Mutual Shares Corporation v. Genesco, Inc.

• Decision Date: 14 August 1967
• Docket Number: No. 405,Docket 31123.,405
• Citation: 384 F.2d 540
• Court: U.S. Court of Appeals — Second Circuit
• Parties: MUTUAL SHARES CORPORATION, Spingarn Heine & Co., and Norte & Co., Plaintiffs-Appellants, v. GENESCO, INC., and W. Maxey Jarman, Defendants-Appellees.

384 F.2d 540 (1967)

MUTUAL SHARES CORPORATION, Spingarn Heine & Co., and Norte & Co., Plaintiffs-Appellants, v. GENESCO, INC., and W. Maxey Jarman, Defendants-Appellees.

No. 405, Docket 31123.

United States Court of Appeals Second Circuit.

Argued April 13, 1967.

Decided August 14, 1967.

William Klein, II, New York City (Julius J. Rosen, New York City, on the brief), for plaintiffs-appellants.

Breck P. McAllister, New York City (Donovan, Leisure, Newton & Irvine, James R. Withrow, Jr., Richard L. Bond, Sanford M. Litvack, New York City, on the brief), for defendants-appellees.

Philip A. Loomis, Jr., Gen. Counsel, David Ferber, Sol., Edward B. Wagner, Sp. Counsel, Martin D. Newman, Atty., Washington, D. C., for Securities and Exchange Commission as amicus curiae.

Before MOORE, SMITH and FEINBERG, Circuit Judges.

FEINBERG, Circuit Judge:

We are again faced here with a claim that alleged misconduct affecting holders of publicly-owned securities violated the Securities Exchange Act of 1934 ("the Act") and Rule 10b-5 issued thereunder by the Securities and Exchange Commission. The complaint of plaintiffs Mutual Shares Corporation ("Mutual"), Spingarn Heine & Co. and Norte & Co., in the District Court for the Southern District of New York alleges violations of the Act and of state law by defendants Genesco, Inc. and W. Maxey Jarman. Judge Bonsal dismissed the complaint for lack of jurisdiction, holding that there was neither a federal question nor complete diversity of citizenship. Plaintiffs appeal from that order;¹ for reasons more fully set forth below, we affirm in part and reverse in part.

I

According to the complaint or undisputed matters of record, the relevant facts are as follows: Mutual is a publicly-held, open-end investment company; Spingarn Heine & Co. is a brokerage firm with a partner who is a vice president, director and stockholder of Mutual; and Norte & Co. is the registered nominee of Mutual's investment adviser. For diversity purposes all plaintiffs are citizens of New York. Defendant Genesco, Inc. is a large manufacturing and retailing concern, and Jarman is its chairman and principal stockholder. Both defendants are citizens of Tennessee for diversity purposes. Not named as a party, but at the center of the suit, is S. H. Kress and Company, a New York corporation which operates more than 250 variety stores in many states throughout the country.²

Between July and October 1963, Genesco acquired 94.1 per cent of the outstanding stock of Kress, 43 per cent by purchase from the Kress Foundation, and the rest from the public through tender offers. By the time the amended complaint was filed in November 1966, Genesco had increased its holdings to 94.6 per cent of Kress. The complaint alleges that the stock was obtained pursuant to "a fraudulent conspiracy" to acquire control of Kress, use Kress's own property to finance the acquisition and then manage Kress and appropriate its assets for Genesco's sole benefit. Appellants claim that defendants euchred them into buying 16,608 shares of Kress stock, which they still own and have continued the fraud by operating Kress against its corporate interest to the minority shareholders' detriment.

Stripped of its pejoratives and redundancies, the complaint alleges fraudulent activities falling essentially into two time periods — before and after plaintiffs acquired their stock. The fraud attributed to defendants in the period before plaintiffs became Kress stockholders — November 15, 1963 for Mutual, November 20, 1963 for Norte, and August 1964 for Spingarn — may be summarized as follows: In their tender offer for the stock of Kress, defendants failed to disclose (1) that Kress's real estate was worth substantially more than its financial statements indicated, and (2) their intention, after gaining control of Kress, to sell this real estate to Genesco's pension fund for an inadequate consideration, thereby raising the funds necessary to pay for the Kress stock acquisition, and otherwise to manage Kress for the sole benefit of Genesco. The fraud attributed to defendants after the dates when plaintiffs became Kress stockholders is that defendants financed their acquisition of Kress stock with Kress's own assets, have dominated Kress and run it in the interest of Genesco rather than Kress, including diversion of assets to Genesco, and have manipulated the market price of Kress stock, in part by keeping the Kress dividends to a minimum, in order to acquire shares of Kress's minority stockholders at less than the true value.

Plaintiffs seek damages as well as injunctive relief, including a prayer relating to the alleged manipulative scheme that defendants be barred from further purchases of Kress stock, which are allegedly still continuing. Judge Bonsal held that the complaint did not state a federal cause of action under various sections of the Act or Rules thereunder and that Kress, a New York corporation, was an indispensable party-defendant whose presence would destroy the requisite diversity of citizenship for adjudication of state law claims. On appeal, plaintiffs claim that both grounds of the district court's decision were incorrect; we turn first to the federal law issues.

II

The complaint bases the federal claims on section 10 (b) of the Act and Rule 10b-5 thereunder³ and section 14(a) of the Act and Rule 14a-9;⁴ the latter, which deal with proxy statements, will be discussed hereafter.⁵ Section 10 of the Act provides:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange —

* * * * * *

(b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors.

Rule 10b-5 of the Commission provides:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,

(a) To employ any device, scheme, or artifice to defraud,

(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,

in connection with the purchase or sale of any security.

Section 10(b) and Rule 10b-5 have been the focal point for a spectacular growth in the law governing civil liability for transactions in securities.⁶ This has been all the more remarkable because the Act does not explicitly provide a private civil remedy for violations of the section and Rule, and the Supreme Court has never held that one exists, although J. I. Case Co. v. Borak, 377 U.S. 426, 84 S.Ct. 1555, 12 L.Ed.2d 423 (1964), impliedly suggests that it does. Nevertheless, it is now common ground that an injured investor does have a private cause of action under Rule 10b-5, e. g., Fischman v. Raytheon Mfg. Co., 188 F.2d 783 (2d Cir. 1951). However, various concepts have been utilized to limit liability under the sweeping language of the Rule, although none is specifically required by it. 3 L. Loss, Securities Regulation 1763-67 (2d ed. 1961). Thus, a requirement of privity was at first suggested, see Joseph v. Farnsworth Radio & Television Corp., 99 F.Supp. 701 (S.D.N.Y.1951), aff'd per curiam, 198 F.2d 883 (2d Cir. 1952),⁷ but has more recently been ignored, e. g., Cochran v. Channing Corp., 211 F.Supp. 239, 243-245 (S.D.N.Y.1962); see Texas Continental Life Ins. Co. v. Dunne, 307 F.2d 242 (6th Cir. 1962); Cooper v. North Jersey Trust Co., 226 F.Supp. 972, 978 (S.D.N.Y.1964).⁸ However, the search for limiting doctrine has continued.⁹ Thus, some courts have looked to see whether a plaintiff actually relied on the allegedly fraudulent statement,¹⁰ whether such reliance was reasonable,¹¹ whether the fraud actually caused the harm to plaintiff,¹² whether the plaintiff's injury was foreseeable,¹³ and whether plaintiff falls within the category of a buyer or seller of securities.¹⁴

In the face of the broad language of Rule 10b-5 and the measured judicial treatment of it, it is most important to ascertain precisely the theory upon which plaintiffs sue. In this court, appellants' principal claim under Rule 10b-5 is that defendants "deceived them into buying Kress shares which they would not have bought had they known the facts," and that this fraud arose "in connection with Genesco's purchase of Kress shares." The alleged deceit was defendants' silence as to their true fraudulent intentions and the actual value of Kress's real estate. In other words, appellants claim that the maker of a tender offer to purchase the stock of a corporation can by silence violate a duty under the Act to plaintiffs even though he and they are both strangers to the corporation.

Use of a tender offer by an outsider to obtain control of a publicly-held corporation is a fairly recent development. This means of corporate takeover has become increasingly popular,¹⁵ and has led to demands for legislative regulation to prevent abuses. Bills have been introduced in Congress designed to achieve this end.¹⁶ While not conclusive, this legislative activity at least indicates the conviction of many that existing statutes do not adequately cover the field. Indeed, the chairman of the Commission has stated, albeit not in his official capacity, that "the bills now pending before Congress would fill a hiatus."¹⁷

It is against this background that we must consider appellants' claim that Rule 10b-5...