Slavin v. Germantown Fire Ins. Co.

• Decision Date: 12 November 1947
• Docket Number: No. 6564.,6564.
• Citation: 74 F. Supp. 876
• Parties: SLAVIN et al. v. GERMANTOWN FIRE INS. CO. et al.
• Court: U.S. District Court — Western District of Pennsylvania

74 F. Supp. 876

SLAVIN et al. v. GERMANTOWN FIRE INS. CO. et al.

No. 6564.

District Court, E. D. Pennsylvania.

November 12, 1947.

Murdoch, Paxson, Kalish & Dilworth, C. Richardson Dilworth and James A. Sutton, all of Philadelphia, Pa., for plaintiffs.

C. Brewster Rhoads and Sidney L. Wickenhaver, both of Philadelphia, Pa., for Germantown Fire Ins. Co., Wm. H. Emhardt, Warren R. Humphreys, Edward M. Cushmore, Thomas Evans, Arthur W. Jones, Charles E. Dearnley, Wm. L. Gruhler, Harry E. Baton, Elmer S. Carll, Horace M. Schell and Glenn K. Morris.

Schnader, Kenworthey, Segal & Lewis, Charles E. Kenworthey and Robert M. Blair-Smith, all of Philadelphia, Pa., for Arthur O. Rosenlund.

Harold Evans, of Philadelphia, Pa., for Charles E. Kenworthey, Richard P. Brown and Walter Weir.

Clark, Brown, McCown, Fortenbaugh & Young and Everett H. Brown, Jr., all of Philadelphia, Pa., for National Bank of Germantown & Trust Co.

Guckes, Shrader & Burtt and Howard Burrt, all of Philadelphia, Pa., for Bioren & Co.

Felix & Felix, David H. H. Felix, of Philadelphia, Pa., for Charles Frazier, Charles K. Allman and Miriam S. Felix.

Thomas C. Egan, of Philadelphia, Pa., for Harry P. Gatter, Earle N. Barber, Clifford R. Koelle.

WELSH, District Judge.

This is a stockholders' derivative suit in which the plaintiffs base their cause on alleged violations of the Securities Exchange Act of 1934, 15 U.S.C.A. § 78a et seq. There is no diversity of citizenship and jurisdiction is wholly dependent upon the applicability of that Act and the regulations promulgated thereunder.

The Mutual Fire Insurance Company of Germantown, a 100-year old mutual having a surplus of approximately $3,500,000 was converted into a stock company, now called Germantown Fire Insurance Company, by the actions of its policyholders under a plan which provided the policyholders with pre-emptive rights to subscribe to the stock in proportion to the premiums paid. This case grows out of that conversion and the issuance of the stock of the new company.

The plaintiffs are stockholders who seek redress on behalf of the Germantown Fire Insurance Company. The defendants are the new company, directors of the old or mutual company, and Arthur O. Rosenlund, an insurance broker now occupying the positions of President and Chairman of the Board of the new company.

Section 10 of the Act provides that it shall be unlawful for any person, by the use of any instrumentality of interstate commerce, or of the mails, or of the facilities of any national securities exchange, to use or employ, in connection with the purchase or sale of securities, any manipulative or deceptive device or contrivance in contravention of the rules and regulations of the Securities Exchange Commission. Rule X-10B-5 of the Commission declares it unlawful, in securities transactions using such facilities, (1) to employ any device, scheme or artifice to defraud; (2) to make any untrue statement of a material fact or to omit to state a material fact necessary to make expressed statements not misleading; or, (3) to engage in any act or practice which operates or would operate as a fraud or deceit upon any person.

Section 27 of the Act gives to the district courts exclusive jurisdiction of violations of the Act and rules, and of all suits in equity and at law to enforce any liability or duty created by the Act or regulations. Section 29(b) provides that every contract made in violation of the Act and regulations, or the performance of which involves such violations, shall be void as regards the right of any person who shall have made or engaged in the performance of such contract.

The allegations of the bill were deemed sufficient to give preliminary jurisdiction in that they averred the accomplishment of a manipulative device or scheme, dominated and directed by Rosenlund and involving the use of the mails, which resulted in the acquisition of stock at substantially less than its true value. It was alleged that the scheme or device consisted of the transferring of Rosenlund's extensive insurance business to Mutual, inducing his assureds to extend their insurance, placing and controlling Rosenlund's associates, E. M. and C. L. Cushmore, in the key positions respectively of manager and counsel for Mutual, promoting the conversion of Mutual into a stock company in which process false and misleading statements were filed with the S. E. C., obtaining subscription warrants from policyholders by fraudulent representations, and connivance between Rosenlund and the directors for the purpose of enabling Rosenlund to gain control of the new company, and enabling him and the directors to obtain its shares at a mere fraction of their worth. The bill demanded the appointment of a receiver, surrender of the stock issued to Rosenlund and the directors, termination of a voting trust and other agreements, an election of new directors, and general relief.

The evidence submitted at the trial falls short of establishing the comprehensive device or scheme alleged, and the plaintiffs, although still demanding the redress originally prayed for, have modified their theory of recovery. As stated in their brief, they now "seek on behalf of the Company to have restored to the Company the secret profit which Rosenlund and a few directors were able to obtain and did obtain by the misuse of their confidential relationship to the Company in its conversion"; and deem this action one "in the nature of an accounting to compel Rosenlund to turn over to the Company the fruits of the abuse of fiduciary duty", the essential nature of the suit being "to restore to the corporation the profits which they (defendants) obtained through the abuse of their confidential relationship with the Company". The specific relief claimed is the surrender and cancellation of the stock issued to the defendants and the repayment to them of the amount of their subscriptions, with supplemental relief deemed essential to making rescission of the subscriptions effective.

There has been no substantive evidence of the setting up of a device, scheme or artifice to defraud any person by the means and for the purposes alleged in the bill; nor is there any proof that Rosenlund and his alleged conspirators dominated and controlled Mutual and its directors in the process of conversion, or in the filing and distribution of false or incomplete statements and prospectuses through the mails or otherwise. There is no evidence that the directors devised the plan of conversion, fixed the issue price at $20, and filed or issued untrue or incomplete statements or prospectuses with the view to misleading or discouraging subscribers so that the directors could buy the stock at less than its value. To construe the evidence in such light would require the adoption of inferences and suppositions not warranted or justified by the facts.

The evidence upon which the plaintiffs base their demand for recovery, and which we adopt as the basis for our disposition of the principal issues, shows: In the course of the conversion of the company, Rosenlund, its principal broker and business producer, was given full details of the plan of conversion and asked by the company to obtain waivers by certain assureds of their rights to subscribe to stock in excess of 1,000 shares. Rosenlund procured such waivers, and subsequently at the request of the company procured proxies sufficient to enable the company to effect the conversion. In the course of such contacts, and notwithstanding his knowledge that the company planned and sought to limit the holding of stock of any stockholder to 1,000 shares, he obtained from his policyholders agreements to assign their rights to subscribe, and later the warrants themselves.

The method by which he procured those warrants is in some dispute, but is deemed unimportant for present purposes. It seems clear however that Rosenlund concealed or refrained from disclosing to the company his acquisition of the warrants until just prior to the closing of the subscription period, at which time it became known to the company that he had acquired 17,500 of the 50,000 shares authorized. The directors, who were "shocked" to learn of the situation and the defeat of their plan to secure wide distribution of the stock, made an investigation, and with the aid of counsel, concluded that there were no available means of avoiding the issuance of shares to Rosenlund in accordance with the warrants. Shares were issued to Rosenlund for the $20 subscription price, whereas the book value exceeded $80 a share.

There is no substantive evidence of connivance or domination between Rosenlund and the directors or of misleading statements or omissions in the S. E. C. statement and the prospectus mailed to policyholders. The facts on which the plaintiffs rely to establish a breach of fiduciary duty on the part of the directors are, that they failed to discover and prevent Rosenlund's actions in procuring warrants by assignment in contravention of the adopted plan, and upon ultimate discovery the directors failed to take any action to rescind or preclude Rosenlund's rights to the stock represented by the warrants he had acquired; the directors had also made an arrangement with the underwriters of the issue whereby the underwriters would allot to the directors warrants not exercised by the policyholders, and that such directors took advantage of their confidential knowledge and relationship by acquiring stock at $20 which they knew to have a book value greatly in excess thereof.

Assuming the existence of the fiduciary relationship of Rosenlund and the directors with Mutual, and that such relationship and all its incidental rights and obligations were carried over to the successor corporation, and conceding for the purpose of demonstration that the facts recited constitute breaches of fiduciary duties of the defendants, the question arises as to whether such breaches are violations of the Act...