# Petition — Heizer Corp. v. Wright

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Petition
- **Published:** January 1, 1978
- **Citation:** 434 U.S. 1066

## Text

Supreme Court, U. S, “ No. 72 C 2536
THE HEIZER CORPORATION and
INTERNATIONAL DIGISONICS
CORPORATION,
Defendants.

4

MEMORANDUM DECISION.

This action presents questions concerning the class of persons
who may maintain a private action for equitable relief under
Rule 10b-5 of the Securities and Exchange Commission; the
scope of the substantive provisions of that Rule; and the appro-
priate equitable relief to be granted in light of the violations of
the Rule which have been proved.

The case was tried without a jury’ prior to the Supreme
Court’s decision in Blue Chip Stamps, et al. Vv. Manor Drug
Stores, 421 U.S. 723 (1975). There the Court gave limited

1. When plaintiffs withdrew their jury demand, defendant Heizer
demanded trial by jury. Heizer’s demand was denied because all of
the relief sought is equitable and all of the issues of fact raised by the
pleadings are of a nature which can be tried by a chancellor without
a jury consistent with the Seventh Amendment. Cf. Ross v. Barnhard,
396 U.S. 531 (1970).

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A43

approval to the Birnbaum? purchaser-seller limitation on the
class of persons entitled to seek money damages under Rule
10b-5. It is that limitation which gives rise to the threshold
question of whether plaintiffs may maintain this action for
equitable relief in view of the fact that they did not participate
directly as either the purchasers or sellers of the securities in-
volved in this action.

Our starting point will be the basic facts which are essen-
tially undisputed. Jurisdiction is present under 15 U.S.C. §§ 78)
and 78aa. This memorandum will stand as our findings and
conclusions under Rule 52(a), Fed. R. Civ. P.

The Basic Facts

Plaintiffs, Peter Wright and Beneficial Standard Corporation
are and at all material times have been minority common share-
holders in defendant International Digisonics Corporation
(IDC), a Delaware corporation. IDC and its wholly owned
subsidiary Talent and Residuals, Inc. (TR), also a Delaware
corporation, are engaged in two separate but related service
businesses: IDC monitors television commericals as they are
shown on the air to assure that the commercials are shown as
agreed to by the television industry; TR performs the account-
ing and record keeping services necessary to the accurate and
adequate compensation of the persons performing in the com-
mercials. IDC and TR were organized in 1968 by Jordon Ross
who is IDC’s principal common shareholder and who, during
most of the transactions complained of, was IDC’s president
and chief executive officer.

IDC’s monitoring service has not prospered financially. The
fact of this financial distress is of significance; the reasons for
that distress are not and they were not fully developed at the
trial. Suffice it to say that IDC has encountered technical elec-
tronic problems occasioned in part by the fact that some com-

2. Birnbaum vy. Newport Steel Corp., 193 F.2d 461 (2d Cir.
1952), cert. denied, 343 U.S. 956 (1952).

A44

mercials are shown on film, others on video tape, some nation-
ally, others locally.

In contrast, TR’s talent accounting service has prospered
financially. So much so that, as we shall see, it became the
plum which defendant Heizer Corporation (Heizer) plucked as
a hedge against Heizer’s large investments in IDC’s monitoring
operation.

Heizer is a closely heid investment company specializing in
privately piaced venture capital investments in new and de-
veloping industries and businesses. Many of its own investors
are regulated institutions that could not invest directly in a
new and developing business or industry because of the risk.
Heizer and its investors hope to reap substantial profits from
their venture investments. But their hopes are not always real-
ized as the facts in this case show.

In November 1969, IDC was in need of cash for its moni-
toring business. It sought its needs from Heizer who invested
$1,500,000 on the following terms.

Pursuant to a written agreement, IDC amended its certifica-
tion of incorporation to create a new class of stock known as
Class A common stock. Heizer purchased 100,000 shares of
Class A common at $10 per share. IDC issued to Heizer a
warrant to purchase 155,000 shares of IDC common at a basic
purchase price of $8.50 per share, which contained an adjust-
ment of purchase price (“anti-dilution clause”) reducing the
price to Heizer in the event IDC issued or sold any of its com-
mon shares at less than $8.50. Heizer agreed to lend IDC, at
the latter’s option, up to $500,000 with interest at 2% over
prime. The agreement between Heizer and IDC contained rather
typical disclosure, continuation of business, and non-merger,
sale or encumbrance of assets clauses.

The documents embodying the agreement were presented to
the IDC board of directors at a duly called meeting held No-
vember 5, 1969. The directors unanimously approved all the
terms and conditions of the agreement and resolved to present

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A45

to the IDC stockholders the amendment to IDC’s certificate of
incorporation creating the Class A common stock.

The stockholders meeting was held immediately following
the directors meeting pursuant to notice given the stockholders,
which included a statement of the important terms of: the pro-
posed Class A common stock. In addition, prior to the meeting,
the holders of approximately 80% of IDC’s outstanding com-
mon stock, including plaintiff Beneficial Standard Corporation,
had received from IDC copies of all of the documents relating
to the total transaction with Heizer. A quorum of stockholders
attended the meeting and the proposed amendment to the cer-
tificate of incorporation was unanimously approved by those in
attendance. On November 6, 1969, the first transaction was
closed. On May 25, 1970, pursuant to the first transaction,
Heizer loaned IDC $500,000 until May 25, 1971 with interest
at 2% over prime.

In the summer of 1970 IDC was again in need of cash for its
monitoring business and it approached Heizer to make an addi-
tional investment for the monitoring business. On September 1,
1970, IDC and Heizer entered into and executed an agreement
which culminated in Heizer’s investment of $2,000,000. The
agreement provided that IDC would again amend its certificate
of incorporation, this time to authorize 350,000 shares of a new
class of preferred stock with certain rights and preferences, the
most significant of which was a weighted vote of 4.4 per share
on all shareholder votes. Heizer was to exchange the 100,000
shares of its previously purchased Class A common for 100,000
shares of the new preferred. IDC was to sell Heizer an additional
200,000 shares of the new preferred at $10 per share in two
takedowns of $1,000,000 each. Upon completion of the second
takedown, IDC was to issue to Heizer an additional warrant to
purchase 400,000 shares of IDC common at a basic purchase
price of $6 per share, with an anti-dilution clause comparable
to the first warrant. The protective provisions regarding con-
tinuation of business, etc., were, of course, repeated.

A46

The documents evidencing the second transaction were pre-
sented to the IDC board of directors at a meeting duly called
pursuant to notice on August 31, 1970. At that meeting a
majority of the IDC directors were present and those present
unanimously approved the terms and conditions of the second
transaction and resolved to present to the stockholders the pro-
posed amendment to IDC’s certificate of incorporation creating
the new preferred stock.

On August 5, 1970 IDC had mailed a notice of a special
meeting to stockholders calling the meeting for September 1,
1970. The notice was not accompanied by any enclosures, at-
tachments or documents relating to the second transaction but
it did state the shareholders would “review, consider and vote
upon the financing propositions.” Furthermore, prior to the
September 1, 1970 stockholders meeting, the holders of ap-
proximately 54% of IDC’s outstanding common stock received
copies of all of the documents relating to the second transaction.
Pursuant to the notice, the special meeting of stockholders was
held. A quorum of a majority of the stockholders was present.
By a unanimous vote of those present and voting, the new pre-
ferred stock was approved as was the second transaction.

In February, 1971, the second transaction was fully consum-
mated to the end that Heizer was then the owner of 300,000
shares of the new preferred stock, one warrant to purchase
150,000 shares of common at $8.50 per share, a second warrant
to purchase 400,000 shares of common at $6 per share and
IDC’s note for $500,000 due May 25, 1971.

In the spring of 1971, IDC again approached Heizer to make
yet another investment to provide IDC with funds to purchase
more monitoring equipment. On May 13, 1971, IDC and
Heizer executed an agreement which became the third trans-
action. It provided for an amendment to IDC’s certificate of in-
corporation to imcrease the authorized common stock to
3,000,000 shares, the sale by IDC to Heizer of a 20-year senior
note in the principal amount of $1,700,000, the issuance by IDC

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A47

to Heizer of an additional warrant to purchase 472,222 shares
of IDC common at $3.60 per share and an adjustment in the
purchase price under the warrants issued in the first two trans-
actions so that they could be exercised for common stock at a
price of $3.60 per share. The effect of the price adjustment
was not, however, limited to a reduction in the purchase price
per share under the first two warrants. It also increased the
number of shares of common purchasable at the reduced price.
Thus, under the first warrant Heizer could now purchase 276,223
shares of common at $3.60; under the second 555,555 at $3.60;
under the third 472,222 at $3.60; all to the end that at the
conclusion of the third transaction it could purchase 1,304,000
shares of common at $3.60 per share.

The documents regarding the third transaction were presented
to the IDC board of directors at a meeting duly called pursuant
to notice on May 11, 1971. At that meeting a majority of
IDC’s directors were present and those present unanimously
approved the terms and conditions of the third transaction and
resolved to present to the stockholders the necessary amend-
ment to IDC’s certificate of incorporation.

Prior to May 11, 1971 IDC had mailed a notice of its an-
nual meeting to its stockholders calling for the meeting on May
11. Prior to that date the holders of approximately 73% of
IDC’s outstanding common stock, including the plaintiff Bene-
ficial Standard Corporation, received from IDC copies of all
documents relating to the third transaction.

Pursuant to the notice, a meeting of the stockholders of IDC
was held on May 11. A quorum of a majority, but not all of
the stockholders was present, and by a unanimous vote of all
the stockholders present and voting, the third transaction was
approved. At that meeting of stockholders, the following per-
sons were elected directors of IDC: Jordon I. Ross, chairman
of the board and chief executive officer; Glenn M. Dekraker,
president of IDC and its chief operating officer; Marcus Loew
II, vice president and treasurer, Beneficial Standard Life In-

A48

surance Co., representing Beneficial Standard Corp.; Edgar F.
Heizer, Jr., president, Heizer Corporation, representing Heizer
Corporation; Charles L. Palmer, finance vice president, Heizer
Corporation, representing Heizer Corporation; Ronald Labow,
managing partner Cerebrus Fund, an independent director;
Douglas F. Johnston, executive vice president for Investments,
Title Insurance Corporation of California, an independent di-
rector.

Following the amendment of IDC’s certificate of incorpora-
tion in connection with the third transaction, IDC’s capital
structure and the voting rights of its shareholders were: common
stock, 3,000,000 shares authorized, 840,010 issued and out-
standing and entitled to one vote per share, or 39% of the total
votes at a shareholders meeting; preferred stock, 350,000 shares
authorized, 300,000 issued and outstanding and entitled to cast
4.4 votes per share for a total of 1,320,000 votes or 61% of the
total votes at a shareholders meeting. All of the issued and out-
standing preferred stock was (and still is) owned and held by
Heizer. None of the common was or is owned by Heizer. Heizer
also held the previously described warrants for ',304,000 shares
of common at $3.60 per share and IDC’s notes for $2,200,000.

In the fall of 1971, IDC required still additional cash to
finance the continued operation of its monitoring business. It
approached Heizer for an additional investment. On Movember
12, 1971, Dekraker resigned as a director of IDC as did
Johnston on November 16, 1971. As a consequence, on Novem-
ber 19, 1971, when IDC and Heizer entered into an agreement
which became the fourth transaction, the IDC board consisted
of Ross, its chief executive officer, Loew, representing Bene-
ficial Standard Corporation, Heizer and Palmer, representing
Heizer, and Labow, an independent director.

The fourth transaction agreement provided for loans up to
$600,000 by Heizer to IDC evidenced by IDC’s note payable
on demand after March 31, 1972. In the event Heizer loaned
the entire $600,000 and the note was not timely paid, it would

A49

become convertible into common stock of IDC at $1.00 per
share. In the event the note became convertible, the price pro-
visions of the three warrants previously issued to Heizer would
again be adjusted so as to decrease the warrant exercise price
from $3.60 per share to $1.00 per share and increase the
number of common shares purchasable under those warrants
from 1,304,000 to 4,694,400 shares.

The documents comprising the fourth transaction were pre-
sented to a meeting of the IDC board held on November 19.
Only Ross, Labow, Heizer and Palmer were present. They
voted unanimously to approve the fourth transaction. Heizer
and Palmer deferred their votes until Ross and Labow voted
on the proposal. But the votes of Heizer and Palmer were es-
sential to approval. The board also resolved to recommend to
the stockholders the adoption of an amendment to IDC’s cer-
tificate of incorporation increasing the number of authorized
common shares from 3,000,000 to 7,000,000. And they directed
that in lieu of a stockholders meeting, written consents to the
amendment be obtained as permitted under the Delaware cor-
poration law.

The consents of 52.4% of IDC’s common shareholders and
100% of the preferred shareholders (i.e., Heizer), were ob-
tained to the amendment to the certificate of incorporation in-
creasing the number of authorized common shares from
3,000,000 to 7,000,000. Thereafter and pursuant to the terms
of the fourth transaction, Heizer loaned IDC $600,000. At
the time the loan was funded there was virtually no chance that
IDC could 12pay it by its due date, March 31, 1972.

On March 13, 1972 a meeting of IDC’s board of directors
was held at which all five of the incumbent directors were
present either in person or by telephone. At that meeting, by a
vote of 4 to 1 the directors authorized an amendment to the
November 19, 1971 agreement providing for an additional loan
from Heizer to IDC of an amount up to $250,000. Ross, Labow,
Heizer and Palmer voted in favor, Loew, representing plaintiff

ASO

Beneficial, voted against. The new loan was to be governed
by all of the terms of the November 19 agreement. On March 13
Heizer loaned IDC an additional $105,000 pursuant to the
amendment. In addition, fees due from IDC to Heizer for
management services performed by Heizer under the ea: lier
agreements were accrued and deemed to have been loaned to
IDC under the terms of the November 19 agreement, if not paid
on March 31, 1972. They were aot and IDC issued a convertible
demand note in the amount of $114,508 to cover them.

IDC was unable to repay any of the loans or fees pursuant
to the fourth transaction by March 31, 1972. As a consequence,
all of the fourth transaction notes held by Heizer became
convertible into IDC common stock at $1.00 per share, and as
a consequence of that, the previously issued warrants held by
Heizer became operative at the decreased exercise price of $1.00
per share so as to increase the number of shares purchasable
by Heizer to 5,513,000 shares of IDC common representing
approximately 87% of IDC pro forma common stock equity.

To date Heizer has not exercised any warrants or other rights
to purchase IDC common stock. Plaintiffs seek to enjoin that
exercise and obtain a rescission of the first, second, third and
fourth transactions.

At the annual meeting of IDC stockholders held May 25,
1972, the following persons were elected directors of IDC:
Jordan Ross, chairman of the board and chief executive officer;
Marcus Loew II representing Beneficial Standard Corp.; Edgar
F. Heizer, Jr., representing Heizer; Powers Cameron, vice
president, Heizer Corporation, representing Heizer; and George
Sneed, representing Heizer. On June 21, 1972, Loew resigned.

At a meeting of IDC’s board of directors held June 29, 1972,
attended by Heizer, Cameron and Sneed, Paul M. Roth was
elected president and a director of IDC. On November 20, 1972,
Sneed resigned from the board.

On October 11, 1972, this action was commenced.

(ae in

AS1

On June 8, 1973, the board of directors of IDC consisted
of Heizer, Cameron, Roth and Ross. On that date IDC required
still additional cash to continue the operation of its monitoring
business. Accordingly, the board approved a pledge agreement
between IDC and Heizer by a vote of 3 to 1, Roth, Heizer and
Cameron voting “yes” and Ross “no”. Again the votes of Heizer
and Cameron were essential to approval. The pledge agreement
provided that Heizer would refrain, until January 2, 1974, from
making demand for payment of the demand notes totalling
$819,508, issued to it by IDC pursuant to the fourth transaction.
It also covered some additional non-convertible demand notes
which had been issued to Heizer by IDC between April 14, 1972
and April 19, 1973, in the amount of $2,015,000. The agree-
ment further provided that Heizer would make additional
demand loans to IDC during the balance of 1973 in the
maximum amount of $1,181,700, and the minimum of
$460,400, and that Heizer would refrain from making demand
for repayment of those additional loans until January 2, 1974.
Pursuant to the agreement, IDC pledged all of the stock of its
wholly owned and profitable subsidiary, Talent and Residuals,
Inc., to Heizer as security for repayment of all loans made by
Heizer to IDC on a non-convertible demand note basis since
April 14, 1972, as well as the new loans made pursuant to the
pledge agreement. Upon consummation of the agreement, the
TR stock was delivered by IDC to Heizer.

By an amended complaint, plaintiffs challenge the fifth or
pledge transaction.

Plaintiffs Maintenance of the

Action as Shareholders of IDC
Plaintiffs assert that, as minority common shareholders in
IDC, they may maintain this action challenging the foregoing
IDC-Heizer securities transactions either derivatively in behalf
of IDC, the issuer-seller of the securities, or individually and as

A5S2

representatives of a class of common shareholders who are
investors in IDC. They agree that their alternative “investor”
theory is bottomed upon Eason v. General Motors Acceptance
Corp., 490 F.2d 654 (7th Cir. 1973), cert. denied, 416 U.S.
960 (1974). They concede, as they must, that they did not
directly sell or purchase the securities in questior.

Substantively they allege that the entire series of transactions
were tainted by conduct prohibited by Rule 10b-5. The full scope
of their claimed violations of the Rule will be considered later;
suffice it here to say that they assert that material facts con-
cerning the first four transactions were concealed from the
shareholders of IDC and that Heizer aided and abetted in that
concealment; that in the course of the transactions, Heizer
assumed the position of a controlling person or shareholder
and owed a fiduciary duty of disclosure to the minority share-
holders, which it breached; that Heizer, through the directors
it elected to the IDC board of directors engaged in fraudulent
self dealing in respect to the fourth and fifth or pledge trans-
actions; and that the fifth or pledge transaction entered into
as it was subsequent to plaintiffs’ challenge here of the first four,
was a maneuver patently calculated to frustrate the effectiveness
of any remedy which might be granied here in respect to
the first four.

Heizer vigorously challenges plaintiffs’ right to maintain the
action in light of the Supreme Court’s decision in Blue Chip,
supra, and it denies with equal vigor any wrongdoing in
connection with the sale to it of the subject securities. It does
concede, however, that IDC was an issuer-seller of securities
and that the conduct of which plaintiffs complain was in
connection with the sales of those securities (including
the notes and transfer of TR stock attendant the pledge) by
IDC to Heizer.

The threshold question to be decided is whether plaintiffs
as shareholders in IDC may maintain this action. We believe the
answer is clearly that they may derivatively in behalf of IDC.

AS3

The history of the judicially created private action under
Rule 10b-5 need not be retold here. It had its origin in Kardon
v. Nationa! Gypsum Co., 69 F.Supp. 512 (E.D.Pa. 1946).
While judicial interpretations and applications of the substantive
scope of the Rule’s prohibitions have varied, they have steadily
expanded to the end that in Karvelas v. Sellas, 376 F.Supp.
1010, 1012 (N.D.Ill. 1974), we observed, “The language of
Rule 10b-5 interdicts any act or practice which operates as a
fraud or deceit . . . in connection with the purchase or sale of a
security.” See, also, Superintendent of Insurance v. Bankers Life
and Casualty Co., 404 U.S. 6 (1971).

The concomitant question of who may complain of an
alleged violation of the Rule’s prohibitions has also been steadily
answered, primarily as the result of the Second Circuit's pilot
decision in Birnbaum v. Newport Steel Corp,, 193 F.2d 461
(2d Cir. 1952), cert. denied, 343 U.S. 956. There one Feldman,
a controlling shareholder of Newport, sold his stock at a
premium after rejecting a highly profitable offer of merger which
he did not communicate to the other shareholders. Plaintiffs,
shareholders of Newport, brought an action on behalf of the
corporation and all similarly situated shareholders alleging that
the transaction operated as a fraud upon the shareholders in
connection with the sale of Feldman’s stock and that Rule 10b-5
was violated. The district court dismissed the action because the
Rule was “aimed only at ‘a fraud perpetrated upon the pur-
chaser or seller’ of securities and having no relation to breaches
of fiduciary duty by corporate insiders resulting in fraud upon
those who were not purchasers or sellers.” Jd. at 463. The court
of appeals affirmed similarly concluding that the Rule was
“directed solely at that type of manipulative or fraudulent
practice usually associated with the sale or purchase of securities
rather than at fraudulent mismanagement of corporate affairs,
and [the Rule] extended protection only to the defrauded
purchaser or seller.” Jd. at 464.

AS4

Of course, Birnbaum’; restrictive interpretation of the nature
of the fraud prohibited by the Rule has been discarded. Super-
intendent of Insurance v. Bankers Life and Casualty Co., supra;
Dasho v. Susquehanna Corp., 380 F.2d 262 (7th Cir. 1967),
cert. denied, 389 U.S. 977 (1967). However, its conclusion that
the Rule extends protection “only to a defrauded purchaser or
seller” has survived. But see, Eason v. General Motors Accept-
ance Corporation, supra; Karvelas v. Sellas, supra.

In Blue Chip Stamps v. Manor Drug Stores, supra, the
Supreme Court for the first time considered Birnbaum’s purchaser-
seller limitation. There plaintiffs were offerees of common shares
in a new company organized by defendants under an anti-trust
consent decree. Charging that defendants had devised a scheme
to discourage plaintiffs from purchasing the shares by materially
misleading statements containing an overly pessimistic appraisal
of the new business so that the rejected shares might be offered
to the public at a higher price, plaintiffs sued for money damages
alleging a violation of Rule 10b-5. The district court, relying
on Birnbaum, dismissed the action. The court of appeals re-
versed, holding that the particular facts of tue case warranted
an exception to the Birnbaum limitation. On certiorari the
Supreme Court reversed. The Court traced the history and
application of the Birnbaum dictum, noting without disapproval
that shareholders have “frequently [been] able to circumvent
the Birnbaum \imitation through bringing a derivative action on
behalf of the corporate issuer if the latter is itself a purchaser
or seller of securities.” As an example of that circumvention,
the Court cited Schoenbaum v. Firstbrook, 405 F.2d 215, 219
(2d Cir. 1968), cert. denied sub nom. Manley v. Schoenbaum,
395 U.S. 906 (1969), in which the Second Circuit declined to
apply its own Birnbaum limitation to a derivative action by the
shareholders of a seller corporation who alleged 10b-5 fraud in
the sale of the corporation’s securities.

More significant, however, was the Court's citation of the
Seventh Circuit’s decision in Dasho v. Susquehanna Corp.,

ASS

sipra, as an example of a reaffirmation by lower federal courts
“that the plaintiff class for purposes of . . . Rule 10b-5 private
damage action[s] is limited to purchasers and sellers of securi-
ties.” 421 U.S. at 731-32. Dasho was a derivative action brought
by shareholders of Susquehanna who alleged that the corpora-
tion had been defrauded by its directors in both the purchase
of its own stock and the sale of stock it owned in another corpo-
ration. While the opinion of the court in Dasho, which was
written by Judge Schnackenberg, made no mention of the Birn-
baum limitation, a tightly reasoned concurrence by now Chief
Judge Fairchild, joined in by Judge Cummings, expressly con-
fronted the limitation and rejecicd it because derivatively “the
corporation is here suing as a defrauded seller and buyer of
securities.” 380 F.2d at 270.

Thus, we conclude that the purchaser-seller limitation as
examined and rearticulated in Blue Chip does not preclude
plaintiffs, as shareholders in IDC, from complaining derivatively
of injuries to IDC occasioned by conduct prohibited by the Rule
in connection with IDC’s sale of its securities to Heizer.

Plaintiff's efforts to maintain their claim as investors in IDC
under Eason v. General Motors Acceptance Corp., supra, is a
different matter.

At the outset we observe that plaintiffs’ investor posture is
redundant of their derivative stance to the extent that they
complain of injuries inflicted on IDC. But to the extent that they
complain of injury to themselves as investors—i.e., holders of
securities which they have previously purchased—do they col-
lide with the Blue Chip limitation? We believe the answer to
this lies in a careful analysis of Eason upon which they rely and
a further analysis of Blue Chip and its recognition and treatment
of Eason.

In Eason, plaintiff, who incidentally was a shareholder in
Bank Service, guaranteed obligations of Waite to GMAC when
Waite sold its automobile leasing business to Bank Service in

A56

exchange for Bank Service’s assumption of Waite’s primary lia-
bility to GMAC and shares of stock in Bank Service. The auto-
mobile leasing business failed, Bank Service went mto bank-
ruptcy and GMAC sued Eason on his guarantee. Eason re-
sponded with a 10b-5 action against GMAC and Waite in which
he alleged that the underlying stock transaction between Bank
Service and Waiie was tainted by the fraud of both Waite and
GMAC. As his guarantee was an integral part of the stock
transaction, he sought rescission of the guarantee eschewing re-
scission of the sale of stock because Bank Service was bankrupt.

The district court dismissed Eason’s complaint on the author-
ity of Birnbaum because has was not the purchaser or seller of
the subject securities. On appeal, the Seventh Circuit Court of
Appeals reversed holding that the alleged fraud had been prac-
ticed in connection with the sale of Bank Service’s stock to Waite
and that Eason was a person entitled to the protection of Rule
10b-5 as an investor in Bank Service.

The court of appeals placed particular reliance on the Su-
preme Court's statements in Superintendent of Insurance Vv.
Bankers Life and Casualty Co., supra, that Manhattan Casualty
Co. (of which the Superintendent was liquidator) “was injured
as an investor” and “suffered injury as a result of deceptive prac-
tices touching its sale of securities as an investor.” 404 U.S. at
10, 12-13. And it concluded that the Court had “repudiated”
Birnbaum in Bankers Life. 490 F.2d at 661.

The court of appeals’ ultimate conclusion that Birnbaum had
been repudiated by the Sepreme Court in Bankers Life was
questionable in view of the fact that Manhattan was clearly a
defrauded seller of a security. But in any event, that conclusion
cannot withstand the light of Blue Chip:

. . . we are of the opinion that Birnbaum was rightly
decided. ...

* = * > *

Available evidence from the texts of the 1933 and 1934
Acts as to the congressional scheme in this regard, though

AS7

not conclusive, supports the result reached by the Birnbaum
court. ...

~ = * * *
The Birnbaum rule, on the other hand, permits exclu-

sion prior to trial of those plaintiffs who were not them-
selves purchasers or sellers of the stock in question. . . .

* ~ * * +
The virtue of the Birnbaum rule, simply stated, in this
situation, is that it limits the class of plaintiffs to those

who have at least dealt in the security to which the pros-
pectus, representation, or omission relates. . . .

421 U.S. 731, 733, 742, 747.

But, plaintiffs argue, Eason expressly survived Blue Chip by
reason of the Court’s treatment of it which is found in two
places in the opinion. First, in support of it in an earlier quoted
passage that federal courts have “reaffirmed Birnbaum’s con-
clusion” the Court cited: “Compare Eason v. General Motors
Acceptance Corp., 490 F.2d 654 (CA7 1973), cert. denied,
416 U.S. 960 (1974), with Dasho v. Susquehanna Corp., 380
F.2d 262 (CA7), cert. denied sub nom. Bard v. Dasho, 389 U.S.
977 (1967).” 421 U.S. at 732. Plaintiffs urge that A Uniform
System of Citation (1967), p. 87, states that “compare...
with” is used when “the authorities cited, taken together, offer
some support for statement in text.” (Our emphasis.) But Eason
in tandem with Dasho does “offer some support” for the Court’s
statement. As we have seen, Dasho was a derivative suit in
behalf of a seller in which Birnbaum was embraced. Eason was
a challenge to a guarantee which was an integral part of a tri-
partite security transaction. And while the court of appeals re-
jected the contention that Eason was a seller of either his guar-
antee or Bank Service’s stock or a forced purchaser of the Waite
notes held by GMAC, that does not mean that the Supreme
Court, in appraising Eason approved the investor analysis which
the court of appeals adopted. Indeed, as we have noted, while
Eason’s role as an investor undoubtedly motivated him to give

AS8

his guarantee, it was quite incidental to the undertaking he
sought to avoid.

Furthermore, the Supreme Court’s second treatment of Eason
certainly cannot be stretched to read approval. Having acknowl-
edged the court of appeals’ statement that the risk of expanded
litigation is not a “reason [to] reject what we believe to be a
correct interpretation of the statute or the rule” (490 F.2d at
660) the Court said:

But . . . we are not dealing here with any private right
created by the express language of § 10b or of Rule 10b-5,
. . » 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. . ..

421 US.

With some regret (see, Karvelas v. Sellas, supra), we conclude
that the Eason investor rationale was not approved by Blue
Chip.

There are other ramifications of Blue Chip which require
attention, however, before we conclude that plaintiffs may not
complain as injured shareholders under the facts presented here.

The Supreme Court carefully delineated the issue there pre-
sented: “. . . what limitations there are on the class of plaintiffs
who may maintain a private cause of action for money dam-
ages for violation of Rule 10b-5. . . .” (421 U.S. 727. Emphasis
supplied). And it took care to note that its “decision in SEC v.
National Securities, Inc., 393 U.S. 453 (1969), established that
the purchaser-seller rule imposes no limitation on the standing
of the SEC to bring actions for injunctive relief under § 10(b)
and 10b-5.” (421 U.S, 751, n. 14, Emphasis supplied.) Further-
more, it is fair to say that the policy arguments mustered by the
Court in support of its approval of Birnbaum were keyed to its
apprehensions of “strike” or in terrorem actions for money dam-

AS9

ages brought by owners of stock who do not sell or offerees
who do not purchase allegedly because of overly optimistic or
pessimistic representations regarding the future of the business
in question. In short, it is clear to us that in Blue Chip the Court
was concerned with the prospects of money damage litigation
concerning securities transactions which had not occurred.

And so, what of shareholders, such as plaintiffs here, who
rather than seeking money damages for the wrong allegedly
done them by the fraudulent issuance and sale or threatened
issuance and sale of additional securities, seek merely to undo
or restrain the wrong? Should they likewise be barred by the
purchaser-seller limitation? In this regard, we note that at no
point in Blue Chip did the Court cite, let alone discuss or dis-
approve a cluster of courts of appeals decisions which appear to
have declined to apply the strictures of Birnbaum to private
10b-5 actions seeking solely equitable relief, See Mutual Shares
Corp. Vv. Genesco, Inc., 384 F.2d 540, 546-47 (2d Cir. 1967);
Vincent v. Moench, 473 F.2d 430, 434-35 (10th Cir. 1973);
Kahan vy. Rosensteil, 424 F.2d 161, 173 (3d Cir. 1970); but
see, Greater lowa Corp. V. McLendon, 378 F.2d 783, 791 (8th
Cir. 1967).

We are tempted by the lure that Blue Chip should be con-
fined to its facts and the relief there sought. But we must be
mindful of the Court's function in hearing and deciding such
cases, It does not sit to adjudicate individual disputes; that is
the business of the district courts and courts of appeal, Rather,
it uses individual cases and controversies to shape and guide the
development of the law. This is particularly true where, as here,
it speaks in an area of judge made law.

Thus, we have concluded that we would not be justified in
drawing a distinction here between an action at law and one in
equity. Compare Rule 2, Fed. R. Civ. P. And although the ele-
ments of uncertainty present in Blue Chip are not present here,
we should apply its limitations upon the class of persons entitled
to maintain any action under Rule 10b-5. Indeed, the Court

A60

recognized that consequence when it said that the “three prin-
cipal classes of potential plaintiffs .. . barred by the Birnbaum
rule . . . [include] shareholders, creditors and perhaps others
related to an issuer who suffer loss in the value of their invest-
ment due to corporate or insider activities in connection with
the purchase or sale of securities which violate Rule 10b-5.”
421 U.S. 737, 738. Nor does its previously noted tacit approval
of a shareholder derivative action on behalf of a corporate
issuer-seller mean that shareholders such as plaintiffs can be
heard to complain in their own behalf. Accordingly, to the
extent that plaintiffs’ complaint is dependent on their status as
investors in IDC, it will be dismissed.’

The Merits of Plaintiffs’ Complaint

Plaintiffs’ second amended complaint and their pre-and post-
trial briefs are limited to a single theory of recovery: that the
previously described securities transactions were tainted by fraud
either practiced or aided and abetted by Heizer in violation of
Section 10(b) of the Securities Exchange Act of i934* and
Rule 10b-5 of the Securities and Exchange Commission.’ No

3. This conclusion renders moot plaintiffs’ motion to certify a
class of shareholders of IDC,
4. Section 10(b) provides in material part:

It shall be unlawful for any person . . . [t]o use or employ, in
connection with the purchase or sale of any security registered
on a national securities exchange or any security not so regis-
tered, any manipulative or deceptive device or contrivance in
contravention of such rules and regulations as the [Securities
and Exchange} Commission may prescribe as necessary or
appropriate in the public interest or for the protection of
investors. 15 U.S.C. § 78j(b).

5. Rule 10b-5 provides:
It shall be unlawful for any person, directly or indirectly, by
the use of any means or instrumentality of interstate, or of the
mails, or of any facility of any national securities exchange:

(a) To employ any device, scheme, or artifice to

defraud,
(Footnote continued on next page.)

A6él

other theory of relief has been urged. In these circumstances,
our conclusion that plaintiffs can maintain their action only as
a derivative one in behalf of IDC necessarily limits the scope
of our inquiry as to whether IDC was victimized by Heizer’s
alleged misconduct. !

The genius of 10b-5 lies in its breadth. It prohibits “any de-
vice, scheme or artifice to defraud” and “any act, practice or
course of business which operates or would operate as a fraud
or deceit... .” It prohibits “all fraudulent schemes in connection
with the purchase or sale of securities, whether the artifices
employed involve a garden type variety of fraud, or present a
unique form of deception. Novel or atypical methods should not
provide immunity from the securities laws.” A. J. Brod & Co. v.
Perlow, 375 F.2d 393, 397 (2d Cir. 1967). Despite Birnbaum's
early conclusion that the Rule was not aimed at “fraudulent
mismanagement of corporate affairs” (193 F.2d at 464), we
know today that a breach of trust by corporate fiduciaries clearly
falls within its ambit. Superintendent of Insurance v. Bankers
Life and Casualty Co., supra; Dasho v. Susquehanna Corp.,
supra, and Dasho v. Susquehanna Corp., 461 F.2d 11 (7th
Cir. 1972); Schoenbaum vy. Firstbrook, supra.

But the breadth of the Rule’s prohibitions does not permit its
application to transactions in connection with which there has
been no fraud practiced upon the person enjoying the protection
of the Rule. Here that person is IDC.

When we examine plaintiffs’ proof in respect to the first
three transactions we find it wanting. IDC was in need of cash

(Footnote continued from preceding page.)

(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 light of the circumstances
under which they were made, not misleading, or

(c) To engage in any act, practice, or course of busi-
ness which operates or would operate as a fraud or deceit
upon any person, in connection with the purchase or sale
of any security.

17 C.F.R. § 240.10b-5,

A62

which Heizer was willing to provide. Heizer drove a hard bar-
gain, particularly in respect to the third transaction. But
nothing was concealed from IDC’s directors, who were inde-
pendent of Heizer, although subject to its weighted preferred
shares vote following the second transaction. Nor was anything
concealed from IDC’s independent and able counsel. For all
that appears here the first three transactions were open and at
arms length vis-a-vis Heizer and IDC.

Plaintiffs’ primary complaint in regard to the first three trans-
actions is that their terms and the consequence thereof were
concealed from IDC’s common stockholders. And this is par-
ticularly true, they assert, in respect to the fact that the anti-
dilution clauses in the warrants would be triggered not only
by sales of common stock to outsiders but also by sales of com-
mon stock to Heizer under the terms of the later warrants which
were issued at successively lower prices. Heizer, say plaintiffs,
through its orchestrating officers and counsel, aided and abetted
that concealment. Alternatively they urge that Heizer itself
owed a duty of disclosure to the stockholders because it had
assumed control of IDC through the continuation of business
provisions of the agreements, its weighted preferred shares votes
and the anti-dilution clauses which discouraged other investors
and rendered IDC a captive investee.

This theory of fraud by concealment practiced on the share-
holders is not available to plaintiffs under our interpretation
and application of the Blue Chip limitation on the persons pro-
tected by Rule 10b-5. But if it were, the proof does not sustain
the charge.

The terms and consequences of the first three transactions
were not concealed from the stockholders, All of the stock-
holders meetings were held pursuant to notice, The notices and
accompanying summaries described the business to be trans-
acted at each meeting. The documents pertaining to the three
transactions were made available to the shareholders prior to
each meeting. The transactions were discussed at each meeting.

A63

All three transactions were unanimously approved by the stock-
holders in attendance and voting. None of the transactions was
challenged until this actiou was brought following the fourth
transaction.

We find and conclude that the first three transactions were not
tainted by any 10b-5 fraud of which plaintiffs can be heard to
complain,

The fourth and fifth transactions are quite different. By the
time they were entered into Heizer had put its agents on IDC’s
board and their votes were essential to the consummation of
these transactions. Clearly, in these instances Heizer engaged
in self dealing while occupying a fiduciary relationship to IDC.
As such, if the transactions were not per se rescindable, at the
very least Heizer had the heavy burden of proving their fairness.
This it failed to do.

On the eve of the fourth transaction, Heizer held warrants
to purchase 1,304,000 shares of IDC’s common stock at $3.60
per share. By its additional investment of only $600,000, Heizer
increased its claim on IDC’s common equity to 4,694,000 shares
at $1.00 per share and thereafter by additional demand loans
which IDC had no likelihood of timely repaying to 5,513,000
shares at $1.00 per share.

Heizer’s officers are experts at valuing corporations such as
IDC, At the time of the fourth transaction, Heizer valued IDC
common stock at $3.60 per share. This admission without more
shows the gross inadequacy of the $1.00 per share price imposed
upon IDC by the fourth transaction convertible note.

In addition, Heizer’s audited statement for fiscal 1972, which
was the year of the fourth transaction, confirmed that Heizer’s
valuation of IDC was the “fair value,” and Edgar Heizer ad-
mitted that in November, 1971, when the fourth transaction
was entered into, Heizer could have liquidated its investment in
IDC at cost.

Heizer offered no evidence which discredited its valuation of
IDC at $3.60 per share. Rather its witnesses testified that the

A64

$1.00 per share price in the fourth transaction was the result
of a formula designed to equate Heizer’s pro forma equity to the
percentage which its investment bore to IDC’s total capital.
Such an approach is hardly consistent with Heizer’s obligation
to deal fairly with IDC.

Insofar as the fifth or pledge transaction is concerned, Heizer’s
conduct was even more rapacious. In June, 1973 Heizer had
the power through the warrants and convertible notes issued
to it in the first four transactions, to capture 87% of IDC’s
equity and thereby capture the profitable TR. By then, plain-
tiffs had brought their action here challenging that threatened
equity takeover. And so Heizer, by agreeing to refrain from
demanding payment of the fourth transaction notes as well as
some $2,000,000 which it had loaned IDC in the interim to
keep the monitoring business afloat, took a pledge of all of the
TR stock which Heizer’s valuation committee had just valued
at $8,000,000,

There was no evidence which even suggested that the pledge
transaction was fair. Indeed, Heizer’s witness Cameron admitted
that IDC could not have repaid any of the notes secured by the
pledge out of internally generated funds or any known outside
financing source, and that the pledge was taken in order to
protect Heizer from the outcome of this litigation which was
pending in behalf of IDC. It is difficult to conjure a more
blatant breach of trust. Pepper v. Litton, 308 U.S. 295 (1939);
Lebold v. Inland Steel Co., 125 F.2d 269 (7th Cir. 1941).

The Relief

District courts have the duty “to provide such remedies as
are necessary to make effective the congressional purpose” in
actions such as this. J. 1. Case Co, v. Borak, 377 U.S. 426, 433
(1964). The relief may include setting aside or enjoining the
enforcement of rights purportedly created by the tainted trans-
action. Mills v. Electric Auto-Lite Co., 396 U.S. 375 (1970).

A65

Here plaintiffs seek only equitable relief by way of injunction,
rescission and reformation. The rights of innocent parties have
not intervened. Defendant Heizer has not exercised the warrants
issued to it in the first three transactions or converted the note
of the fourth. Nor has it foreclosed the pledge of. the fifth
transaction. Thus, there is no unscrambling to be done and we
are not inhibited by any practical or countervailing equitable
limitations which would militate against granting all of the relief
warranted by our conclusion on the merits.

The primary thrust of the lawsuit has been directed at the
increased claims upon IDC’s equity which Heizer has acquired
through the second, third and fourth transactions, and to safe-
guard IDC’s stock ownership of TR. In view of the fact that
we have found and concluded that only the fourth and fifth or
pledge transactions are vulnerable to plaintiffs’ challenge, the
relief should be limited to those transactions.

The notes of the fourth transaction should be declared non-
convertible and Heizer should be permanently enjoined from
converting or attempting to convert any of those notes to
shares of common stock of IDC. Any provision of the fourth
transaction which authorizes or permits either directly or in-
directly an increase in the number of shares of common stock of
IDC issuable upon exercise of warrants held by Heizer under
the first three transactions in excess of 1,304,000 shares, should
be declared void. Similarly, any provision of the fourth agree-
ment which authorizes or permits Heizer to exercise the previ-
ously issued warrants at a price of less than $3.60 per share,
should be declared void and Heizer should be enjoined from
seeking to enforce those provisions of the fourth transaction.

The stock pledge agreement of June 8, 1973, between Heizer
and IDC should be cancelled and declared void and Heizer
should be ordered to transfer to IDC all certificates representing
shares of stock of TR held by Heizer pursuant to the stock pledge
agreement. Heizer should also be ordered to release any and all

A66

security interest in the shares of TR and it should be enjoined
from enforcing in any way the stock pledge agreement.

In addition, because of the dominant position which Heizer
holds in relation to IDC and its clear over-reaching manifested
by the fourth and fifth or pledge transactions, Heizer should be
enjoined from entering into any transaction with IDC except
upon terms and conditions as shall be fair and equitable.

Plaintiffs’ prayers for relief in respect to the first three
transactions should be denied.

In view of the nature of these proceedings, the court will
entertain an application by plaintiffs for an award of reasonable
attorneys’ fees.

Because a counterclaim remains pending, brought by IDC
against plaintiffs, the court will direct the entry of judgment
in accord with the foregoing, pursuant to Rule 54(b) of the
Federal Rules of Civil Procedure. A decree to that effect has
been entered this date.

ENTER:

/s/ Prentice H. Marshall
Judge Prentice H. Marshall

DATED: December 3, 1975.

A67

DECREE OF DISTRICT COURT, DECEMBER 3, 1975

IN THE
UNITED STATES DisTRICT COURT
For the Northern District of Illinois
Eastern Division

PETER WRIGHT and BENEFICIAL
STANDARD CORPORATION,

Plaintiffs,
vs.
No. 72 C 2536
THE HEIZER CORPORATION and IN-

TERNATIONAL DIGISONICS CORPO-
RATION,

Defendants. |

DECREE

In accord with the memorandum decision herein which will
stand as findings of fact and conclusions of law under Rule
52(a) of the Federal Rules of Civil Procedure,

IT IS HEREBY ORDERED, ADJUDGED AND DECREED:

1. Any and all notes issued by International Digisonics
Corporation [now known as IDC Services, Inc. (IDC)] to Heizer
Corporation, and any and all loans made by Heizer to IDC,
under or pursuant to that certain Loan Agreement between said
parties, dated November 19, 1971, and any amendment thereof
or supplement thereto, are hereby declared to be nonconvertible
notes. Any provision contained in said Loan Agreement, or any
amendment thereof or supplement thereto, which authorizes or
permits, directly or indirectly, any loan made under or pursuant
thereto, whether or not evidenced by a note, to be converted into
any shares of common stock of IDC, is hereby declared to be

A68

null and void and is now and shall hereafter be of no force or
effect whatsoever. Heizer Corporation and IDC, and each of
them, and their respective officers, directors, successors and
assigns, are hereby permanently enjoined from converting or
attempting to convert, directly or indirectly, any of said loans or
notes into shares of common stock of IDC, and are further
permanently enjoined from issuing or attempting to issue, directly
or indirectly, any shares of common stock of IDC on account of
or pursuant to any provision of said Loan Agreement, or any
amendment thereof or supplement thereto.

2. Any and all warrants to puchase common stock of IDC,
issued or issuable to Heizer Corporation or its nominees or
assignees, by IDC, under or pursuant to the aforesaid Loan
Agreement dated November 19, 1971, or any amendment
thereof or supplement thereto, are hereby cancelled. Any provi-
sion contained in said Loan Agreement, or any amendment
thereof or supplement thereto, which authorizes or permits,
directly or indirectly, an increase in the number of shares of
common stock of IDC issuable upon exercise of warrants held
by Heizer Corporation, or any nominee or assignee thereof, in
excess of 1,304,000 shares, is hereby declared to be null and
void and is now and shall hereafter be of no force or effect
whatsoever. Any provision contained in said Loan Agreement,
or any amendment thereof or supplement thereto, which author-
izes or permits Heizer Corporation, or amy nominee or
assignee thereof, to exercise warrants to purchase shares of
common stock of IDC at an exercise price of less than
$3.60 per share, is hereby declared to be null and void, and is
now and shall hereafter be of no force or effect whatsoever.
Heizer Corporation and IDC, and each of them, and their
respective officers, directors, successors and assigns, are hereby
permanently enjoined from:

(a) Exercising or attempting to exercise, directly or
indirectly, any warrants to purchase shares of common
stock of IDC, at an exercise price of less than $3.60 per
share; and

a

A69

(b) Issuing or attempting to issue, directly or indirectly,
any shares of common stock of IDC at a price of less than
$3.60 per share upon the exercise of any warrants held by
Heizer Corporation, or any nominee or assignee threeof, to
purchase shares of common stock of IDC.

3. In any transaction, direct or indirect, between Heizer
Corporation, its nominee or assignee, and IDC, from and after
the date hereof, no provision contained in any agreement
between Heizer Corporation and IDC heretofore entered into
which authorizes or permits an adjustment in the purchase price
or number of shares issuable upon exercise of any outstanding
warrants to purchase IDC common stock, shall be of any force
or effect, and Heizer Corporation, its nominees and assigns, are
hereby permanently enjoined from enforcing or attempting to
enforce any such provision. Nothing herein contained shall
prohibit Heizer Corporation from otherwise purchasing securities
from or lending money to IDC under such terms and conditions
as shall be fair and equitable.

4. The Siock Pledge Agreement dated June 8, 1973, between
Heizer Corporation and IDC is hereby cancelled and declared
null and void and of no force and effect whatsoever. Heizer
Corporation is hereby ordered and directed forthwith to assign,
transfer, convey and deliver to IDC all certificates representing
shares of stock of Talent & Residuals, Inc., now held by Heizer
Corporation under or pursuant to the aforesaid Stock Pledge
Agreement. Heizer Corporation is further ordered and directed
forthwith to release and cause to be cancelled any and all
security interest in and to said shares of stock of Talent & Resi-
duals, Inc. which Heizer Corporation has or may have acquired,
perfected, filed or otherwise placed of record, and forthwith to
deliver to IDC, with copy to counsel for plaintiffs, evidence of
such release and cancellation. Heizer Corporation and IDC, and
their respective officers, directors, successors and assigns, are
hereby permanently enjoined from performing or enforcing per-
formance of any provision of the aforesaid Stock Pledge Agree-

A70

ment under which Heizer Corporation has or may have any
rights in, to or against either the common stock of Talent
& Residuals, Inc. or IDC itself.

5. Heizer Corporation, and its successors and assigns, are
hereby permanently enjoined form entering, directly or in-
directly, into any transaction with IDC except upon such terms
and conditions as shall be fair and equitable.

6. With respect to warrants issued by IDC to Heizer Corpo-
ration pursuant to the agreements entered into between said
parties on September 1, 1970 and May 11, 1971, plaintiffs’
prayer for cancellation of the increase in the number of shares
issuable and the decrease in the exercise price under said
warrants, and for injunctive relief with respect thereto, are hereby
denied.

7. Plaintiffs’ prayers for cancellation of Article Fourth I,
4(A) of the Amendment to the Certificate of Incorporation of
IDC, dated May 11, 1971, increasing the votes to which the
holders of preferred stock of IDC are entitled from one vote for
each share to 4.4 votes for each share, and for injunctive relief
with respect thereto, are hereby denied.

8. Plaintiffs will be awarded reasonable attorneys’ fees upon
their application.

9. Pursuant to Rule 54(b) of the Federal Rules of Civil
Procedure, the Court expressly determines that there is no just
reason for delay and directs entry of judgment as hereinabove
set forth.

ENTER:

/s/ Prentice H. Marshall
Judge Prentice H. Marshall

DATED: December 3, 1975.

Salle sy A hace OE

A7l

OPINION OF THE DISTRICT COURT, MAY 28, 1976
(AS AMENDED JULY 2, 1976)

IN THE
UNITED STATES DisTRICT COURT
For the Northern District of Illinois
Eastern Division

PETER WRIGHT and BENEFICIAL
STANDARD CORPORATION,

Plaintiffs,

vs.

| = No. 72 C 2536

THE HEIZER CORPORATION and IN-
TERNATIONAL DIGISONICS CORPO-
RATION,

Defendants. |
MEMORANDUM DECISION

Cross appeals were taken from our decision and decree of
December 3, 1975, Wright v. Heizer Corporation, ..... F.
a (N.D.Iil. 1975), which were entered pursuant to
Rule 54(b), Fed. R. Civ. P. Upon docketing in the Court of
Appeals, plaintiffs sought and obtained an order of remand “for
the limited purpose of permiiting the district court to consider
those issues [still] pending before it. . . .” Order Feb. 23, 1976.
There were then pending here defendant IDC’s motion for
summary judgment on Count III of plaintiffs’ amended com-
plaint (which had not been but now is fully briefed) and plain-
tiffs’ motion for attorneys’ fees. Thereafter plaintiffs renewed a
petition for supplemental and preliminary relief which they had
presented (and which was continued by agreement) while Counts
I and II of their amended complaint were under advisement

A72

following the trial of those counts on the merits, That renewed
petition was followed by plaintiffs’ motion for the appointment
of a receiver for defendant IDC. And, most recently, plaintiffs
have presented a new motion for a preliminary injunction in
respect to a proposed recapitalization of IDC. We dispose of
these pending matters seriatim.

IDC’s motion for summary judgment on Count III

While Counts I and II of plaintiffs’ amended complaint were
brought derivatively in behalf of IDC and representatively in
behalf of its common shareholders, Count III is an action by
Beneficial Standard Corporation (BFC) against IDC for alleged
violations of Section 10(b) of the Securities Exchange Act of
1934, 15 U.S.C. §78j)(b) and Rule 10b-5 thereunder, in con-
nection with the conversion of a $425,000 IDC convertible de-
benture held by BFC into common stock of IDC,

BFC acquired the debenture on January 10, 1969. By its
terms it was “mandatory” that the debenture be converted to
common stock “on or before the filing by [IDC] of the necessary
documents and an ‘S-1’ Statement with the Securities and Ex-
change Commission which sets forth that [IDC] earnestly desires
and seeks to make a public offering of its common stock in a
minimum amount of Two Million Dollars... .”

BFC alleges that in June 1969 IDC falsely represented that it
had entered into a firm underwriting agreement for the public
distribution of 200,000 shares of IDC common at $10 or more
per share and that a registration statement would be filed, all to
the end that BFC voluntarily converted its debenture into com-
mon stock. BFC’s original complaint, which was filed October
11, 1972, alleged that it had learned of the falsity of IDC’s
representations on October 1, 1969. Furthermore, IDC did file
a registration statement for more than $2,000,000 of common
stock on July 23, 1969. On these facts IDC asserts that it is
entitled to summary judgment because BFC’s fraud claim is time

A73

barred and alternatively, assuming arguendo that IDC made the
false representations ascribed to it in June 1969, the IDC regis-
tration statement of July 1969 mandated the conversion of
BFC’s debenture.

There is no general federal statute of limitations and no limi-
tations provision in the federal securities laws applicable to
BFC’s claim. Therefore, the appropriate limitations statute of
the state of the forum controls. Parrent v. Midwest Rug Mills,
inc., 455 F.2d 123, 125 (7th Cir. 1972); Janigan v. Taylor,
344 F.2d 781, 783 (lst Cir. 1965). In Parrent the Court of
Appeals held that the three year limitation in the Illinois Securi-
ties Law (Jl. Rev. Stat. ch. 121%, §137.13(D)) applies to
actions under 10b-5, That section provides:

No action shall be brought for relief under this Section or
upon or because of any of the matters for which relief is

granted by this Section after three years from the date of
sale.

BFC’s amended complaint asserts that it converted its deben-
ture into common stock on July 8, 1969. It had three years to
sue from the date of conversion. Silverman v. Chicago Ramada
Inn, 63 Ill.App.2d 96, 211 N.E.2d 596 (1965). This action
was not commenced until October 11, 1972, more than three
years from the date of the conversion.

BFC has asserted, however, that it did not learn of the al-
leged misrepresentations until October 1, 1969. Accepting that
allegation as true, as we must, and applying the case law to the
effect that the applicable statute of limitations in federal actions
does not begin to run until the injured party discovers the alleged
fraud, Bailey v. Glover, 21 Wall 342 (1875); Janigan v.
Taylor, 344 F.2d 781 (ist Cir. 1965)}Morgan v. Koch, 419
F.2d 993 (7th Cir. 1969), BFC’s action is still time barred
since it was filed more than three years from the date of
discovery.

Finally, while BFC appears to allege subsequent factual mis-
representations by IDC there is no showing that it relied on

A74

those supposed misrepresentations in postponing the filing of its
suit. Absent such a showing, the statute of limitations is not
tolled. Dixon Mills, Inc. Vv. Dixon National Bank, 357 F.2d 169
(7th Cir. 1966); cf. Bergeron v. Mansour, 153 F.2d 27 (lst
Cir, 1945). And such a showing is in fact impossible here since
plaintiff could hardly rely on a continuation of the same alleged
misrepresentations which, from the allegations of its own com-
plaint, it already believed to be false. Melhorn v. AMREP
Corp., 373 F. Supp. 1378 (M.D.Pa. 1974).

In any event, on July 23, 1969—almost three months before
the commencement of this action—IDC did file a registration
statement for more than the $2,000,000 of common stock speci-
fied in the mandatory conversion clause of the debenture. Upon
the happening of that event BFC was obliged to convert. How,
in these_circumstances, its earlier conversion injured it escapes
us and BFC has provided no elucidation on the subject. Instead
it seeks to draw a distinction between its “voluntary” conversion
in June 1969 as opposed to a “mandatory” conversion in 1969,
The distinction escapes us insofar as any injury to BFC is
concerned.

IDC’s motion for summary judgment as to Count IT! of the
amended complaint is granted and judgment will enter dismissing
that count.

Plaintiffs’ application for attorneys’ fees

In our memorandum decision of December 3 we stated that
we would entertain an application from plaintiffs for an award
of reasonable atturneys’ fees, which was promptly presented. In
their application plaintiffs’ counsel assert that the fees should be
surcharged against the wrongdoing defendant Heizer Corporation
rather than IDC and its shareholders who, according to plain-
tiffs, are the beneficiaries of plaintiffs’ successful prosecution of
this action. We note, without deciding, that there is substantial
doubt as to the validity of plaintiffs’ assertion that the fees when
awarded should be surcharged against Heizer. See Bailey v.

A75

Meister Brau, Inc., 74-1695, sl. op. 20-24 (7th Cir. May 6,
1976). In any event, the benefits of plaintiffs’ success have not
been finally adjudicated. Plaintiffs first appealed from the Decem-
ber 3 decree; Heizer cross appealed. The fees are “contingent
upon the exigencies of equitable litigation, the final disposition
of which in its entire process including appeal places such a
claim in much better perspective than it would [be] at [this] stage.”
Sprague V. Ticonic National Bank, 307 U. S. 161, 168 (1939).
Accordingly, we will defer hearing and ruling upon the fee appli-
cation until the Court of Appeals has ruled.

Plaintiffs’ petition for supplemental relief

On May 5, 1975, while the merits of Counts I and II were
under advisement, plaintiffs petitioned for supplemental and pre-
liminary injunctive relief respecting the debt obligations of IDC
to Heizer arising out of the fourth and fifth transactions, In es-
sence, plaintiffs sought an injunction which would restrain Heizer
from enforcing those obligations pendente lite. The petition was
continued on Heizer’s assurance that it would not enforce the
obligations until the merits of Counts I and II were decided. The
decree of December 3, 1975 was a final one in respect to Counts
I and II. It granted substantial relief to IDC at plaintiffs’ deriva-
tive behest in respect to the fourth and fifth transactions. It did
not, however, specifically enjoin the collection of the debt obli-
gations or subordinate them.

On January 6, 1976, more than 10 days after the entry of the
December 3, 1975 decree, plaintiffs renewed their May 5, 1975
petition for supplemental relief. In these circumstances, we hold
that the May 5, 1975 petition for supplemental and preliminary
relief was mooted by or merged into the December 3 decree and
the renewed petition was an untimely effort to modify the decree.
Rule 59(e), Fed. R. Civ. P. Accordingly, we deny plaintiffs’
May 5, 1975 petition for supplemental and preliminary relief
and their January 6, 1976 renewal thereof.

A76

Plaintiffs’ petition for appointment of receiver

Since the limited remand from the Court of Appeals, plaintiffs
have presented a petition for the appointment of a receiver for
IDC upon the grounds that it has not joined forces with plaintiffs
in defending the cross appeal taken by Heizer Corporation fol-
lowing plaintiffs’ perfection of their appeal from the December 3
decree and it has not joined forces with plaintiffs in seeking to
surcharge Heizer with plaintiffs’ attorneys’ fees, and because dur-
ing the trial of 1974 there was testimony that a former member
or associate of the law firm of Sidley and Austin (which now
represents IDC) had once represented some of the investors in
Heizer Corporation.

None of the allegations warrant the extraordinary relief plain-
tiffs seek. A decree has been entered which, if affirmed, will be
enforced. Plaintiffs obtained that decree but they are dissatisfied
with it and have appealed seeking more extensive relief than was
granted here. Heizer has cross appealed. IDC, through its inde-
pendent counsel, has played a bystander role in this litigation to
date, save for Count III in which it was sued directly by BFC.
There is no reason why it should not continue to do so.

Insofar as plaintiffs’ attorneys’ fees are concerned, they will
await another day.

The possible conflict of interest said to exist from the alleged
representation of Heizer investors by a former partner or
associate of Sidley and Austin, has been gleaned by plaintiffs
from testimony given two years ago. The case has been fully
adjudicated without any suggestion that IDC’s counsel were dis-
qualified from representing their client. Cf. Cannon vy, U. S.
Acoustics Corp., 398 F.Supp. 209 (N.D.Il. 1975), affd in
part, 75-1810 (7th Cir. Mar. 31, 1976). We decline to entertain
such a suggestion now under the guise of a petition to appoint
a receiver.

The petition to appoint a receiver for IDC is denied.

A77

Plaintiffs’ current motion for a preliminary injunction

On May 20, 1976 plaintiffs presented yet another motion for
a preliminary injunction in respect to a plan of recapitalization
of IDC which has been proposed by Heizer Corporation to be
voted upon at the annual meeting of the stockholders of IDC to
be held June 2, 1976, Under the plan Heizer will, inter alia,
exchange $6,000,000 of its IDC debt obligations for an equal
amount of a new IDC Class A Non-voting Preferred Stock.
Plaintiffs assert that until we have ruled on their petition for
supplemental relief (which we have now done) Heizer should
not be permitted to convert its IDC debt obligations to equity.
Accordingly they seek to enjoin the stockholders meeting.

Clearly plaintiffs’ instant motion is made in aid of their petition
for supplemental relief which has now been denied. Accordingly,
the motion to enjoin the shareholders meeting is likewise denied.
In so ruling, however, we express no opinion as to the merits of
Heizer Corporation’s plan of recapitalization nor do we express
any opinion as to whether it is consonant with the decree entered
herein on December 3, 1975.

Orders in accord with the foregoing will enter.

ENTER:

/s/ Prentice H. MARSHALL
Judge Prentice H. Marshall

Dated: May 28, 1976,

A78

INJUNCTION ENTERED BY DISTRICT COURT,
JUNE 18, 1976

IN THE UNiTED STATES DistTRICT COURT
For the Northern District of Illinois
Eastern Division

PeTeR WRiGHT and BENEFICIAL
STANDARD CORPORATION,

Plaintiffs,

vs.
. No, 72 C 2536

THE HeIzZER CORPORATION and
INTERNATIONAL DIGISONICS
CORPORATION,

Defendants. ,

INJUNCTION PENDING APPEAL

On motion of plaintiffs, and for the reasons set forth this day
in the oral opinion delivered by this Court, which oral opinion
includes the Court's findings of fact and conclusions of law;

IT IS HEREBY ORDERED:

1. Heizer Corporation and IDC Services, Inc. (successor in
name to defendant International Digisonics Corporation), and
each of them, are hereby enjoined, during the pendency of the
appeals in this cause, from taking any steps to authorize,
approve, effect, implement or consummate Heizer Corporation's
proposed plan of recapitalization of IDC Services, Inc., tendered
to the shareholders of IDC under date of May 12, 1976, includ-
ing but not limited to the taking of any action respecting said
plan at the adjourned meeting of shareholders of IDC on June
21, 1976.

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A79

2. Heizer Corporation and IDC Services, Inc., and each of
them, are hereby enjoined, during the pendency of the appeals
in this cause, from directly or indirectly enforcing or permitting
payment of any of the demand notes issued by IDC and held by
Heizer Corporation, or any interest thereon.

ENTER:
/s/ PRENTICE H. MARSHALL
United States District Judge

Dated: June 18, 1976

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385005_0167%3A1. Public record. Not legal advice.