Reid v. Hughes, 76-3673

• Decision Date: 21 August 1978
• Docket Number: No. 76-3673,76-3673
• Citation: 578 F.2d 634
• Parties: Fed. Sec. L. Rep. P 96,537 William M. REID, Individually and derivatively on behalf of Weatherby Engineering Co., Plaintiffs-Appellants, v. H. D. HUGHES et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 634

578 F.2d 634

Fed. Sec. L. Rep. P 96,537

William M. REID, Individually and derivatively on behalf of Weatherby Engineering Co., Plaintiffs-Appellants, v. H. D. HUGHES et al., Defendants-Appellees.

No. 76-3673.

United States Court of Appeals, Fifth Circuit.

Aug. 21, 1978.

Ben H. Schleider, Jr., Paul S. Francis, Houston, Tex., for plaintiffs-appellants.

Barry Allan Brown, Houston, Tex., for Johnson-Loggins, Inc.

John L. Carter, Houston, Tex., for R. E. Reamer.

J. Clifford Gunter, III, Houston, Tex., for G. W. Loggins.

Justin M. Campbell, III, Houston, Tex., D. Robert Owen, New York City, for First Realty Investment.

Lloyd R. Cunningham, Jr., Grant Cook, Houston, Tex., for Larry Johnson.

Morton L. Susman, Michael P. Kessler, Houston, Tex., for Hilderbrand, Hughes et al.

Appeal from the United States District Court for the Southern District of Texas.

Before TUTTLE, GEE and FAY, Circuit Judges.

FAY, Circuit Judge:

This appeal raises a variety of difficult questions under the Securities Exchange Act of 1934. Suing individually and derivatively, William M. Reid charged the defendants with a multitude of sins including violations of Section 10(b) and Rule 10b-5 of the 1934 Act. ¹ The district court granted the defendants' motion to dismiss for failure to state a claim upon which relief can be granted. ² The basis of the district court's order was evidently a determination that the plaintiff had failed to allege in his complaint that either he or the company on whose behalf he brought the derivative suit had bought or sold securities. It is axiomatic that the purchase or sale of securities by a plaintiff is a jurisdictional prerequisite to the maintenance of a claim for damages under Section 10(b) and Rule 10b-5, Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 95 S.Ct. 1917, 44 L.Ed.2d 539 (1975), and the failure to allege such requires a dismissal of the action as a matter of law. After a careful examination of the plaintiff's complaint and the relevant case law, we affirm.

The facts in this case are complex and, unfortunately, have not been fully developed. The plaintiff owns 9.5% of the stock in Weatherby Engineering Co. The remainder of Weatherby stock is owned by defendant IDSO Investments, Inc. (80%), defendant K. G. Watler (9.5%), and Leon B. Dorsey (1%). According to the plaintiff, Weatherby was dominated by defendant H. D. Hughes through IDSO a family holding company.

The actions complained of by the plaintiff revolve around the acquisition of all the outstanding stock of Johnson-Loggins, Inc. (JLI) from its parent corporation First Realty Investment Corporation (FRI). Z Corporation was the ultimate recipient of this stock. According to the plaintiff's complaint, JLI owned substantial amounts of real estate which had been purchased at highly inflated prices and on onerous terms. To be relieved of the cash drain created by the JLI real estate indebtedness, FRI offered to sell the JLI stock to defendants Larry Johnson, Glenn Loggins, and R. E. Reamer for $4,000,000 in cash and promissory notes and 547,214 shares of FRI. In order to finance this acquisition of JLI stock, Johnson, Loggins, and Reamer approached Hughes, Watler, and Herbert V. Hildebrand (all of whom were officers and directors of Weatherby), and worked out an arrangement whereby the cash and assets of Weatherby were committed to finance the purchase of JLI stock from FRI. Exactly how this was done is not clear from the plaintiff's complaint. It is not contested, however, that it was Z Corporation, and not Weatherby, who received the JLI stock.

Some background information on Z Corporation is essential to a complete understanding of the facts of this case. The allegations set forth that Z Corporation was chartered on November 18, 1974, and its initial directors were Hughes, Watler, Hildebrand, Loggins and Reamer. IDSO, Watler, and Dorsey transferred their Weatherby stock to Z Corporation in exchange for 60% of the stock of Z Corporation. Z Corporation also issued stock to Johnson, Loggins, and Reamer. The crux of the plaintiff's complaint is that as of November 30, 1974, Weatherby had assets totalling $13,700,216 of which $6,572,734 was in cash, but that the defendants caused Weatherby to issue promissory notes, transfer cash and pledge certificates of deposits totalling $4,000,000 in order to enable Z Corporation to purchase the stock of JLI. It is alleged that all this was done without consideration or for insufficient consideration to Weatherby.

We have carefully examined the allegations of the plaintiff's complaint, and agree with the district court that the plaintiff, on the face of his complaint, nowhere alleges that either he or Weatherby bought or sold securities. We reach this conclusion fully aware of the fact that a complaint need only provide a short and plain statement of the claim showing that the pleader is entitled to relief, and that both the trial court and this court must accept as true all material allegations in the complaint and must construe the complaint in favor of the plaintiff. A complaint should not be dismissed for failure to state a claim unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief. See Conley v. Gibson, 355 U.S. 41, 78 S.Ct. 99, 2 L.Ed.2d 80 (1957). It is, however, also true that when federal jurisdiction is based on the existence of a federal question, the jurisdictional allegation must state under which particular statute the action arises, and the body of the complaint must set forth facts showing that the case does in fact arise under federal law. A general allegation of a federal question will not suffice if it is not supported by matters constituting the claim for relief as set forth in the complaint. See Givens v. Moll, 177 F.2d 765 (5th Cir. 1950); C. Wright, Law of Federal Courts, 327 (3d ed. 1976).

The plaintiff argues that the body of his complaint sufficiently alleges that Weatherby both bought and sold securities. Initially, plaintiff argues that paragraph 22 of his complaint alleges that Weatherby was a seller of securities. Paragraph 22 provides:

As of November 30, 1974, Weatherby had assets totalling $13,700,216 of which $6,572,734 was in cash. Defendants caused Weatherby to issue promissory notes, transfer cash and pledge certificates of deposit totalling $4,000,000 in order to enable Z Corporation to purchase the stock of Johnson-Loggins from FRI without consideration or for insufficient consideration to Weatherby.

The plaintiff contends that Weatherby, by pledging certificates of deposit and by giving promissory notes, was itself a seller of securities within the meaning of the Securities and Exchange Act of 1934. We disagree. While it may be true that in certain situations a certificate of deposit can be a security as that term is used in the Act, there is absolutely no support for the proposition that a mere pledge of a security in circumstances such as those alleged us would constitute a purchase or sale thereof within the meaning of Section 10(b) and Rule 10b-5. See McClure v. First National Bank of Lubbock, Texas, 497 F.2d 490, 495 (5th Cir. 1974). The issuance of promissory notes provides a somewhat different question. The Securities and Exchange Act of 1934 provides that the term security means "any" note, but judicial decisions have restricted the application of the 1934 Act to only those notes that are investment in nature. Notes which are reflective of individual commercial transactions are generally outside of the purview of the Act. In McClure v. First National Bank of Lubbock, Texas, 497 F.2d 490 (5th Cir. 1974), this Court explained that notes which can be deemed securities usually fall within one of two categories. The first category is those notes which are offered to a class of investors or are acquired for speculation or investment purposes. The second category is when the maker of the note receives investment assets in return for the note. It is impossible to tell from the face of the complaint whether the notes issued by Weatherby fall into either of these two categories. ³ It is certain, however, that the mere allegation by the plaintiff in his complaint that Weatherby issued promissory notes is grossly insufficient to establish the jurisdictional basis for his cause of action since, standing alone, it in no way alleges that Weatherby was a seller of securities.

The plaintiff also argues that Weatherby was a buyer of securities. ⁴ The thrust of this argument is that the cash and resources of Weatherby were used to finance the acquisition of JLI stock from FRI. Because of its vital role in these transactions, it is contended that Weatherby effectively bought the JLI stock from FRI on behalf of Johnson, Loggins, Reamer, Hughes, Watler, IDSO and Z Corporation, and made it possible for them to now own Z Corporation stock. The plaintiff argues that the fact Weatherby does not have legal title to the JLI stock is a formal consideration which should not be controlling. In support of this argument, the plaintiff refers us to a portion of the opinion in Smallwood v. Pearl Brewing Co., 489 F.2d 579 (5th Cir. 1974), which provides:

Pearl and Southdown entered into a contract whereby on the effective date of the merger all of Pearl's assets were transferred to Southdown in return for Southdown preferred stock issued to Pearl's shareholders. Pearl was the contracting party and provided the consideration. In effect, Pearl bought the Southdown stock for its owners, the Pearl shareholders. Although not an active conduit or the ultimate recipient of the Southdown preferred stock, Pearl acted as a "purchaser" in all other respects. Little purpose would be served by hinging Smallwood's standing to sue derivatively under Rule 10b-5 entirely on...