Ketchum v. Green

Citation557 F.2d 1022
Decision Date30 June 1977
Docket NumberNo. 76-2268,76-2268
PartiesFed. Sec. L. Rep. P 96,107 Chandler G. KETCHUM and Harold S. Bigler, Appellants, v. Edward J. GREEN, Harry B. Hiltz, Jr., John C. McCutchen, David G. Roof, William M. Waugh, Jr., Ronald B. Livingston, William M. Steele and Babb, Inc.
CourtUnited States Courts of Appeals. United States Court of Appeals (3rd Circuit)

Edmund K. Trent, Charles C. Cohen, Jonathan W. Delano, Reed, Smith, Shaw & McClay, Pittsburgh, Pa., for appellants.

John J. McLean, Jr., Thomas M. Thompson, Lewis U. Davis, Jr., Buchanan, Ingersoll, Rodewald, Kyle & Buerger, Pittsburgh, Pa., for appellees.

Before ALDISERT and ADAMS, Circuit Judges, and MARKEY, Chief JudUnited States Court of Customs and Patent Appeals. *

OPINION OF THE COURT

ADAMS, Circuit Judge.

The issue in this appeal is whether the district court erred when it dismissed the complaint in a dispute arising out of an intra-corporate contest for control of a close corporation. Specifically, we must ascertain whether the factual matrix here satisfies the "in connection with" clause present in both of § 10(b) of the Securities Exchange Act of 1934 and its administrative derivative, Rule 10b-5. Such clause requires for a cause of action that a misrepresentation be rendered in connection with a sale or purchase of a security.

I.

Although the background for the litigation is somewhat complex, for purposes of this appeal we need only outline those facts pertinent to our decision.

Plaintiffs Ketchum and Bigler are the former Chairman of the Board and President, respectively, of Babb, Inc., a close corporation engaged in the insurance business. In addition to serving as directors of the company, both men were holders of substantial portions of the outstanding Babb stock, owning between them roughly forty-five per cent of such shares. The seven individual defendants constituted other directors and officers of Babb, with five of them holding approximately forty-eight per cent of the outstanding stock.

Under terms contained in a stock retirement agreement, dated November 18, 1968, all Babb shareholders are required to be employees of the corporation. Upon death, retirement or disability, a shareholder or his representative must surrender his stock, and the company is required to redeem such securities at a price determined by a formula relating to corporate income. In the event of a termination of employment for any other reason, only one-third of such formula price would be paid. 1

Late in 1975, several of the defendants began discussions among themselves as to the possibility of removing Ketchum and Bigler as officers and employees of Babb. During the ensuing months, the same coterie of defendants continued to discuss the ouster of Ketchum and Bigler, enlisted the support of the remaining defendants, but concealed their scheme from the plaintiffs. 2

In March of 1976, the entire board of directors, including the plaintiffs as well as the defendants, proceeded to appoint a committee to select nominees for the board and officer elections that were scheduled for the month of April. The committee, consisting of one of the plaintiffs, one of the defendants and another director of the company, decided to nominate the incumbent board members and officers, among them the two plaintiffs.

On April 23, 1976, the nominating committee submitted its slate of candidates for the board and officerships. The list was received, without any signs of dissension, at a directors' meeting that preceded the annual meeting of shareholders. By this juncture, the defendants had agreed among themselves to dislodge the plaintiffs as officers. Nevertheless, the defendants did not reveal their intention to oppose the reelection of the plaintiffs as officers, making no disclosure of their plan to depart from the usual practice of supporting candidates selected by the nominating committee.

During the April 23 shareholders' meeting, the defendants continued to conceal their plans regarding the election of officers. There is some indication that they did so out of necessity. Although the defendants constituted a majority of the board of directors, they held slightly less than fifty per cent of the outstanding Babb stock. Indeed, at the time of the shareholders' meeting, it was Ketchum and Bigler who possessed the controlling bloc of stock, given their own holdings together with proxies that they had obtained. Nevertheless, the plaintiffs, assuming that the defendants would support all of the candidates designated by the nominating committee, and having no reason to believe otherwise, joined with the defendants and other shareholders to reelect unanimously the incumbent directors. The result of the election was to return the defendants to their dominant position on the directorate.

Immediately following the meeting of the shareholders, the board of directors convened to elect company officers. The slate formulated by the nominating committee then was proposed. At that moment, the defendants made known, for the first time, their intention to expel Ketchum and Bigler as corporate officers. Rejecting the nominations of the plaintiffs, the defendants instead produced their own candidates for the positions of chairman of the board and president. The nominees of the defendants then were elected, thereby removing Ketchum and Bigler as officers.

Once the purge of the plaintiffs as officers was accomplished, the defendants, comprising a majority of the board, proceeded to terminate Bigler and Ketchum as Babb employees as well. Thereafter, the board adopted a resolution to purchase plaintiffs' shares, as authorized by the stock retirement plan, and then tendered payment for the purchase price. But Ketchum and Bigler have declined to surrender their stock certificates or to accept any payment for such shares.

Subsequent to these events, plaintiffs initiated the present lawsuit, seeking, inter alia, to enjoin their ouster as officers and shareholders of Babb and to secure damages. Basically, Bigler and Ketchum claim that the defendants, in violation of § 10(b) and Rule 10b-5, had fraudulently induced them to vote for their own demise. By masking and supposedly misrepresenting their intentions with respect to the officership election, the defendants, it is asserted, were able to retain their majority bloc on the board of directors, despite their minority position among the company stockholders. According to Ketchum and Bigler, such alleged improprieties in turn tainted the subsequent vote by the directors to depose and discharge the plaintiffs as officers, which then facilitated the removal of plaintiffs as employees, and which ultimately activated the stock retirement agreement compelling the sale and corporate repurchase of plaintiffs' stock.

After the entry of a stipulation of facts and a hearing concerning the plaintiffs' demand for injunctive relief, the district court dismissed the action for failure to state a claim under § 10(b) and Rule 10b-5. This appeal followed.

II.

By now, § 10(b) of the 1934 Act 3 and Rule 10b-5, 4 promulgated thereunder, are together recognized as a cornerstone of the federal program of securities regulation. The statute has been applied to a plethora of activities involving securities, including insider trading based on undisclosed corporate information, misleading corporate publicity and banker-dealer conduct. This lawsuit, however, concerns the application of § 10(b) to another category of activity an internal struggle for control of a close corporation.

To set forth a claim under § 10(b), the complaint, before trial, and the record, following the completion of evidentiary processes, must enunciate the factual underpinnings for an exercise of authority by the federal courts. Although the provision articulates a number of prerequisites, the existence of three key elements is necessary if a cause of action is to obtain. First, there must be misrepresentation or fraud; second, a purchase or sale of a security must occur; and third, such misrepresentation or fraud must have been rendered "in connection with" the purchase or sale of a security.

Battle has been waged, of course, on many occasions over whether there has been compliance with the "fraud" 5 or "purchase/sale" 6 requirements of § 10(b). By contrast, the "connection" factor has received relatively scant consideration by the Supreme Court and other federal tribunals. Yet this litigation, in large measure, turns on the "connection" facet of § 10(b).

In its opinion, the district court decided that there was no basis for recovery under § 10(b). It did so on the ground that the claimed misrepresentation of the defendants did not occur "in connection with" a purchase or sale of securities. For purposes of such a disposition of the case, the trial judge assumed that the defendants had engaged in actionable fraud or deception, although his opinion voices grave "doubts" whether the conduct of the defendants constituted misrepresentations within the meaning of § 10(b). 7

We now affirm the conclusion of the district judge that the relationship between the alleged misrepresentations and the sale/purchase with respect to plaintiffs' shares does not satisfy the "in connection with" requirement of the statute. Our position, however, diverges to some extent from that of the trial court, thereby making appropriate a full consideration of the "connection" question. In our analysis, we, too, shall assume that the defendants have engaged in a deceptive practice within the meaning of § 10(b).

III.
A.

It is not surprising that the "in connection with" clause of s10(b) has received limited attention from the federal courts. In the usual case, where the alleged deception concerns the terms of a securities transaction, there can be little question that the "connection" requirement has been fulfilled. It is in the less typical situation, such as the one before us, that the "in connection with" language...

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