MADIGAN, INCORPORATED v. Goodman

• Decision Date: 28 March 1973
• Docket Number: No. 72 C 1338,70 C 2151.,72 C 1338
• Citation: 357 F. Supp. 1331
• Parties: MADIGAN, INCORPORATED et al., Plaintiffs, v. Gilbert GOODMAN et al., Defendants.
• Court: U.S. District Court — Northern District of Illinois

357 F. Supp. 1331

MADIGAN, INCORPORATED et al., Plaintiffs, v. Gilbert GOODMAN et al., Defendants.

Nos. 72 C 1338, 70 C 2151.

United States District Court, N. D. Illinois, E. D.

March 28, 1973.

Kirkland & Ellis, Chicago, Ill., for plaintiffs.

Sheldon O. Collen, Sheldon Karon and Joseph A. Spitalli, James K. Gardner, Griffin, Guinan & Griffin, Russell J. Topper, Chicago, Ill., for defendants.

MEMORANDUM OPINION AND ORDER

BAUER, District Judge.

This cause comes on defendants' (Gilbert Goodman, Edward Hollander and Sidney L. Morris) motion to dismiss the complaint or alternatively for summary judgment.

This action was brought to recover damages for alleged fraudulent misrepresentations in the sale of a security in violation of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b); Rule 10B-5, 17 C.F.R. 240.10b-5 promulgated thereunder and Illinois common law fraud. The plaintiffs are a group of corporations and individuals including Madigan, Incorporated (hereinafter jointly referred to as the Madigan Group) who purchased Fidelity General Insurance Company ("Fidelity") stock. The defendants are Gilbert Goodman and Clyde L. Korman, who are officers, directors and shareholders of Fidelity; Samuel Jastromb, Samuel Bernstein, Edward Hollander and Sidney L. Morris, who are directors and shareholders of Fidelity; Fred H. Pearson, who is a shareholder of Fidelity; and Tom I. McFarling, who is the Receiver of Dealers National Insurance Company and Liberty Universal Insurance Company and presently has title to 1,071,650 shares of the common stock of Fidelity. These defendants have allegedly made false representations concerning the financial condition of Fidelity to the detriment of the Madigan Group.

The following facts are relevant to the proper disposition of the instant motion. On December 20, 1968, Mading-Dugan Drug Company (the predecessor to Madigan, Inc.) purchased 51% of the common stock of Fidelity from the defendants and other shareholders for the sum of $1,750,895 in cash. At the same time, Mading-Dugan contracted to make a tender offer for the remaining Fidelity shares before June 30, 1969.¹

On or about May 13, 1969, Mading-Dugan sold the Fidelity stock it had purchased from defendants to Contran Corporation ("Contran") for 250,000 shares of Contran common stock, the value of which was approximately $1,750,895.²

On or about September 19, 1969, Contran sold all of the Fidelity General stock that it had acquired from Mading-Dugan to Texas Consumer Finance Corp. for $1,750,895 in cash.³

At the time that Contran purchased Fidelity stock, Contran agreed to assume Mading-Dugan's obligation to make the tender offer for the remaining Fidelity shares.⁴ Contran subsequently assigned the obligation to make the tender offer to Texas Consumer Finance Corp. Between June and August, 1969, Texas Consumer Finance Corp. purchased 502,845 shares of Fidelity from shareholders other than defendants.

Plaintiffs allege that the defendants' false and misleading representations concerning Fidelity's financial condition caused the following damages:

1. Plaintiffs have lost the amount paid for Fidelity stock (Complaint paragraphs 18(a) and 41(a)).

2. Plaintiffs have lost additional capital contributed to prevent the insolvency of Fidelity and the profits and other benefits that they reasonably could have expected to receive from the purchase of Fidelity stock had its financial condition been what the defendants represented it to be (Complaint paragraphs 18(b) and 41(b)).

3. Plaintiffs have incurred and will continue to incur substantial expenses in defending lawsuits (Complaint paragraphs 18(c) and 41(c)).

4. Plaintiffs have been unable to plan and conduct their financial affairs as a result of such litigation (Complaint paragraphs 18(d) and 41(d)).

The defendants Gilbert Goodman, Edward Hollander and Sidney L. Morris, in support of their motion contend:

1. Plaintiffs have suffered no damage attributable, as a matter of law, to any of the acts allegedly performed by defendants.

2. Certain plaintiffs do not have standing to assert a claim under Section 10(b) of the Securities Exchange Act of 1934 and the Rules promulgated thereunder.

3. Plaintiffs' claims are barred by the applicable statute of limitations.

The plaintiffs, in opposition to the instant motion, contend that their losses exceed two million dollars as a result of the fraudulent conduct of defendants and that the Madigan Group has been exposed to claims exceeding $48 million in case of Baylor, Director of Insurance v. Mading-Dugan Drug Company et al., D.C., 57 F.R.D. 509 ("Liquidator's case") which has been consolidated with the instant action.

It is the opinion of this Court that since the plaintiffs have resold the securities purchased from the defendants for the same price at which those securities were acquired, plaintiffs have suffered no loss and thus have no cause of action.

I. Plaintiffs have suffered no damages which are legitimately attributable to the alleged acts of the defendants or recoverable under the Securities Exchange Act.

It is well settled that the failure to show actual damages is a fatal defect in bringing a cause of action based on the Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq. This legislation permits recovery of actual damages based on violations of the Act. "Actual damages" for one who through fraud or misrepresentation has been induced to purchase bonds or corporate stock, is the difference between the contract price, or the price paid, and the real or actual value at the date of the sale, together with such outlays as are attributable to the defendants' conduct. In other words, the federal rule of damages for such fraud is an "out of pocket rule", the difference between the amount parted with and the value of the thing received. Smith v. Bolles, 132 U.S. 125, 10 S.Ct. 39, 33 L.Ed. 279 (1889); Sigafus v. Porter, 179 U.S. 116, 21 S.Ct. 34, 45 L.Ed. 113 (1900); Hindman v. First National Bank, 112 F. 931 (6th Cir. 1902), cert. denied, 186 U.S. 483, 22 S.Ct. 943, 46 L.Ed. 1261; Tooker v. Alston, 159 F. 599 (8th Cir. 1907); Chandler v. Andrews, 192 F. 543 (2nd Cir. 1911); Nashua Savings Bank v. Burlington Electric Lighting Co., 100 F. 673 (S.D. Iowa, 1900); Morris v. United States, 303 F.2d 533 (1st Cir. 1962); Mott v. Tri-Continental Financial Corporation, 330 F.2d 468 (2nd Cir. 1964).

The pleadings and recent pre-trial discovery demonstrate that the plaintiffs have failed to properly show actual damages based on the alleged violation.

A. Damages based on loss of purchase price.

Plaintiffs claim in paragraphs 18(a) and 41(a) of their Complaint that they have lost $3,322,155, the price paid for 1,067,650 shares of Fidelity common stock. As noted earlier, the Fidelity stock was purchased in two transactions. 564,805 shares were purchased from defendants and other shareholders by Mading-Dugan in December, 1968, and 502,845 shares were purchased by Texas Consumer Finance Corp. ("TCFC") pursuant to a tender offer between June and August, 1969.

With respect to the Fidelity stock purchased in December 1968 from defendants, the following facts have been disclosed during pre-trial discovery.⁵

1. Mading-Dugan Drug Company purchased all of the Fidelity General shares transferred in December 1968 for $1,750,895 in cash.

2. In May, 1969, Mading-Dugan sold those Fidelity shares to Contran in exchange for 250,000 shares of Contran stock. The Contran stock was valued, by the seller and buyer, at 20% below its market value of $8.50 per share. Thus the total value of Contran shares traded approximately equaled the amount at which Mading-Dugan had originally purchased the Fidelity shares.

3. In September, 1969, Contran sold all of the Fidelity shares it had purchased from Mading-Dugan to Texas Consumer Finance Corporation for $1,750,895 in cash, the same amount Contran had paid in Contran stock, and the same amount Mading-Dugan had earlier paid in cash in acquiring the Fidelity stock.

Plaintiffs Madigan and Contran therefore fully recovered the purchase price that they paid for Fidelity stock. Thus there is no out of pocket loss or actual damages to the plaintiffs in their purchase of Fidelity stock.

The Fidelity stock purchased pursuant to the tender offer during the summer of 1969 was not purchased by any of the plaintiffs, but was purchased by Texas Consumer Finance Corporation, Trans-Texas Life Insurance and Consumers Casualty Company.⁶

No other plaintiff purchased or held Fidelity stock at any time.⁷ Kaufman v. Mellon National Bank and Trust Company, 366 F.2d 326 (3rd Cir. 1966); Chaney v. Western States Title Insurance Company, 292 F.Supp. 376 (D.Utah, 1968). Further, plaintiff's answer to Interrogatory No. 31(a) is illustrative of the lack of damages flowing from the purchase of Fidelity stock. Interrogatory No. 31(a) states:

State what portion of the $3,332,155, if any, plaintiffs claim in paragraph 18(a) of the Complaint to have lost is allocable to you.

The answer given for all plaintiffs states:

None.

B. Damages based on loss of profits and other expected benefits.

It it clear that the question of damages turns not on what the plaintiffs might have gained, but what has been lost by being allegedly deceived into a purchase. The defendants are liable for such damages as naturally and proximately resulted from the alleged fraud; they are bound to make good the loss sustained. More specifically, the defendants are liable for losses as the plaintiff has sustained, with interest, and any other outlay legitimately attributable to the defendants' fraudulent conduct. It is clear that liability does not include the speculative fruits of unrealized profit. Smith v. Bolles, supra; Estate Counseling Service v. Merrill, Lynch, Pierce, etc., 303 F.2d 527 (10th Cir. 1962). Thus the plaintiff cannot recover the expectant profits claimed in paragraph 18 (b) of the Complaint.

The plaintiffs also claim that th...