Rochelle v. Marine Midland Grace Trust Co. of New York

• Decision Date: 10 May 1976
• Docket Number: No. 74-1429,74-1429
• Citation: 535 F.2d 523
• Parties: Fed. Sec. L. Rep. P 95,562 William J. ROCHELLE, Jr., Trustee in Reorganization of Sunset International Petroleum Corporation on his own behalf and as a representative of certain classes, and American Income Life Insurance Company, on its own behalf and as representative of certain classes, Plaintiffs-Appellants, v. MARINE MIDLAND GRACE TRUST COMPANY OF NEW YORK, being joined as Involuntary Plaintiff, v. ARTHUR YOUNG & COMPANY et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 523

535 F.2d 523

Fed. Sec. L. Rep. P 95,562

William J. ROCHELLE, Jr., Trustee in Reorganization of

Sunset International Petroleum Corporation on his own behalf

and as a representative of certain classes, and American

Income Life Insurance Company, on its own behalf and as representative of certain classes, Plaintiffs-Appellants, v. MARINE MIDLAND GRACE TRUST COMPANY OF NEW YORK, being joined

as Involuntary Plaintiff,

v.

ARTHUR YOUNG & COMPANY et al., Defendants-Appellees.

No. 74-1429.

United States Court of Appeals Ninth Circuit.

May 10, 1976.

Rehearing Denied June 16, 1976.

Richard W. Havel (argued), of Shutan & Trost, Los Angeles, Cal., for plaintiffs-appellants.

Hillel Chodos (argued), Beverly Hills, Cal., for defendants-appellees.

OPINION

Before HUFSTEDLER, WRIGHT and GOODWIN, Circuit Judges.

HUFSTEDLER, Circuit Judge:

This appeal by Rochelle, reorganization trustee of Sunset International Petroleum Corporation ("Sunset") and by American Income Life Insurance Company ("American"), purchaser of a debenture issued by Sunset, against former officers and directors of Sunset and an independent certified public accountant, Arthur Young & Company ("Young") ¹ presents a series of questions arising at the intersection of federal securities and bankruptcy law. The district court granted judgment of dismissal of Rochelle's federal securities claims for failure to state a claim for relief and of his common law claims on the ground of lack of jurisdiction. Summary judgment against American was based on the district court's determination that limitations barred American's federal securities suit.

On May 25, 1970, Sunset filed a petition for reorganization under Chapter X of the Bankruptcy Act. Rochelle was appointed trustee. Rochelle brought this action on behalf of Sunset, a class of allegedly defrauded holders of Sunset's debentures, and a class of allegedly defrauded creditors of Sunset. The gist of Rochelle's action was that the defendants, through mismanagement, misrepresentations, and breaches of duties owed to the corporation and to the investing public, grossly overstated the net worth of Sunset and concealed its deteriorating financial condition, causing substantial losses to Sunset, its creditors, and debenture purchasers and holders.

We begin with Sunset's family tree. On April 30, 1966, Sunset, a Delaware corporation, ("Sunset-Del") merged with Sunasco, Inc. (formerly Atlas Credit Corp.). Sunasco formed the present Sunset as a wholly owned subsidiary and caused Sunset-Del's assets to be transferred to Sunset. On January 23, 1968, Commonwealth United Corporation ("CUC") purchased all of Sunset's outstanding stock, and Sunasco acquired certain of Sunset's assets and liabilities.

In the middle and late 1960's Sunset was engaged in substantial real estate development projects in California. According to Rochelle's complaint, the value of Sunset's real estate began to decline precipitously under the impact of a general real estate market downturn in 1965. Sunset's financial statement for the period ending August 31, 1965, certified by Young on November 12, 1965, reported Sunset's net worth to be in excess of $16,000,000. This 1965 statement was included in Sunset's 1965 Annual Report, its proxy statement of March 24, 1966, and two S-1 Registration Statements filed with the Securities and Exchange Commission ("SEC"), effective August 26, 1966. Sunset's September 1966 statement was even rosier. It showed a net worth of more than $18,000,000, with current assets exceeding current liabilities by over $7,500,000. Sunset's financial statement for the period ending September 30, 1966 was certified by Young as of December 1, 1966. All of the roses wilted in 1967. Assets were written down $20,000,000 as of July 31, 1967, although the write down was not published until December 1967, when it was revealed in proxy materials relating to CUC's acquisition of Sunset. At that time Sunset showed an earned surplus deficit of $3,000,000, and a $19,000,000 provision for loss. The 1967 proxy materials also first disclosed to the public that Sunset had unsuccessfully tried to raise operating capital through its 1966 debenture offering, that Sunset's operating capital was exhausted, that it was unable to meet its real property tax obligations, and that it was in default on purchase money loans secured by its real estate. ²

The securities involved in this litigation are some of Sunset's debentures. Sunset, as issuer, received full value on the debentures that it publicly sold. On two occasions Sunset repurchased its debentures at a discount; on a third occasion, on September 8, 1966, it reacquired some of its 61/4 percent debentures with a face value of $100,000 at a price of $100,000, then immediately resold them for $80,000. The only loss that it alleges from its dealings in its own debentures is the $20,000 lost on its resale of the debentures acquired on September 8, 1966. It does not contend that resale was below market value. The cumulative financial effect of its acquisition and resale of its debentures was to reduce Sunset's indebtedness by $805,600 at a cost of $629,200.

Sunset's fall and the present suit take place against a decidedly litigious background. Sunset was undergoing reorganization in a federal district court in Texas, when on September 12, 1972 (more than 2 years after the filing for reorganization) the trustee recommended the present suit to the creditors' committee. The latter split 2 for, 2 against, 1 abstaining on whether to prosecute this action; there was concern that the suit would deplete the "general expense fund of the estate, but that recovery on any of the class action theories would only go to the benefit of a few creditors." Later in September 1972, Rochelle received permission to file this suit (to avoid statute of limitations cut-offs), but was restricted to filing and serving notice. A Referee and Special Master finally granted Rochelle full authorization to proceed in May 1973; the committee was still split. The dispute on whether or not to sue may account for the lack of participation on

the plaintiff's side. 1. Rochelle's claims on behalf of

creditors and debenture purchasers and holders.

We can quickly dispose of the claims that Rochelle purported to assert on behalf of Sunset's creditors and its debenture purchasers. The district court correctly dismissed this phase of the litigation because Caplin v. Marine Midland Grace Trust Co. (1972) 406 U.S. 416, 92 S.Ct. 1678, 32 L.Ed.2d 195, held that a reorganization trustee has no standing to maintain the action on the part of any person or entity other than his debtor corporation. (Accord: Clarke v. Chase National Bank (2d Cir. 1943) 137 F.2d 797; Warheit v. Osten (E.D.Mich. 1973) 57 F.R.D. 629.)

2. Rochelle's federal securities law claims on behalf of Sunset.

Rochelle also asserted claims founded on Section 10(b) of the Securities Exchange Act of 1934 (15 U.S.C. § 78a-hh-1 (1970)) and Rule 10b-5 (17 C.F.R. § 240.10b-5 (1975)) on behalf of Sunset against the named directors and officers of Sunset and against Young.

Rochelle has standing to assert Sunset's Section 10(b) and Rule 10b-5 claims against these defendants. (Superintendent of Insurance v. Bankers Life & Casualty Co. (1971) 404 U.S. 6, 92 S.Ct. 165, 30 L.Ed.2d 128; Thomas v. Roblin Industries, Inc. (3d Cir. 1975) 520 F.2d 1393; Hooper v. Mountain States Securities Corp. (5th Cir. 1960) 282 F.2d 195.) Debentures, of course, are securities. (Securities Exchange Act of 1934, § 3(a)(10), 15 U.S.C. § 78c(a) (10).) Issuers of other kinds of securities, such as notes (Rekant v. Desser (5th Cir. 1970) 425 F.2d 872) and stocks (Sargent v. Genesco, Inc. (5th Cir. 1974) 492 F.2d 750; Dasho v. Susquehanna Corp. (7th Cir. 1967) 380 F.2d 262; Ruckle v. Roto American Corp. (2d Cir. 1964) 339 F.2d 24; Hooper v. Mountain States Securities Co., supra ) have been held to be "sellers" within the meaning of the Birnbaum rule (Birnbaum v. Newport Steel Corp. (2d Cir. 1952) 193 F.2d 461), limiting standing under Section 10(b) and Rule 10b-5 to one who is a purchaser or a seller of securities. (Birnbaum was adopted by the Supreme Court in Blue Chip Stamps v. Manor Drug Stores (1975) 421 U.S. 723, 95 S.Ct. 1917, 44 L.Ed.2d 539.) A debenture issuer should be treated no differently than an issuer of other kinds of securities for Birnbaum purposes. Moreover, Sunset was also both a purchaser of the debentures it reacquired and a seller of the debentures that it reacquired and resold.

The complaint avers adequate facts to show that the 1965 and 1966 financial statements, included in Sunset's Annual Reports, its proxy statements, and its two registration statements were seriously misleading and that the named officers and directors participated in producing these misrepresentations of its financial condition. Young prepared and certified these financial statements.

Rochelle's Section 10(b) and Rule 10b-5 action against the defendants reaches swampy territory when we ask whether the manipulative devices, fraud, and claimed breaches of duty were "in connection with" the purchase or sale of the debentures and whether these activities caused any potentially recoverable damage to Sunset.

Sunset's securities transactions fall into three categories: (1) Its June 1965 acquisition of its 5 percent debentures with a face value of $600,000 for $450,000, and its September 1966 acquisition of similar debentures with a face value of $105,000 for $79,200; (2) its September 1966 acquisition of its 61/4 percent debentures with a face value of $100,000 for $100,000, and the prompt resale of the same debentures for $80,000; (3) the initial issuance of all of its debentures.

We agree with the defendants that Sunset cannot base any Section 10(b) or Rule 10b-5 action on the repurchase of its debentures at a discount. Even assuming that the defendants' alleged misconduct was in connection with these...