Ray v. Karris

• Decision Date: 16 December 1985
• Docket Number: No. 84-2382,84-2382
• Citation: 780 F.2d 636
• Parties: Fed. Sec. L. Rep. P 92,416, RICO Bus.Disp.Guide 6142 Russell V. RAY, et al., Plaintiffs-Appellants, v. Nicholas A. KARRIS, et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 636

780 F.2d 636

Fed. Sec. L. Rep. P 92,416, RICO Bus.Disp.Guide 6142

Russell V. RAY, et al., Plaintiffs-Appellants, v. Nicholas A. KARRIS, et al., Defendants-Appellees.

No. 84-2382.

United States Court of Appeals Seventh Circuit.

Argued June 5, 1985.

Decided Dec. 16, 1985.

Michael J. Freed, Much, Shelist, Freed, Denenberg, Ament & Eiger, Chicago, Ill., for plaintiffs-appellants.

N.A. Giambalvo, Boodell, Sears, Giambalvo & Crowley, Chicago, Ill., for defendants-appellees.

Before COFFEY and FLAUM, Circuit Judges, and WRIGHT, Senior Circuit Judge. ^*

FLAUM, Circuit Judge.

Appellants, the minority shareholders of Water Tower Trust & Savings Bank, appeal from the district court's granting of appellees' motion pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure for failure to state a cause of action under section 10(b) and Rule 10(b)(5) of the Securities Exchange Act of 1934, 15 U.S.C. Sec. 78a, et seq., section 17(a) of the Securities Exchange Act of 1933, 15 U.S.C. Sec. 77a, et seq., and the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. Secs. 1961-1968 (1980). We affirm the district court's order with respect to the securities claims. We reverse with respect to the RICO counts and remand to allow the district court to consider an amended complaint.

I.

Plaintiffs-appellants are the minority shareholders of Water Tower Trust and Savings Bank ("Bank") of Chicago, Illinois. They brought this four count action against appellees, the directors and majority shareholders of the Bank, on behalf of themselves as individual stockholders and derivatively on behalf of the Bank. The dispute arose over alleged misstatements and omissions with concomitant breaches of fiduciary duty surrounding the offering of the stock of the Water Tower Realty Co. ("Realty"), which prior to the spin-off was a wholly-owned subsidiary of the Bank. Appellants claim the alleged improprieties in this transaction resulted in injury to their interest in the Bank, as well as a direct injury to the Bank.

Taking the allegations in plaintiffs' complaint as true, as we must for purposes of evaluating the legal sufficiency of a cause of action, the transaction emerges as a purported conspiracy among the defendant-directors to appropriate the value of Bank assets held by Realty. Prior to 1981 the Bank became aware that banking regulations required the divestment of a 99-year ground leasehold in improved real estate held by Realty and located at 677-79 North Michigan Avenue, Chicago, Illinois (the "677-79 property"). The Bank did not operate any facilities on this property at that time, thus precipitating the need to make the spin-off. The Board of Directors decided to make the divestiture by offering the stock of Realty to the existing shareholders of the Bank. At this time the Board included defendants, Wallace Carroll, George B. Collins, Martin I. Gore, Howard J. Johnson, and Nicholas A. Karris (Defendant Bernard Leviton replaced Collins as a board member in October, 1982) and plaintiff James R. Frankell, who resigned in June, 1982.

In late 1981 and early 1982 certain transactions were consummated by the directors so that Realty was endowed with three major assets. First, Realty held the leasehold in the "677-79 Property." Subsequently, in early 1983, Realty granted the Bank an option to sublease this property for use as a commercial facility for a ten year term beginning in 1993. An independent appraisal pursuant to the offering of Realty stock stated that the option diminished the value of the leasehold by $1,000,000. Plaintiffs allege that this interest lacked any business purpose and was used only to artificially depress the value of Realty stock. Second, the Bank's leasehold in the property housing its commercial facilities, which was located at 717 North Michigan Avenue (the "717 Property"), was renegotiated so that Realty became the lessee with Bank obtaining a sublease from its subsidiary. Plaintiffs allege that the sublease is prejudicial to the Bank's interest since Realty holds at a fixed rent for a fifty year term while Bank's sublease is only for a twenty-five year term with rent equal to fair market value following an initial ten year period during which the rent is fixed at a rate equal to Realty's. Finally, the directors obtained for Realty a two percent interest in a limited partnership formed to redevelop the "717 Property." Subsequent developments have made this interest quite valuable. Plaintiffs allege that the defendants were aware of the potential of the site for redevelopment but failed to disclose the information. Plaintiffs conclude that the market value of Realty's assets was in excess of $2,500,000 in the absence of the option on the "677-79 Property."

The final state of the alleged conspiracy was the spin-off of Realty through an offering of the subsidiary's stock to the shareholders of the Bank for a total price of $1,000,000. This price was far below the actual fair market value of Realty based on, according to the plaintiffs, the existence of the option on the "677-79 Property" and the omission of the true value of the 2% limited partnership interest. While the sale of an asset at an inadequate price may on appropriate facts amount to a fraud on the selling corporation, the shareholders, in theory, would be presented with an attractive investment opportunity. Defendants counteracted the attractiveness of the offering, according to the complaint, by issuing on March 29, 1983 an offering memorandum that through alleged material omissions and misrepresentations attempted to discourage participation in the offering. Plaintiffs allege a large number of misrepresentations and omissions relating to all aspects of the transaction, none of which is specifically relevant to our disposition of this case. The defendant directors were thus able to acquire a "disproportionately large percentage" of the Realty stock and deprive Bank of the full value of its interest in Realty.

The original complaint against the defendants filed in April of 1983 also sought a temporary restraining order and preliminary injunction. Judge Parsons, after a hearing, denied the temporary restraining order, but allowed the plaintiffs to participate in the Realty offering without prejudice to their rights in any pending litigation. Plaintiffs Russell Ray, Mary Rose Ray, Vance Ray, and James R. Frankel, did purchase Realty stock, allegedly for the purpose of protecting their interest in the former assets of the Bank. Plaintiffs Daniel C. McKay and Ivan Himmel never purchased any Realty stock. On June 20, 1983 plaintiffs filed their amended complaint alleging violations of Federal securities law and RICO as well as pendent state law claims. Defendant Johnson moved to dismiss the claims under Rule 12(b)(6) of the Federal Rules of Civil Procedure while the remaining defendants sought summary judgment. Judge Parsons elected to treat all defendants' motions under Rule 12(b)(6) and dismissed plaintiffs' claims for failure to state a cause of action. The court held that the securities claims were inadequate since they failed to allege that the plaintiffs were "buyers" or "sellers" of securities as required by Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 95 S.Ct. 1917, 44 L.Ed.2d 539 (1975), and that the RICO counts were insufficient in that no predicate acts were alleged and the injury to the plaintiffs was the result of the predicate acts alone, rather than the alleged pattern of racketeering activity. The trial court clearly indicated that the case implicates only state law breach of fiduciary duty concerns.

II.

While neither the trial court nor plaintiffs-appellants' briefs distinguish between the individual and derivative securities claims, the two counts do raise distinct legal issues and must be treated separately. The application of the appropriate principles to each count sustains the lower court's judgment that plaintiffs' complaint as amended failed to state a cause of action under Rule 10b-5 of the Securities Exchange Act of 1934.

A.

With respect to the individual securities claims this case presents a derivation of the fact pattern faced by the Supreme Court in Blue Chip Stamps. There, as in the present case, plaintiffs were claiming that they were defrauded out of the opportunity to purchase stock by the use of a deceptively pessimistic offering circular. The Court found that the plaintiffs could not take advantage of Rule 10b-5's implied civil remedy if they were not "purchasers" or "sellers" of securities. 421 U.S. at 749, 95 S.Ct. at 1931-32. Thus plaintiffs McKay and Himmel, who never purchased any Realty stock, fall squarely within the Blue Chip doctrine. ¹

With respect to the remaining plaintiffs the fact pattern deviates from Blue Chip in that these plaintiffs did purchase Realty shares. Superficially this presents the somewhat inapposite situation of a purchaser of shares of stock claiming he was defrauded by buying stock in an offering in spite of an allegedly deceptive offering memorandum designed to discourage such participation. While this raises a number of technical aspects of a Rule 10b-5 cause of action, such as issues of reliance, ² it is most significant for what it illustrates about the nature of plaintiffs' claim. The plaintiffs argue that they were forced to purchase the Realty stock to protect their investment in the Bank because of the fraud perpetrated on the Bank by the defendants. Clearly the gravamen of the individual securities count is the conduct of the directors with regard to Realty as an asset of the Bank. The plaintiffs' purchase of the stock was not induced by fraud; rather, it was a distinct, albeit related, consequence of a separate pattern of fraudulent conduct that injured the bank.

Since the allegations here relate to the decision to sell Realty and the terms of that sale, not the conduct of the offering, plaintiffs' claims implicate only...