Sterling Recreation Organization Co. v. Segal, Civ. A. No. 81-K-2013.

• Citation: 537 F. Supp. 1024
• Decision Date: 27 April 1982
• Docket Number: Civ. A. No. 81-K-2013.
• Parties: STERLING RECREATION ORGANIZATION CO., Plaintiff, v. David M. SEGAL and Bruce B. Paul, Defendants.
• Court: U.S. District Court — District of Colorado

537 F. Supp. 1024

STERLING RECREATION ORGANIZATION CO., Plaintiff, v. David M. SEGAL and Bruce B. Paul, Defendants.

Civ. A. No. 81-K-2013.

United States District Court, D. Colorado.

April 27, 1982.

John D. Phillips, Jr., Daniel R. Satriana, Jr., Hall & Evans, Denver, Colo., for plaintiff.

Donald Bain, Edmond F. Noel, Jr., Holme, Roberts & Owen, Denver, Colo., for defendants.

KANE, District Judge.

This case involves the sale of a Colorado radio station from the defendants to the plaintiff. The sale was effected by an agreement that transferred all of the station's outstanding capital stock from the defendants to the plaintiff. The plaintiff alleges that the defendants made various negligent and intentional misrepresentations regarding the station in the agreement. Its first claim for relief, securities fraud, is brought under the Securities Act of 1933, 15 U.S.C. §§ 77a-77aa, the Securities Exchange Act of 1934, 15 U.S.C. §§ 78a-78kk, and the Colorado Securities Act, C.R.S. §§ 11-51-101-11-51-129. Its other claims for relief are based on negligent misrepresentation, breach of contract and indemnification. This court has jurisdiction to hear the federal claims under 15 U.S.C. § 77v(a), 78aa, and 28 U.S.C. § 1331. It has jurisdiction to hear the remaining claims under id. § 1332, because of diversity of citizenship.

The defendants moved to dismiss the first claim for relief, on three grounds. First, they argue that this case does not involve any securities that are covered by the federal and state securities laws. Second, they allege that the complaint does not contain sufficient allegations of scienter to state a claim under the securities laws. Third, they argue that section 17(a) of the 1933 Act, 15 U.S.C. § 77q(a), one of the sections on which the first claim is based, does not provide for a private right of action. The plaintiffs submitted an answer brief, to which the purchase agreement was attached. However, even without considering this extraneous matter, I conclude that the motion to dismiss should be denied, and therefore I do not convert this motion into one for summary judgment.

I. APPLICABILITY OF THE SECURITIES LAWS

Section 2(1) of the 1933 Act, 15 U.S.C. § 77b(1), determines the scope of the act by defining "security" as:

any note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profit-sharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, or, in general, any interest or instrument commonly known as a `security', or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing.

Section 3(a)(10) of the 1934 Act, 15 U.S.C. § 78c(a)(10), contains a similar definition of "security," as does C.R.S. § 11-51-102(12).¹ I must determine whether the capital stock that was transferred in the present case is included within the definition of securities under these statutes.

The U.S. Supreme Court has stated:

in searching for the meaning and scope of the word `security' in the 1933 Act, form should be disregarded for substance and the emphasis should be on economic reality.

Tcherepnin v. Knight, 389 U.S. 332, 336, 88 S.Ct. 548, 553, 19 L.Ed.2d 564 (1967) (citing S. E. C. v. W. J. Howey Co., 328 U.S. 293, 298, 66 S.Ct. 1100, 1102, 90 L.Ed. 1244 (1946)).

Applying the "economic reality" test, Judges Arraj and Finesilver of this court have held that transfers of stock shares that are merely "indicia of ownership" of a corporation will not be subject to the federal securities laws. Bula v. Mansfield, Civil Action No. 76-F-871 (May 13, 1977) (CCH Fed.Sec. Law Rep. ¶ 96, 964); Chandler v. Kew, Inc., Civil Action No. 75-A-602 (Dec. 4, 1975) (CCH Fed.Sec. Law Rep. ¶ 96, 965), aff'd, No. 76-1083 (10th Cir. April 19, 1977) (CCH Fed.Sec. Law Rep. ¶ 96,966).

In United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 95 S.Ct. 2051, 44 L.Ed.2d 621 (1975), the court considered the applicability of the federal securities laws to sales of stock shares in a co-operative housing project. The shares were non-transferable, did not have voting rights, and normally could only be resold to the issuer at the original price. Id. at 842, 95 S.Ct. at 2055. Although they were called stock shares, their sole purpose was to be a recoverable deposit on an apartment to be occupied by the purchaser. Id. In part II.A. of its opinion, id. at 848-51, 95 S.Ct. at 2058-60, the court held that these shares were not "stock," as used by the federal securities laws in defining securities. In part II.B. of its opinion, id. at 851-58, 95 S.Ct. at 2060-63, the court held that the shares were not "investment contracts," as used by the statutes defining securities. Accordingly, the court held that the federal securities laws did not apply at all to the shares. Id. at 859, 95 S.Ct. at 2064.

I considered the applicability of the federal securities laws where a plaintiff had purchased all of the outstanding stock of two corporations from the defendants in Titsch Printing, Inc. v. Hastings, 456 F.Supp. 445 (D.Colo.1978). There I noted,

the contract involved the sale of stock which carried with it `the right to receive dividends contingent upon an apportionment of profits. The stock is and was negotiable; it can be pledged and indeed was pledged initially as security for the underlying transaction; it confers voting rights in proportion to the number of shares owned; and the stock itself can appreciate in value and later be sold in a block or in portions so as to realize some or all of the appreciation,

id. at 448, and concluded that the federal securities laws would apply. In reaching that conclusion, I applied part II.A. of the Forman opinion and determined that the shares involved were "stock." Id. at 447-48. I also considered part II.B. of the Forman opinion, which stated,

the touchstone of the definition of a security is the presence of an investment in a common venture premised on a reasonable expectation of profits to be derived from the entrepreneurial or managerial efforts of others.

421 U.S. at 852, 95 S.Ct. at 2060. However, I concluded that the supreme court was only addressing the issue of whether a share was an "investment contract" under section 2(1) of the 1933 Act in part II.B. of its Forman opinion, see 421 U.S. at 851, 95 S.Ct. at 2060, and therefore held that part II.B. did not apply to the definition of "stock." 456 F.Supp. at 449.

The defendants urge that I overrule Titsch and apply part II.B. of Forman to the definition of "stock," as a majority of other federal courts have done. See, e.g., Canfield v. Rapp & Son, Inc., 654 F.2d 459, 463 (7th Cir. 1981); Anchor-Darling Industries, Inc. v. Suozzo, 510 F.Supp. 659, 662-66 (E.D.Pa.1981). In the absence of controlling precedent, I decline to do this. I thought when I decided Titsch, and I still think today, that the supreme court only intended part II.B. of its Forman opinion to apply to the definition of an "investment contract," and not to the definition of "stock."

Because the present transfer agreement did not involve an investment where profits were to be derived from the "entrepreneurial or managerial efforts of others," no investment contract was involved. However, on the record before me I cannot determine whether "stock," as defined by the 1933 Act, was involved. I do not know whether there was a "right to receive dividends contingent upon an apportionment of profits." I do not know whether the stock was negotiable, whether it conferred voting rights, or whether it could appreciate in value. If the stock carried with it many of these rights, then its transfer was subject to the securities laws. On the other hand, if the shares were merely "indicia of ownership" of the corporation, then the securities laws will not apply. While these issues can probably be decided on an appropriate motion for partial summary judgment, they cannot be decided on a motion to dismiss when the complaint does not contain the relevant factual allegations.

II. PLEADING OF SCIENTER

The parties do not dispute that scienter, i.e., intent to deceive, manipulate or defraud, is an essential element to a claim of violation of section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and of SEC Rule 10b-5, 17 C.F.R. § 240.10b-5. See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193-214, 96 S.Ct. 1375, 1380-1391, 47 L.Ed.2d 668 (1976). The present complaint alleges that the defendants knew or should have known that the radio station to be sold was making various concealments and misrepresentations to the Federal Communications Commission, that the defendants misrepresented to and concealed from the plaintiffs various details regarding the radio station's ground system, and that the defendants committed knew or should have known that the radio station to be sold was making various concealments and misrepresentations to the Federal Communications Commission, that the defendants misrepresented to and concealed from the plaintiffs various details regarding the radio station's ground system, and that the defendants committed fraud when making these misrepresentations in connection with the sale of the radio station's stock.

The defendants argue that these allegations do not allege any scienter and therefore that the first claim for relief should be dismissed. The plaintiff responds that the allegations are sufficient, and, alternatively, that it will amend its complaint to state the claim more specifically.

In order to succeed under section 10(b) and rule 10b-5,

there must be allegations of scienter-intent to deceive, manipulate or defraud.... Willful or intentional misconduct, or the

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