Iroquois Industries, Inc. v. Syracuse China Corporation

• Decision Date: 03 November 1969
• Docket Number: No. 428,Docket 32984.,428
• Citation: 417 F.2d 963
• Parties: IROQUOIS INDUSTRIES, INC., Plaintiff-Appellant, v. SYRACUSE CHINA CORPORATION, William R. Salisbury, Foster T. Rhodes, Malcolm E. Kelley, James Salisbury Pass, Robert M. Salisbury, Harold C. Brown & Co., Inc., Harold C. Brown, C. Herbert Feuchter, and Towle Manufacturing Company, Defendants-Appellees.
• Court: U.S. Court of Appeals — Second Circuit

417 F.2d 963 (1969)

IROQUOIS INDUSTRIES, INC., Plaintiff-Appellant, v. SYRACUSE CHINA CORPORATION, William R. Salisbury, Foster T. Rhodes, Malcolm E. Kelley, James Salisbury Pass, Robert M. Salisbury, Harold C. Brown & Co., Inc., Harold C. Brown, C. Herbert Feuchter, and Towle Manufacturing Company, Defendants-Appellees.

No. 428, Docket 32984.

United States Court of Appeals Second Circuit.

Argued April 21, 1969.

Decided November 3, 1969.

COPYRIGHT MATERIAL OMITTED

Frank G. Raichle, Buffalo, N. Y. (Raichle, Banning, Weiss & Halpern, Buffalo, N. Y., Ralph L. Halpern, Buffalo, N. Y., on the brief), for plaintiff-appellant.

George H. Bond, Jr., Syracuse, N. Y. (Bond, Schoeneck & King, Charles T. Beeching, Jr., Syracuse, N. Y., on the brief), for defendants-appellees Syracuse China Corporation, William R. Salisbury, First Trust & Deposit Co. and Josephine Rhodes, as Executors of Estate of Foster T. Rhodes, Malcolm E. Kelley, James Salisbury Pass, Robert M. Salisbury.

Hilary P. Bradford, Buffalo, N. Y. (Cohen, Swados, Wright, Hanifin & Bradford, F. Harris Nichols, Buffalo, N. Y., on the brief), for defendants-appellees Harold C. Brown & Co., Inc., Harold C. Brown and C. Herbert Feuchter.

Hugh McM. Russ, Sr., Buffalo, N. Y. (Hodgson, Russ, Andrews, Woods & Goodyear, John J. Cooney, Stephen Kellogg, Buffalo, N. Y., on the brief), for defendant-appellee Towle Manufacturing Co.

Philip A. Loomis, Jr., Gen. Counsel, Walter P. North, Associate Gen. Counsel, Jacob H. Stillman, Asst. Gen. Counsel, Alan Blank, Atty., Washington, D. C., for Securities and Exchange Commission, amicus curiae.

Before LUMBARD, Chief Judge, ANDERSON, Circuit Judge, and WYATT, District Judge.^*

WYATT, District Judge:

The principal question, an important one, raised by this appeal is the extent to which Section 10(b) of the Securities Exchange Act of 1934 (15 U.S.C. § 78a and following; the "1934 Act") is applicable in tender offer situations. Closely related is a question as to the continuing vitality of the decision of this Court in Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2d Cir.), cert. denied 343 U.S. 956, 72 S.Ct. 1051, 96 L.Ed. 1356 (1952).

The rule laid down in Birnbaum is that a civil action under Section 10(b) of the 1934 Act (15 U.S.C. § 78j(b)) may be maintained only by a purchaser or seller of securities. We find no reason to deviate from that rule in the present case. The decision below is therefore affirmed.

Iroquois Industries, Inc. (Iroquois), the appellant, wanted to buy 50,000 shares of common stock of Syracuse China Corporation (Syracuse China), evidently to secure working control of Syracuse China. Iroquois made a public offer to purchase the shares and invited stockholders to tender their shares for purchase. The management of Syracuse China resisted the tender offer and it failed. Iroquois then brought this action, charging violations of Section 10 (b) and other sections of the 1934 Act.

Judge Henderson in the Western District of New York granted motions of the defendants and, with an unreported memorandum opinion, dismissed the action as to all defendants for failure of the complaint to state a claim upon which relief can be granted (Fed.R.Civ.P. 12 (b) (6)). We agree that the action should be dismissed.

The complaint has five counts, each purporting to state a separate claim. The averments of the complaint for present purposes must be assumed to be true.

Jurisdiction of the first three claims is rested on Section 27 of the 1934 Act (15 U.S.C. § 78aa); there is no diversity jurisdiction of such claims. The fourth claim is against defendant Towle Manufacturing Company (Towle) only; there appears to be diversity jurisdiction as to this claim. The fifth claim is said to be within the pendent jurisdiction principle. Hurn v. Oursler, 289 U.S. 238, 53 S.Ct. 586, 77 L.Ed. 1148 (1933).

THE FIRST COUNT

The first count avers the basic factual pattern applicable to all counts.

Plaintiff Iroquois is a Delaware corporation with its principal place of business in Buffalo.

Syracuse China is a New York corporation doing business in Syracuse. Syracuse China has outstanding 113,000 shares of common stock; there are some 600 stockholders. The individual defendants, except Brown and Feuchter, are officers or directors or both of Syracuse China. Defendant Harold C. Brown & Co., Inc. (Brown Inc.) is an investment banking house in Buffalo. The individual defendants Brown and Feuchter are connected with Brown Inc. Defendant Towle is a Massachusetts corporation which also does business in New York City.

Iroquois invited stockholders of Syracuse China to tender their shares for purchase and Iroquois agreed to purchase all shares tendered, up to 50,000 shares.

The defendants conspired together to prevent Iroquois from obtaining shares under the tender offer and did prevent Iroquois from obtaining shares. The defendants retained professional solicitors, at the expense of Syracuse China, who persuaded stockholders not to tender their shares. The defendants themselves asked stockholders not to tender. Letters were written by defendants to the stockholders, falsely stating that Syracuse China was negotiating a merger, that negotiations for a merger with Towle were continuing, and that details of the merger would shortly be submitted; in fact, there was never any intention to conclude any merger with Towle but the talk was to mislead and to interfere with the tender offer. The letters of Syracuse China were false and misleading. The defendants advised stockholders that members of management would buy their shares if any stockholder wanted to sell; in fact, members of management did purchase a substantial number of shares. Towle aided the other defendants by conducting sham merger negotiations, knowing that no merger was intended. Brown Inc. and its officers and employees refused to advise the customers of Brown Inc. of the tender offer of Iroquois but instead advised them to sell their shares to members of the management of Syracuse China.

The claim in this count is that the acts of defendants were in violation of Section 10(b) of the 1934 Act and of Rule 10b-5 of the Securities and Exchange Commission (the "Commission") thereunder. The cited statute and Rule make it unlawful to employ fraud "in connection with the purchase or sale of any security."

We may put to one side most of the averments of the first count. The wrongful use of the funds of Syracuse China to defeat the tender offer might give rise to a derivative action in equity to recover for Syracuse China the amount of those funds. This, however, is not such an action and if it were, there would be no jurisdiction to entertain it because there is no diversity of citizenship.

There remain averments which are appropriate to a Section 10(b) claim, namely, that there were untrue statements of material facts by defendants to stockholders of Syracuse China.

The history of Rule 10b-5 has been set out in the Birnbaum opinion. A summary will suffice here.

The Securities Act of 1933 (15 U.S.C. § 77a and following; the "1933 Act") contained a provision (Section 17(a); 15 U.S.C. § 77q) making it unlawful to employ fraud (including half-truths) "in the offer or sale of any securities." This applied only to fraud on purchasers of securities.

The 1934 Act contained a broader provision, Section 10(b), conferring rule making power on the Commission in respect of fraud "in connection with the purchase or sale of any security * * *" (emphasis supplied). The rule making power thus included fraud on sellers of securities.

No rule was adopted for some years and as long as there was no rule, fraud on a purchaser was actionable under the 1933 Act but fraud on a seller was not actionable under either the 1933 Act or 1934 Act.

The Commission in May 1942 acted to close this loophole by adopting Rule 10b-5. This rule makes it unlawful to employ fraud (including half-truths) "in connection with the purchase or sale of any security * * *" (emphasis supplied), thus making it unlawful to employ fraud on sellers of securities as well as on purchasers.

In the light of this history, this Court decided in Birnbaum that Congress meant Section 10(b) to be "directed solely at that type of misrepresentation or fraudulent practice usually associated with the sale or purchase of securities" and that Rule 10b-5 "extended protection only to the defrauded purchaser or seller" (193 F.2d at 464). Professor Loss in 1961 gave his approval to this view as "basically correct" (3 Loss, Securities Regulation (hereafter "Loss") (2d ed. 1961) 1469) and has not since changed his mind (6 Loss (Supp.1969) 3617).

In Birnbaum, plaintiffs were minority stockholders of Newport Steel Corporation (Newport). Their complaint showed the following situation. Feldmann owned enough stock of Newport to have voting control and was an officer and director of Newport. Follansbee Steel Corporation and Newport were negotiating for a merger which would have been highly profitable for stockholders of Newport. Feldmann rejected the merger and instead sold all his stock to Wilport Company (Wilport) for twice its market value. Wilport had been formed by a group of manufacturers who, with control of Newport, could secure its steel during a then critical shortage; this explained the premium paid. In letters which the defendants sent to stockholders of Newport both before and after the sale by Feldmann, there were misrepresentations and half-truths said to be in violation of Rule 10b-5. This Court held that, because the plaintiffs had not been either purchasers or sellers of Newport stock, they were not within the protection of Section 10(b) and that the complaint failed to state a claim. Dismissal of the action was affirmed.

Iroquois is not here complaining that it was misled by the acts of defendants as to any purchases or sales by it of Syracuse China stock; indeed, its basic complaint is that, because of the acts of defendants, it could...