rescission of the stock sale under Section 12 and compensatory damages under 10b-5.

Defendant Gino Marinelli has counterclaimed against Plaintiff Gendel for $60,000 owed pursuant to a document signed by Mr. Gendel in favor of Mr. Marinelli for the stock sold by Marinelli to Gendel. This document does not contain a demand date and Gendel claims that, although he signed it, the parties never worked out the final terms of the note.

Marie Marinelli did not own any of the ACC stock sold to Plaintiffs. Additionally she held no position at ACC. She has been named as a Defendant in this suit because Gino Marinelli, her husband, directed Plaintiff Hedden make his payment for the securities by wire to her account.

DISCUSSION

1. Liability Under the 1933 Act:

a. Application of the 1933 Act Beyond Issuer Transactions:

Defendant Gino Marinelli asserts that Plaintiffs' claims pursuant to Section 12(1) and 12(2) of the 1933 Act must be dismissed because the transaction complained of in this case was not an initial offering of ACC stock and as such the 1933 Act do not apply.

Section 12(2) of the 1933 Act provides as follows:

Any person who ...

(2) Offers or sells a security ... by the use of any means or instruments of transportation or communication in interstate commerce or of the mails, by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements, in the light of the circumstances under which they were made, not misleading ... and who shall not sustain the burden of proof that he did not know, and in the exercise of reasonable care could not have known, of such untruth or omission, shall be liable to the person purchasing such security from him ...

15 U.S.C. § 77l(2).

There is a split of opinion regarding whether Section 12 should apply outside the context of initial offerings to cover secondary market transactions. Those courts holding that Section 12 should not be limited to the context of initial offerings reach this conclusion because there is no explicit restriction contained within the language of Section 12. Additionally, although Section 12 refers to misstatements in a "prospectus", suggesting an initial offering, the definition of "prospectus" in the 1933 Act defines the term as a written offer to sell without any indication that it is limited to offers in initial distributions.

Despite the lack of limiting language in the 1933 Act, however, a majority of district courts and the Third Circuit have held that Section 12(2) is limited to initial offerings and does not apply to secondary market transactions. See eg. Ballay v. Legg Mason Wood Walker, Inc., 925 F.2d 682, 693 (3d Cir.1991), cert. denied, ___ U.S. ___, 112 S.Ct. 79, 116 L.Ed.2d 52 (1991); Grinsell v. Kidder, Peabody & Co., 744 F.Supp. 931 (N.D.Cal.1990); Bank of Denver v. Southeastern Capital Group, Inc., 763 F.Supp. 1552, 1559 (D.Colo.1991). In such cases the courts refused to apply Section 12 to impose liability upon enterprises, such as brokerage firms, involved in secondary market transactions.

In reaching the conclusion that Section 12(2) does not apply to certain secondary market transactions, these courts relied, in part, upon the legislative history of the 1933 Act which strongly suggests that the Act was intended to address the need for regularized registration of securities before their initial offering to the public in order to provide adequate disclosure of information held by the issuer to the public. This court agrees that under the facts presented to those courts, involving instances of secondary trading conducted through brokerage firms, it was prudent to withhold the application of the 1933 Act since such entities are quite removed from the initial issuer and not necessarily privy to inside information regarding the company.

This court cannot conclude, however, that Section 12 is always inappropriate in the context of secondary market sales. The House Report accompanying the 1933 Act stated that the Act was designed to "affect only new offerings of securities ... and does not affect the ordinary redistribution of securities unless such redistribution takes on the characteristics of a new offering by reason of the control of the issuer possessed by those responsible for the offering." H.R.Rep. No. 85, 73d Cong., 1st Sess. 5 (1933) (emphasis added). Thus, the Act may be appropriately applied when a corporate insider sells his own stock in such a manner that it takes on the characteristics of a new offering.

This concern for control was further elaborated in a later portion of the House Report discussing the scope of the underwriter definition contained in Section 2(11) of the Act. According to the House,

All the outstanding stock of a particular corporation may be owned by one individual or a select group of individuals. At some future date they may wish to dispose of their holdings and to make an offer of this stock to the public. Such a public offering may possess all the dangers attendant upon a new offering of securities. Whenever such a redistribution reaches significant proportions, the distributor would be in the position of controlling the issuer and thus able to furnish the information demanded by the bill. This being so, the distributor is treated as equivalent to the original issuer, and, if he seeks to dispose of the issue through a public offering, he becomes subject to the act. The concept of control herein involved is not a narrow one, depending upon a mathematical formula of 51 percent of voting power, but is broadly defined to permit the provisions of the act to become effective

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