Ohashi v. Verit Industries, 74-2027

• Decision Date: 25 May 1976
• Docket Number: No. 74-2027,74-2027
• Citation: 536 F.2d 849
• Parties: Fed. Sec. L. Rep. P 95,605 Joe OHASHI, Plaintiff and Appellant, v. VERIT INDUSTRIES, a corporation, et al., Defendants and Appellees.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 849

536 F.2d 849

Fed. Sec. L. Rep. P 95,605

Joe OHASHI, Plaintiff and Appellant, v. VERIT INDUSTRIES, a corporation, et al., Defendants and Appellees.

No. 74-2027.

United States Court of Appeals Ninth Circuit.

May 25, 1976.

Ralph R. Scott (argued), Los Angeles, Cal., for appellant.

Thomas M. Norminton (argued), Beverly Hills, Cal., for appellee.

OPINION

Before BARNES and HUFSTEDLER, Circuit Judges, and SKOPIL, ^* District Judge.

HUFSTEDLER, Circuit Judge:

Ohashi appeals from the dismissal of his damage claims for failure to state a claim for relief under the federal securities laws (Securities Exchange Act of 1934, § 10(b), 15 U.S.C. § 78j(b), and SEC Rule 10b-5, 17 C.F.R. § 240.10b-5) and for want of jurisdiction of the common law tort claims. The defendants are Verit Industries, a corporation ("Verit"); three of its directors and officers, Hagopian, Clabaugh, and Cobb; United States Stock Transfer Corporation ("Stock Transfer") and its president, Marshall.

The district court held that the Birnbaum rule (Birnbaum v. Newport Steel Corp. (2d Cir. 1952) 193 F.2d 461) barred relief under Section 10(b) and Rule 10b-5; with the demise of the federal claim, the pendent state claims were also dismissed.

We agree with the district court's disposition of all theories of federal securities relief, save one: Verit's fraud was alleged to have impaired the consideration for the exchange of securities after the securities had been transferred to Ohashi, but while the contract was still executory. That alleged fraud was "in connection with the purchase or sale of any securities" within the meaning of Section 10(b) and Rule 10b-5. The complaint adequately pleaded enough facts to withstand the motion to dismiss filed by Verit, Hagopian, Clabaugh, and Cobb on this theory.

In substance, the pleadings recited the following facts, the truth of which is presently assumed. Ohashi was the majority stockholder of Commerce-Pacific, Inc. ("Commerce") when Tanger Industries (now Verit) undertook to acquire Commerce in 1968. Ohashi's Commerce stock was then worth about $300,000. As a part of the acquisition agreement of May 13, 1968, Ohashi exchanged his Commerce stock for shares of Verit's $1 par common stock. Although Verit's common stock was being publicly traded, the shares issued to Ohashi were not registered with the SEC; that block of stock was issued pursuant to the private offering exemption of Section 4(2) of the Securities Act of 1933. (15 U.S.C. § 77d(2).) An integral part of the exchange agreement was the provision requiring Ohashi to execute an "Investment Letter" wherein he agreed not to transfer his Verit shares until (1) he had given a detailed statement of facts surrounding the proposed transfer to Verit, and had received a written opinion from Verit's counsel stating that the proposed transaction would not violate federal securities regulations, or (2) he had received a "no action" letter from the SEC. The following legend and transfer restriction was placed on his shares:

"No sale, offer to sell or transfer of the shares represented by this certificate shall be made unless a registration statement under the Federal Securities Act of 1933, as amended with respect to such shares is then in effect or an exemption from the registration requirements of such Act is then in fact applicable to such shares."

Verit instructed its transfer agent, Stock Transfer, that none of Ohashi's stock could be sold, offered for sale, or transferred without Verit's express authorization.

From December 1970, until January 1972, Ohashi repeatedly inquired about removal of the restrictions and was falsely assured by the Verit defendants that removal was imminent or that they were taking appropriate steps in that direction. In November 1971, Ohashi sent Verit a "no action" letter from the SEC. The Verit defendants continued their inaction and false assurances of their intent to perform. When relief was still not forthcoming, Ohashi was coercively induced to enter an escrow agreement in January 1972, whereby he agreed to removal of the restrictions on a piecemeal basis. Ohashi avers that all of these misrepresentations were made to further a conspiracy among the defendants to keep Ohashi's stock off the market and thereby to limit the "public float" of Verit's stock for the purpose of artificially raising the price of the publicly traded stock. The restrictions were removed on January 12, 1972, but, by that time, the defendants' manipulations of publicly traded Verit stock were under investigation which culminated in the SEC's suspending trading in Verit on May 18, 1972.

During the period from August 1, 1972 to October 31, 1973, Ohashi sold about one-third of his Verit stock to third persons. At the time he acquired his stock, Verit common was trading at $14 per share, but when he sold it, the price had fallen to $1.50 per share.

For claimed fraud in connection with the purchase and sale of securities, he sought compensatory and punitive damages and attorney's fees.

The district court correctly held that Ohashi could not state a Section 10(b) or Rule 10b-5 claim based on his inability to sell or offer to sell his Verit stock to third persons, even if his inability was caused by defendants' fraudulent or deceptive acts. As to these nonsales, Ohashi was neither a buyer nor a seller of securities, and the Birnbaum rule foreclosed his claim. (Blue Chip Stamps v. Manor Drug Stores (1975) 421 U.S. 723, 95 S.Ct. 1917, 44 L.Ed.2d 539.)

Likewise correct was the dismissal of his Section 10(b) and Rule 10b-5 claim based on the diminished value of the stock that he sold to third persons. He was a seller of that stock, but the complaint fails to make any showing that connects any of the alleged fraudulent activities to these sales. The deceptive conduct involving his shares occurred between June 1, 1971, when the restrictions were supposed to be removed and January 12, 1972, when the restrictions were removed. His sales did not occur until August 1, 1972, and thereafter. He did not claim that he sold his shares for less than their market value at the time of the sales. Rather, his theory is that the market value of the stock would have been much higher if the value of all of the Verit stock, including his own, had not been impaired by the wrongful conduct that had occurred before January 12, 1972. Recovery on this theory is also foreclosed by the Birnbaum rule. (Birnbaum v. Newport Steel Corporation, supra.) As the Supreme Court explained in Blue Chip Stamps, supra :

"Three principal classes of potential plaintiffs are presently barred by the Birnbaum rule. . . . Third are shareholders, creditors, and perhaps others related to an issuer who suffered loss in the value of their investment due to corporate or insider activities in connection with the purchase or sale of securities which violate Rule 10b-5. It has been held that shareholder members of the . . . third of these classes may frequently be able to circumvent the Birnbaum limitation through bringing a derivative action on behalf of the corporate issuer if the latter is itself a purchaser or seller of securities." (Blue Chip Stamps v. Manor Drug Stores, supra, 421 U.S. at 738-39, 95 S.Ct. at 1926.)

Ohashi is within the "third class" in respect of his own sales, and he cannot circumvent Birnbaum in this action. It does not purport to be a derivative suit.

One theory remains: Was there fraud "in connection with" the acquisition of received Verit stock that he in exchange for his Commerce stock?

If the exchange had been fully executed upon Verit's issuance of its stock to him and his transfer to Verit of his Commerce stock, the answer would be "No." Ohashi does not contend that the defendants fraudulently induced the exchange or that any fraud tainted the initial restrictions placed upon his Verit stock. The fraud of which he complains occurred after the exchange; the subsequent illegal conduct was not in connection with the inducement nor concurrently with the exchange.

However, if the contract by which Ohashi acquired Verit stock was still executory when the fraudulent activities occurred and if those acts affected the unperformed part of the bargain, the fraud may be "in connection with the sale or exchange of any securities." If the contract was still executory, a sufficient contractual relationship existed. It is clear by our prior decision in Mount Clemens Industries, Inc. v. Bell (9th Cir. 1972),464 F.2d 339 that "the existence of a contractual relationship between the parties (is an essential element to elevate) the plaintiffs to the status of statutory purchasers or...