William Dasho, Dasho-Rogers, Inc., an Illinois Corporation, and Maurice H. Schy v. The Susquehanna Corporation, a Delaware Corporation

FAIRCHILD, Circuit Judge (with whom CUMMINGS, Circuit Judge, joins),

concurring.

Two different transactions are presented as foundations for causes of action under the fraudulent interstate transactions section of the securities act 1 and the manipulative and deceptive practices section of' the exchange act. 2 And we must answer two questions of law, each of considerable difficulty.

The Transactions:

I. The transfer, by successive steps, of 435,000 shares of Susquehanna stock from the Lannan defendants to Korholz and Gypsum, and ultimately into the assets of post-merger Susquehanna, via the merger of Gypsum into Susquehanna. It is claimed that this was a fraudulent scheme by-which the Lannan defendants could extract a highly excessive pricé from Susquehanna for their shares.

II. The sale by Susquehanna of 140,-000 shares of Vanadium stock to the Kansas City group in return for 222,107 shares of Susquehanna stock, plus boot money. It is claimed that this sale produced a large profit for the Kansas City group and was a scheme devised by defendants in order' to silence the Kansas City group and protect the carrying out of Transaction I for the benefit of defendants.

The Questions:

A. Does a statutory merger involve a sale of securities so that a cause of action in favor of Susquehanna can be predicated upon the alleged fraudulent scheme involved in Transaction I? It is not claimed that Gypsum had a cause of action which became the property of *268 Susquehanna upon merger, presumably because the Lannan group did not owe Gypsum the special duty as directors which they owed Susquehanna.

B. When the directors of a corporation cause it to buy securities at an excessive price or to sell securities at an inadequate price, in order to serve some personal interest of the directors, adverse to the corporation, may a cause of action under the securities and exchange acts arise in favor of the corporation by reason of the failure of the directors to fulfill the special obligations they owe the corporation as directors? Causes of action may well arise under state law under these circumstances, but, assuming other grounds required for federal jurisdiction, do activities of corporate directors for their personal advantage at the expense of the corporation amount to fraud under the securities and exchange acts?

A. Does a statutory merger involve a sale of securities? This question has usually been considered in terms- of whether, upon merger, there is a sale of shares in the post-merger surviving corporation to the shareholders of the merging corporations in exchange for their pre-merger shares in each corporation. If such sale occurs, within the meaning of the securities and the exchange acts, fraud in persuading the shareholders to approve merger would give rise to a federal cause of action in favor of the shareholders. Here, however, one of the merging corporations, which is also the surviving corporation, is asserting a cause of action grounded on the fact that the merger, by design of the defendants, has forced it to assume the obligation for the excessive price at which the other merging corporation purchased an asset. (Or perhaps the merger could be analyzed as a purchase by Susquehanna of Gypsum’s assets including the 485,000 shares, accepted at a figure in excess of their value, in return for issuance of Susquehanna shares to Gypsum shareholders.)

Neat corporate theory would dictate that a statutory merger involves no sale of the shares or assets of merging corporations, but in the light of the purpose of the securities and exchange acts to protect the investing public, it seems reasonable that the concept of sale in these acts may encompass the various modifications in rights which are produced by merger.

Legislative history, administrative contruction, and judicial decision do not produce a clear and consistent answer. 3

Professor Loss finds, in a 1933 committee report, an indication that a merger was regarded as a sale for which 15 U.S.C. § 77e would require a registration statement, 4 and the Federal Trade Commission, which at first administered the securities act, required a registration statement before a proposal for merger was submitted to shareholders.

Starting in 1934, however, the Securities and Exchange Commission indicated that a merger was not a sale such that a registration statement is required. 5 This remains the position of the commission, although in 1956, the commission considered repeal of its Rule 133, stating that its construction had “become an instrument of evasion of the law.” 6 Prior to 1951 the commission took the even broader position that a merger was not a sale, apparently for any purpose. 7 In 1951, the commission adopted Rule 133, making it clear that its position that *269 a statutory merger involves no sale applies only to the registration requirements of the act. In the case at bar, the commission takes the position that an exchange of shares pursuant to a merger is a sale so that the antifraud sections of the acts apply.

Judicial decisions have not been entirely consistent in this field.

In 1943, the ninth circuit indicated the view that a consolidation did not involve a sale of securities or an exchange amounting to a sale 8 although this was not the principal ground for the decision.

In 1960, a district court held that a merger “may or may not involve a purchase and sale within the meaning of Section 10(b)” of the exchange act, and that the transaction before the court appeared to be a purchase and sale. The type of merger does not appear in the opinion. It was said that “Plaintiff is a corporation which issued its stock in exchange for the stock of another corporation.” 9

In 1963, this circuit considered an attack on a merger where a violation of sec. 10(b) of the exchange act had been alleged, among other things, but the opinion sets forth no distinct holding that a statutory merger is not a sale under the securities and exchange acts. 10

In 1966, a district court appears to have held that a merger was a sale so that shareholders had a cause of action on account of misleading reports which persuaded them to vote for the merger 11

And in 1967, the second circuit held that a shareholder who was given the right, in a short form merger, to turn in his shares for cash, and who had the statutory alternative of seeking an appraisal, was a seller who might have a cause of action for deceptive practices under the exchange act. 12 A district court reached the same conclusion in 1965. 13

The argument that the transformation of rights occurring upon statutory merger is a distinct corporate phenomenon which does not involve purchase and sale of securities has some appeal, but in view of the objectives of the securities and the exchange acts, it seems to me better to recognize, for the purpose of the antifraud provisions, that sales and purchases are involved. This view does. no violence to the statutory language, and is the present interpretation of the body which is responsible for the administration of the acts.

B. Misuse of directors’ power as fraud. Deception by defendants is more readily spelled out in Transaction I. The allegations suggest that the sale of 435,-000 shares owned by the directors to the corporation at an excessive price was somewhat concealed by a scheme, composed of the successive transfers and the ultimate merger. There may be both palpable deception and failure to disclose defendants’ adverse personal interest. With respect to Transaction II, there is only the latter.

In Birnbaum v. Newport Steel Corp. 14 the second circuit held that where a corporate insider sold his stock to a third party, and misrepresented the facts to the other shareholders, this gave rise *270 to no cause of action under the exchange act in favor of the shareholders. “The district court, however, viewed the Rule in question as aimed only at ‘a fraud perpetrated upon the purchaser or seller’ of securities and as having no relation to breaches of fiduciary duty by corporate insiders resulting in fraud upon those who were not purchasers or sellers.” The court of appeals agreed. The case can be distinguished on its facts from the present one because the corporation is here suing as a defrauded seller and buyer of securities. The second circuit has recently noted the commission’s view that the Birnbaum rule is too narrow. 15

In Ruckle v. Roto American Corporation, 16 the second circuit held “that federal courts have jurisdiction over actions in which the complaint alleges that a corporation has been or may be defrauded into issuing or selling securities through the failure or refusal of some of its directors fully to disclose to the remaining directors material facts concerning the transactions or the financial condition of the corporation.” The same holding would follow (under the exchange act) where a corporation, as here, has purchased securities.

In O’Neill v. Maytag, 17 the second circuit concluded that where all the directors participated in causing the corporation to exchange stock at a disadvantage to it and personal advantage to them, there could be no claim of deceit, withheld information, or misstatement of material fact. The only possible material difference I can perceive between Ruckle and O’Neill is that in Ruckle there were directors who were not participants in the transaction and thus could be deceived in the ordinary sense. In either case, however, the failure of the defendant directors to perform their duty presumably injured the corporation, and I do not believe it is sound to differentiate between situations where the directors were unanimous in wrongdoing and those where less thán all were involved.

I conclude that Susquehanna has a cause of action both with respect to the allegedly improvident acquisition, by merger, of 435,000 Susquehanna shares and the allegedly improvident exchange of Vanadium shares for Susquehanna shares.

. 15 U.S.C. § 77q.

. 15 U.S.C. § 78j.

. See, generally, Loss, Securities Regulation (1961 ed.) 518-539.

. Loss, op. cit. 519, H.R.Rep. No. 85, 73d Cong. 1st Sess. (1933) 16.

. Loss, supra footnote 3, p. 520; Note to Rule 5 of Form E-1, adopted 1935; Rule 133, adopted 1951.

. Loss, supra footnote 3, p. 529, n. 232.

. In National Supply Co. v. Leland Stanford, Jr. University (9th Cir. 1943), 134 F.2d 689, 694 , cert. den. 320 U.S. 773 , 64 S.Ct. 77 , 88 L.Ed. 462 , the court noted that the commission had filed an amicus brief “indicative of its view that the consolidation did not involve a ‘sale’ of securities, or an exchange amounting to a sale, hence the civil liability provisions of the Act have no application.”

. National Supply Co. v. Leland Stanford Jr. University, supra footnote 7. See Sawyer v. Pioneer Mill Company (9th Cir. 1962), 300 F.2d 200 , where the question would have arisen again, hut for mootness.

. H. L. Green Company v. Childree (S.D.N.Y.1960), 185 F.Supp. 95, 96 .

. Borak v. J. I. Case Company (7th Cir. 1963), 317 F.2d 838 , 847, aff’d, 377 U.S. 426 , 84 S.Ct. 1555 , 12 L.Ed.2d 423 (1964).

. Simon v. New Haven Board & Carton Company (D.Conn.1966), 250 F.Supp. 297 , involving a long form merger such as in this ease.

. Vine v. Beneficial Finance Company (2d Cir. 1967), 374 F.2d 627, 635 .

. Voege v. American Sumatra Tobacco Corporation (D.Delaware 1965), 241 F.Supp. 369, 373 .

. (2d Cir. 1952), 193 F.2d 461, 462-463 , cert. den. 343 U.S. 956 , 72 S.Ct. 1051 , 96 L.Ed. 1356 (1952).

. A. T. Brod & Co. v. Perlow (2d Cir. 1967), 375 F.2d 393, 397 , footnote 3.

. (2d Cir. 1964), 339 F.2d 24 , 26.

. (2d Cir. 1964), 339 F.2d 764 .