Citations
- 417 F. Supp. 620
Full opinion text
ORDER
CARL B. RUBIN, District Judge.
This matter is before the Court upon two motions, the motion of defendant KDI Corporation (hereinafter KDI) for summary judgment, and the motion of defendants Cors, Hair and Hartsock and Charles F. Hartsock (hereinafter Hartsock) for summary judgment. The parties have submitted memoranda, affidavits and exhibits in support of their respective positions. These motions are made pursuant to Rule 56, Fed.R.Civ.P., and for the Court to grant such motions it must find “that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law.” Rule 56(c), Fed.R.Civ.P.
INTRODUCTION
Plaintiffs seek to invoke this Court’s jurisdiction pursuant to the Securities Exchange Act of 1934 as amended, 15 U.S.C. § 78a et seq., and particularly § 10(b) thereof, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. 240.10b-5, and § 20(a) thereof, 15 U.S.C. § 78t(a), and related laws of the United States.
Both the United States Court of Appeals for the Sixth Circuit and the Supreme Court of the United States have recently considered the appropriate procedure with regard to questions of jurisdiction similar to those raised herein.
Common to this type of lawsuit is an alleged Rule 10b-5 claim which requires the court to explore the frontiers of statutory interpretation in order to ascertain whether federal question jurisdiction exists. Thus in dealing with the issues raised here we are not faced with the question whether the defendants’ alleged wrongs call for a remedy, but only whether plaintiffs should have access to the federal courts as well as the state courts to seek the remedy, (emphasis added)
Marsh v. Armada Corporation, 533 F.2d 978 (6th Cir. 1976).
Failure to qualify under the Birnbaum rule is a matter that can normally be established by the defendant either on a motion to dismiss or on a motion for summary judgment.
Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 742, 95 S.Ct. 1917, 1928, 44 L.Ed.2d 539 (1975).
Three of the issues that have been raised will be considered by the Court: (1) Do the plaintiffs herein have standing under the Birnbaum-Blue Chip “purchase or sale” requirement? (2) Are plaintiffs barred by the statute of limitations applicable to federal securities violations? (3) Are plaintiffs’ state law malpractice claims cognizable in federal court?
The first of these issues was raised in the motion of KDI. After adopting and agreeing to KDI’s arguments as to the first issue and KDI’s statement of the facts, the last two issues were raised in the motion of Hartsock and Cors, Hair and Hartsock.
I. Material Facts As To Which There Are No Genuine Issues
A. The plaintiffs herein were the controlling stockholders of The Herbert Chemical Company (hereinafter Herbert) which sold substantially all of its assets to KDI for KDI stock pursuant to a Reorganization Agreement between KDI, Herbert, and the plaintiffs, dated July 31, 1969 (hereinafter Reorganization Agreement). The sale was closed on August 30, 1969. In connection with the sale to KDI, Herbert was dissolved and liquidated and the 136,368 shares of KDI stock that it received was distributed to its stockholders, including the plaintiffs herein, who received 87,191 shares.
B. The contract of sale included a guarantee protecting both plaintiffs against a drop in the value of the KDI stock below $22.00 per share and KDI against an increase in the value of the stock beyond $35.00, $40.00, or $50.00 per share, at different points in time. The guarantee was in three parts: (1) As to 23,647 of plaintiffs’ shares, if the market value thereof as computed by a price form'ula in the agreement did not equal $22.00 per share six months from the date of closing, KDI would make up the deficiency by additional stock. If, however, the price exceeded $35.00 per share, the plaintiffs would return stock equal to the excess over $35.00 per share; (2) The second part of the guarantee was similar to the first, except that it became operative one year after the date of closing, and the operative return price was limited to the excess over $40.00 per share. This second part of the guarantee also attached to 23,647 of plaintiffs’ shares; (3) The third part of the guarantee was similar to the other parts, except that it became operative two years after the date of closing, and the operative return price was limited to the excess over $50.00 per share, and it covered 47,294 of plaintiffs’ shares.
KDI was obliged to deliver as many additional shares as necessary to satisfy any of the parts of the guarantee. The Reorgani-
zation Agreement initially required that 11,643 shares of KDI stock be held in escrow as security for the guarantee; this did not, however, limit the number of shares that might be owed under the guarantee.
C. On March 1, 1970, six months after closing, the first part of the guarantee expired. Although the actual market price for KDI stock was around $19.00 per share at that time, the price formula required by the Reorganization Agreement resulted in a price of $22.70 per share. Under the guarantee at that date the plaintiffs were not entitled to any additional shares.
D. The Court need not find, but will accept arguendo for the purposes of this order, that in March of 1970 the plaintiffs decided to sell the 23,647 KDI shares covered in the first part of the guarantee, since such shares were no longer protected, and, that the plaintiffs were dissuaded from selling by certain representations as to the impending listing on the New York Stock Exchange of KDI stock, made by two of the defendants herein.
E. On April 8, 1970, the parties entered into an extension agreement which reinstated the first six months price guarantee (the first part of the guarantee) and extended its expiration date of March 1, 1970, to a date 150 days after listing of the KDI stock on the New York Stock Exchange. In consideration for this extension, the plaintiffs agreed that they would not sell the 23,647 shares subject to this extended guarantee until 60 days after such listing.
F. In September, 1970, plaintiffs exercised their rights under the second part of the guarantee (the one-year provision) and received an aggregate of 80,668 additional KDI shares thereunder. In May of 1971, plaintiffs applied for and received under KDI’s Plan of Arrangement confirmed under Chapter XI of the National Bankruptcy Act, 72,714 additional KDI shares in settlement of their rights under the first and third parts of the guarantee (the six-months and two-years provisions).
G. This lawsuit does not challenge the Reorganization Agreement by which KDI acquired Herbert and plaintiffs acquired their KDI stock, nor does it challenge the stock value guarantees in that Agreement or anything else involved in the 1969 transaction.. Plaintiffs assert that they have been injured by the decision not to sell the 23,647 shares of KDI stock in March, 1970 which was allegedly induced by representations made to them by the defendants herein, which representations were violative of the provisions of the federal securities laws.
Other fact issues material to specific portions of this order will be discussed where pertinent.
II. Do Plaintiffs Herein Have Standing Under the Birnbaum-Blue Chip “Purchase or Sale” Requirement?
This issue is raised in the motion and memorandum of defendant KDI (doc. 13, pp. 7-11) and is adopted by defendants Hartsock, Walter G. Cox, and Cors, Hair and Hartsock.
The specific question relating to the plaintiffs herein is a part of the general area of law concerning the private, plaintiffs’ rights to maintain a civil action for damages under the federal securities statutes. This general area of law surrounding Rule 10b-5 has been described by the Supreme Court as having a “peculiar blend of legislative, administrative, and judicial history.” This “peculiar blend” began with the legislative enactment of the Securities Act of 1933, which is best described as a disclosure statute, and the Securities Exchange Act of 1934,' which is a regulatory statute. Title II of the- 1934 Act is an amendment to the 1933 Act, and it is Section 10 of the 1934 Act that makes it “unlawful for any person . (b) [t]o use or employ, in connection with the purchase or sale of any security . . . any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe . .” In 1942 the Securities and Exchange Commission, pursuant to the enabling authority of Section 10(b), promulgated Rule 10b-5 thereunder (17 C.F.R. § 240.-10b-5) which states:
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 cireumstances 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.
While there is no language in either Section 10(b) or in Rule 10b-5 explicitly providing for a civil remedy, the federal courts, since the decision in Kardon v. National Gypsum Co., 69 F.Supp. 512 (E.D.Pa.1946), have repeatedly held that such a cause of action exists. Ernst & Ernst v. Hochfelder, 423 U.S. 816, 96 S.Ct. 1375, 47 L.Ed.2d 668, 44 L.W. 4451, 4455 (March 30, 1976); Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 730, 95 S.Ct. 1917, 44 L.Ed.2d 539 (1975); Superintendent of Insurance v. Bankers Life and Casualty Co., 404 U.S. 6, 13 n. 9, 92 S.Ct. 165, 30 L.Ed.2d 128 (1971).
Having judicially found that a civil cause of action exists, it is incumbent upon the judiciary to delineate the confines of that right.
We quite agree that if Congress had legislated the elements of a private cause of action for damages, the duty of the Judicial Branch would be to administer the law which Congress enacted; the Judiciary may not circumscribe a right which Congress has conferred because of any disagreement it might have with Congress about the wisdom of creating so expansive a liability. But as we have pointed out, we are not dealing here with any private right created by the -express language of § 10(b) or of Rule 10b-5. No language in either of those provisions speaks at all to the contours of a private cause of action for their violation. However flexibly we may construe the language of both provisions, nothing in such construction militates against the Birnbaum rule. We are dealing with a private cause of action which has been judicially found to exist, and which will have to be judicially delimited one way or another unless and until Congress addresses the question.
Blue Chip Stamps v. Manor Drug Stores, supra, 421 U.S. at 749, 95 S.Ct. at 1931.
In the Blue Chip Stamps case the Supreme Court went on to conclude that the Birnbaum rule “is a sound rule and should be followed.”
The Birnbaum rule stems from the seminal case of Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2d Cir. 1952), where the court adopted a narrow approach in determining the limits of the judicially created private cause of action under the securities laws. In that case- the plaintiffs were stockholders in the Newport Steel Corporation. When the defendant Feldmann, the president of their corporation, sold his stock to the Wilport Company, the shareholders brought suit. The action was essentially a shareholders derivative suit alleging a breach of fiduciary duty by corporate insiders resulting in fraud upon the corporation. In relation to the transaction in question, however, the plaintiffs did not purchase or sell any securities. In construing the “in connection with the purchase or sale of any security” language of the Rule, the Birnbaum court held that:
[Section 10] was directed solely at that type of misrepresentation or fraudulent practice usually associated with the sale or purchase of securities rather than at fraudulent mismanagement of corporate affairs, and that Rule X-10B-5 extended protection only to the defrauded purchaser or seller.
This is the beginning of the “Birnbaum Doctrine” and the “purchaser or seller requirement” for a plaintiff to have standing to sue under Rule 10b-5.
Subsequent to the Birnbaum decision, two attempts were made by the Securities and Exchange Commission to have the “in connection with the purchase or sale of any security” language of Section 10(b) changed to “in connection with the purchase or sale of, or any attempt to purchase or sell, any security.” These attempts to amend the 1934 Act were made in 1957 and 1959, and both attempts failed to be adopted by Congress. In support of the Birnbaum holding, the Supreme Court cites some twenty years of judicial consideration.
Just as this Court had no occasion to consider the validity of the Kardon holding that there was a private cause of action under Rule 10b-5 until 20-odd years later, nearly the same period of time has gone by between the Birnbaum decision and our consideration of the case now before us. As with Kardon, virtually all lower federal courts facing the issue in the hundreds of reported cases presenting this question over the past quarter century have reaffirmed Birnbaum’s conclusion that the plaintiff class for purposes of § 10(b) and Rule 10b-5 private damage actions is limited to purchasers and sellers of securities (citations omitted).
Blue Chip Stamps v. Manor Drug Stores, supra, 421 U.S. at 731, 732, 95 S.Ct. at 1923.
Since numerous references have been made to the Supreme Court’s decision in the Blue Chip Stamps case, the facts therein should be considered.
The Blue Chip Stamp Co. (Old Blue Chip) was merged into a newly formed corporation, Blue Chip Stamps (New Blue Chip). New Blue Chip was required to offer a substantial number of its shares of common stock to retailers who had used the stamp service in the past but who were not stockholders in the old company. This was intended to reduce the holdings of the majority shareholders pursuant to an antitrust consent decree. Manor Drug Stores contended that the offer was made to them in terms that were overly pessimistic so as to dissuade offerees from purchasing the shares. They asserted fraud in that New Blue Chip would later offer the rejected shares to the public at a higher price.- Man- or Drug Stores elected not to purchase the securities and was therefore neither a purchaser or seller of securities. The Supreme Court adopted the Birnbaum rule and held that since Manor Drug .Stores was not an actual purchaser or seller of securities, they were barred from maintaining suit.
In Blue Chip Stamps, the Supreme Court stated the Birnbaum rule in three distinct categories.
Three principal classes of potential plaintiffs are presently barred by the Birnbaum rule. First are potential purchasers of shares, either in a new offering or on the Nation’s post-distribution trading markets, who allege that they decided not to purchase because of an unduly gloomy representation or the omission of favorable material which made the issuer appear to be a less favorable investment yehjcle than it actually was. Second are actual shareholders in the issuer wh