Rochez Bros. Inc. v. Rhoades

• Decision Date: 24 January 1973
• Docket Number: Civ. A. No. 68-1048.
• Citation: 353 F. Supp. 795
• Parties: ROCHEZ BROS. INC., a Pennsylvania corporation, Plaintiff, v. Charles R. RHOADES et al., Defendants.
• Court: U.S. District Court — Eastern District of Pennsylvania

353 F. Supp. 795

ROCHEZ BROS. INC., a Pennsylvania corporation, Plaintiff, v. Charles R. RHOADES et al., Defendants.

Civ. A. No. 68-1048.

United States District Court, W. D. Pennsylvania.

January 24, 1973.

Ralph German, Pittsburgh, Pa., for Rochez Bros. Inc.

W. Gregg Kerr, Pittsburgh, Pa., for Rhoades.

Edmund S. Ruffin, Pittsburgh, Pa., for M. S. & R. Inc.

OPINION

DUMBAULD, District Judge.

This is an action alleging violation of Rule 10b-5 promulgated by the Securities and Exchange Commission. (A claim for fraud under Pennsylvania law is annexed on the theory of pendent jurisdiction.¹) That rule reads as follows:

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.²

It was originally adopted on May 21, 1942, as Rule X-10B-5, borrowing language from § 17(a) of the Securities Act of May 27, 1933³ and applying it "in connection with the purchase or sale of any security."⁴

The rule was purportedly in pursuance of Section 10(b) of the Securities Exchange Act of June 6, 1934, which 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.⁵

As will be seen in due course, an extensive judicial gloss has encrusted these texts, with the result that "A startling variety of everyday transactions have turned out to be `fraudulent' under SEC Rule 10b-5."⁶ The interpretative transmutation has been so extensive that "Rule 10b-5 no longer means what it says. This is a signal failing in any positive law."⁷

The rule was extemporized by two SEC employees who wanted to do something about a Boston executive who was buying up his company's stock by telling the owners that the company was doing badly, whereas in fact the earnings had quadrupled.⁸ Thus "the archetypal 10b-5 case is the purchase by one group in a closed corporation of the interest of another, without disclosing negotiations for sale or other disposition of the issuer's assets or its securities at a higher price."⁹

Originally, only administrative enforcement was contemplated. But now it is clear that the seller as well as the buyer may bring a civil action.¹⁰ The pioneer holding to this effect was a decision by the late distinguished Judge Kirkpatrick in Kardon v. National Gypsum Co., 69 F.Supp. 512, 513-514 (E.D. Pa.1946). It is noteworthy that in this field of the law leadership has been manifested by District Judges (especially in the Southern District of New York) but that the Supreme Court has made few pronouncements on the subject.¹¹

It is clear that mere mismanagement or violation of a fiduciary duty under state corporation law does not violate the rule.¹² There must be use, "in connection with the purchase or sale" of a security, of information, accessible to a corporate "insider" for limited fiduciary purposes, but used instead for personal economic advantage, to the detriment of a party to the transaction not having access to such information.¹³ The information must be such as would have influenced the uninformed party's decision with respect to the transaction.¹⁴ Information equally accessible to both parties, or which the other party in fact knows or should have known, need not be disclosed.¹⁵ Mere speculations or opinions as to present value or future earnings do not constitute violations, as such differences are the life of the stock market as well as of horse races, and parties are relegated to their own judgment in such matters; but an opinion insincerely professed can have the consequences of a misstatement of fact,¹⁶ since the state of a person's mind is as much a fact as the state of his digestion, as an English judge once remarked.¹⁷

In applying the foregoing body of judicially created legal precepts, in order to determine whether plaintiff has established a violation of Rule 10b-5 by defendant, it will be necessary to scrutinize the facts developed in the record, during 18 trial days.

This case arises out of the business activities of defendant Charles R. Rhoades, whose blunt staccato speech resembles that of a military officer, and who is said to be a hard-driving executive. (Tr. 1604-1605). He is of litigious disposition and also has a special aptitude for dissension with his business associates (Tr. 1679, 1694-1695). When evicted from his office with Mason, Shaver, and Rhoades he occupied space in plaintiff's office. (Tr. 23-25). Later an arrangement was made whereby plaintiff and defendant each acquired half ownership of the stock of that company, and the name was changed to MS&R Inc. Plaintiff paid $272,500 for its share on July 1, 1964 (Tr. 30-31). Rhoades was president and director of the company, Joseph Rochez (president of plaintiff) was vice president and director, and George McClaran, of Pittsburgh National Bank, was the third director. (Tr. 31-32).

Rhoades was a sanguine plunger and promoter, a salesman type. Rochez was shrewd and suave, a financier type. (Tr. 1794). Rhoades would occasionally book business and get a disproportionate advance in progress payments from the customer to carry the expenses arising out of performance of the contract. (Tr. 176-178). Rochez complained of lack of working capital, and disfavored overextension. But he was unwilling for plaintiff to supply unilaterally the needed capital (except for small urgent needs), and Rhoades was unwilling or unable to furnish his share (Tr. 43, 47). A contract with Babcock & Wilcox was one of the chief bones of contention. This was a large order which required considerable expense on the part of MS&R for equipment and materials in order to perform the contract. (Tr. 1336-39). Rochez vigorously opposed taking on the contract, and upon learning that counsel considered the contract to be binding, he caused his protest to be entered in the minutes for his protection as a director. (DX 15 and 16, Tr. 155-157, 306-307).

Rhoades regarded the contract as the opening wedge to future profitable business and declared he would personally undertake the commitment if MS&R declined it (DX-97). At a directors' meeting of September 8, 1967, Western Pennsylvania National Bank (WPNB) undertook to make loans of $600,000 to MS&R, with an unsecured line of credit of $200,000, replacing Pittsburgh National Bank (PNB) as the company's lender. After some controversy, the resignation of McClaran as a director was accepted (DX-98). No further meetings were held until after the sale of Rochez stock to Rhoades.

On May 2, 1965, plaintiff moved its offices into the MS&R premises and consolidated accounting continued until April 30, 1967, when separate accounting was resumed and physical removal of plaintiff's employees took place on August 19, 1967.

The dissension was such that both Rochez and Rhoades interviewed prospective purchasers of the company. They also discussed a buy-sell agreement whereby one of them would buy out the other's interest. (A restriction prevented sale to outsiders without first offering it to the other stockholder. DX-4, Tr. 1693).

In pursuance of this plan plaintiff finally named the price for which it was willing to sell its stock to defendant. On September 16, 1967, an agreement of sale was executed, under which Rhoades bought plaintiff's stock for $598,000 (PX-9). The closing, and delivery of the stock certificates to defendant, took place on November 13, 1967 (Tr. 92).

When plaintiff on September 11, 1967, stated its terms, one of them was that the deal should be concluded by noon on September 15th, and that Rhoades should put $50,000 in escrow, to be forfeited if the closing did not take place on September 29th.¹⁸ (DX-56). Rhoades borrowed that sum from WPNB, and later borrowed the remainder of the purchase price from the same bank. His well-to-do cousin Edward C. McCormick, Jr., would have furnished the money to pay for the Rochez stock if Rhoades had been unable to borrow it from the bank. (Tr. 1533-1535, 1675).

It is fair to assume that Rochez knew that Rhoades would have to borrow the money from a bank or "from other investors that he may have had in the wings." Plaintiff did not care where the money came from "as long as we got our price." (Tr. 385-386).

In February of 1968 Joseph Rochez received a phone call from one Wingate Royce, who claimed that Rhoades had employed him to find a purchaser for MS&R, that Royce had found a ready, willing, and able purchaser, and had earned his commission or finder's fee, but that Rhoades would not go through with the deal or pay (Tr. 96-97). Royce in fact sued Rhoades; Rhoades paid Royce some money under some other pretext without admitting liability; and the suit was withdrawn (Tr. 1702-1704).

From the tale unfolded to him by Royce Rochez obtained documents and information which led to the present litigation (Tr. 101).

It is now clear that in fact Rhoades did answer an advertisement and Royce visited the MS&R plant on April 21, 1967, and was introduced by Rhoades to Rochez....