Appendix — BALTIMORE AND OHIO RAILROAD CO. V. PITTSBURGH TERMINAL TERMINAL CORP (Nos. 82-622, 82-620)

Appendix A

UNITED STATES COURT OF APPEALS

For THE THIRD CIRCUIT

No. 81-1674

System, INc.

(D.C. Civil No. 77-1455)

No. 81-1675

STEVENSON, Hays T. WaTKIns, Howarp E. Srimpson and

(D.C. Civil No. 79-0094)

On APPEAL FROM THE UNITED States District Court

FOR THE WESTERN DISTRICT OF PENNSYLVANIA

Argued: December 16, 1981

Before: ADAMs, GIBBONS and GARTH, Circuit Judges

(Opinion Filed: June 3, 1982)

Pittsburgh and

Monroe Guttmann, —— epee.

judgment dismissing

a dividend by the B & O on that date of stock of Mid-

and the laws of several states. The defendants are B & O,

a Maryland corporation, The Chesapeake & Ohio Railway

Company (C & O), a Virginia corporation which on De-

cember 13, 1977, owned more than 99% of B & O’s com-

mon stock, Chessie System, Inc. (Chessie), a Virginia

corporation which is a holding company for C & O and its

holders are B & O Series A, dated January 1, 1956 and

maturing January 1, 2010, paying interest at 4.5%, and

convertible at any time before maturity into 10 shares of

B & O common stock for each $1000 of face value. The

action of which the Bondholders complain is the action of

the defendants in fixing December 13, 1977, as both the

date of declaration of, and the

Court held that it violated no legally protected rights of

the debenture holders.' We reverse.

1. The District Court decision is reported. Pitts-

rern

F.Supp 02 (W. D. Pa. 1981).

Appendix A. 5a

I.

B & O owns and operates a railroad regulated by the

Interstate Commerce Commission (ICC). Prior to the

transactions giving rise to this lawsuit, B & O also owned

substantial non-rail assets such as real estate, timber and

mineral reserves. At one time both its common stock and

its debentures were traded on the New York Stock Ex-

change (NYSE). When C & O acquired 99.63% of B & O’s

common stock, trading in that security ceased and it was

delisted, although 13 individuals still held some shares.

The NYSE listing of B & O’s convertible debentures

continued. No dividends were paid on the B & O common

stock after 196i. Thus the holders of convertible deben-

tures had no particular incentive to exercise the conver-

sion privilege unless the no dividend policy were to

change.

Because the regulations of the ICC prohibited a rail-

road corporation from engaging in non-rail business,

B & O’s and C & O’s assets not used in rail transportation

remait.ed undeveloped. Beginning in 1973 when Cheasie

was formed, C & O began segregating its non-rail assets

in a separate corporation, Chessie Resources, Inc., so

that they rould be developed free of constraints imposed

by the ICC. The Chessie management desired to accom-

plish the same result with respect to B & O’s non-rail

assets. To that end, in January of 1977, the Chessie Cor-

poration Restructuring Committee settled on a plan

whereby the B & O would transfer those assets to MAC,

a wholly owned B & O subsidiary, and then distribute the

MAC stock as a dividend to B & O’s fourteen common

stockholders.

If, prior to the dividend in MAC stock, the number of

B & O common stockhoiders were to increase substan-

tially, B & O might have had to file a registration state-

6a Appendiz A.

ment for MAC with the Securities and Exchange Com-

mission (SEC). 15 U.S.C. §77f (1976). There were practi-

cal difficulties with the preparation of a registration

statement, especially that of placing a value on B & O’s

non-rail assets. But if notice of the MAC transaction had

been given to the convertible debenture holders prior to

the record date of the in kind dividend, many of them

might have elected to convert. Thus the Restructuring

Committee concluded that the MAC transaction should

be structured in such a way that the convertible deben-

ture holders would not have such notice until after the

record date. This, it was thought, would permit counsel

for B & O to obtain from the SEC a no-action letter with

respect to registration of the MAC stock.

At the time the MAC transaction was under consid-

eration, B & O had outstanding bond obligations under

three trust indentures. One of these, a Convertible In-

come Bond Debenture, contained a provision requiring

B&O to pay into a surplus income sinking fund an

amount equal to any dividend. A second, the Refunding

and General Mortgage Indenture, required that

arrearages in the sinking funds had to be made up before

a dividend could be paid. It was these provisions which

had prevented B & O from paying dividends since 1961.

The third Indenture was that governing the convertible

debentures held by the Bondholders. In order to facili-

tate the dividend in MAC stock, B & O called for redemp-

tion the Convertible Income Bonds, and discharged the

sinking fund arrearages on the Refunding and General

Mortgage Indenture by paying the sinking funds ap-

proximately $7,000,000. These steps were accomplished

by the summer of 1977. The Restructuring Committee

then turned to the Indenture for the convertible deben-

tures.

Appendiz A. Ta

The convertible debentures also contained a redemp-

tion feature which in 1977 called for payment of a pre-

mium of 2.5% of their face amount. (344a). B & O did not

elect to redeem. Conversion privilege features of the

indenture oblige B & O to reserve sufficient common

stock and to adjust for changes in par value. (350a).

Conversion rights to the bondholders are protected in

the event of merger or sale. (354a). Article V, Section 12

of the Indenture provide

Section 12. The Company covenants and

agrees that it will not declare and/or pay any divi-

dend on its common stock payable in stock or create

any rights to subscribe for stock or securities con-

vertible into stock unless in any such case notice of

the taking of a record date for the determination of

the stockholders entitled to receive such dividend,

distribution or right is given at least ten days prior

thereto by at least one publication in an Authorized

Newspaper. A copy of each such published notice

shall promptly after such publication be filed with

the Trustee.

(357a). When the convertible debentures were issued in

1956, B & O entered into a listing agreement with the

NYSE relating to them, which incorporated by reference

B & O’s earlier listing agreements. Listing Agreement

A-12653 for an earlier bond issue, incorporated by refer-

ence in that for the 1956 convertible debenture issue,

provides:

4. The Corporation will give the Exchange at

least ten days’ notice in advance of the closing of the

transfer books, or of the taking of a record of its

stockholders for any purpose.

5. The Corporation will publish promptly to the

holders of any of its securities listed on the

(455a). In addition to the Listing Agreements, the B & O

is bound by the Rules of the NYSE. Section A-2 of its

Manual, “Timely Disclosure,” provides:

A corporation whose securities are listed on the

In November of 1977, by which time impediments to

the payment of dividends on B & O stock in the Converti-

ble Income Bond Debenture and the Refunding and Gen-

eral Mortgage Indenture had been removed, plaintiff

Monroe Guttmann wrote to the Secretary of B & O:

As one of the very few public owners of B & O

common stock, we are concerned that we may not be

made aware of any dividend the directors declare on

Appendiz A. 9a

the common stock in sufficient time to convert any of

our convertible debentures.

Although it may not be customary to do so in

view of the fact that declaration of a dividend may

not be widely publicized, if publicized at all, we ask

that you notify us promptly of any such dividend

declaration so that we will have an opportunity to

convert debentures in time to receive such dividend

if we choose to do so.

Will you please let me know what provisions

there are in the by-laws of the company that govern

the time which must elapse between the declaration

of a dividend, the record date and the payable date.

(311). To this pointed inquiry the Secretary, on Novem-

ber 17, 1977, replied:

Thank you for your letter cf November 11. We

appreciate your concern as a holder of B & O Con-

vertible Debentures as to whether B & O would fail

to disclose the declaration of a dividend in its com-

mon stock.

You may be assured that if B & O should have

any information to announce regarding dividend ac-

tion on B & O stock, such information will be dissem-

inated promptly to the public at large. Because we

cannot prefer you over the public at large advance

advice cannot be sent to you, but I will make sure

that you get a copy of such press release. We are not

in a position to help you with respect to your deci-

sion whether or not to convert.

There is no by-law provision relating to the tim-

ing of the declaration, record, and payment dates.

(312a). By the time of Guttmann’s inquiry and the Secre-

tary’s reply, the Restructuring Committee’s plan to

10a Appendix A.

structure the MAC transaction so as to avoid timeiy

notice to the convertible bondholders was well advanced.

Four in-house attorneys emplcyed by B&O or

C & O, one of whom was Chairman of the Restructuring

Committee, examined the 1956 indenture and the New

York Stock Exchange listing agreements. They con-

cluded that the indenture required notice of stock

dividends in B & O stock, but not of distributions of stock

of subsidiaries. They concluded that that provision in the

New York Stock Exchange listing agreement was inappli-

cable because it requires 10 days notice only with regard

to dividends declared on listed stocks, and B & O com-

mon stock had been delisted. They concluded that under

Maryland law, absent any action by the directors, the

payment date of a dividend could be the same as the

declaration date. The Restructuring Committee deter-

mined, therefore, to avoid giving notice to the converti-

ble debenture holders. Their purpose in doing so was to

prevent conversions which might require filing a regis-

tration statement for MAC stock.

The General Counsel of B & O retained the law firm

of Hunton & Williams of Richmond, Virginia, to submit

to the SEC a request for a no-action letter with respect to

B & O’s distribution of MAC shares. Prior to the time

Hunton & Williams wrote to the SEC, the B & O Board of

Directors met and adopted two resolutions. n the first

resolution the Board authorized B & O’s officers to con-

vey a list of non-rail assets to MAC as a contribution to

its capital. (409a). In the second, the Board resolved to

distribute the MAC stock as a dividend to B & O share-

holders. That resolution provides in part:

RESOLVED, that the dividend on the Common

Stock as specified in the next preceding resolution be

payable on this date to shareholders of record at the

Appendix A. lla

close of business on this date; provided, however,

that such payment shall be made by depositing such

stock of Mid Allegheny Corporation with Mercantile

Safe Deposit and Trust Company of Baltimore,

Maryland, in trust, to be delivered to such sherebom

ers of this Company on the e»rlier or the following

dates, viz.: two days tollowing the receipt of a letter

from the Securities and Exchange Commission that

it will take no action if the stock of Mid Allegheny

Corporation is distributed to this Company’s share-

holders without registration under the provisions of

the Securities Act of 1933; or two days following the

date of an effective registration statement with re-

spect to the stock of Mid Allegheny Corporation.

(417a). Thus actual delivery of the MAC stock certifi-

cates to shareholders was made contingent upon the ob-

taining of a no-action letter or the filing of a registration

statement. It seems clear from the wording of the reso-

lution that B & O intended to file a registration

statement if it could not obtain a no-action letter, for the

dividend declaration is unconditional.

Three days after B & O’s dividend action, Hunton &

Williams sent a request for a no-action letter to the SEC.

(908a). That firm’s December 16 letter to the Commission

requested a no-action letter only with respect to a distri-

bution of MAC stock to C & O and 13 individual B & O

stockholders. It made no mention of the rights of con-

vertible debenture holders. In its request Hunton &

Williams opined that the distribution of MAC shares by

B & O was not a sale within the meaning of Section 2(3)

of the Securities Act of 1933, 15 U.S.C. §77b(3). Alterna-

tively the firm suggested that if a sale were involved, the

transaction was exempt under 17 C.F.R. §230.240 (1981).

That SEC rule, issued pursuant to Section 3(b), 15 U.S.C.

12a Appendiz A.

§77c(b), exempts from registration certain securities of

an issuer to fewer than 100 persons, provided that re-

strictions on transferability are legended on the certifi-

cates. The no-action letter was not immediately forth-

coming from the SEC, and on January 18, 1978, Hunton

& Williams withdrew its reliance on 17 C.F.R. §230.240.

(914a). Another written request was filed on June 29,

1979, relying solely on the contention that the dividend

in MAC stock was not a sale. (915a). In September of

1979, long after the commencement of this lawsuit, the

SEC issued a no- action letter provided tuat MAC shares

distributed to persons other than C & O are restricted as

to transfer.” The SEC letter noted that the District Court

had by then entered an order that the defendants must

hold at least 940 shares of MAC for tender to the con-

vertible debenture holders if they prevailed. (919a).

II.

The first of these consolidated actions was com-

menced by Pittsburgh Terminal Corporation on Decem-

ber 28, 1977, and the others soon followed. On March 7,

1978 the District Court issued a preliminary injunction

restraining the defendants from proceeding with the

dividend in MAC stock.“ Defendants appealed frcm that

order, and when they agreed to hold sufficient shares of

B&O and MAC stock to satisfy the claims of the con-

vertible debenture holders, should they prevail, this

court reversed that injunction.* The Bondholders sought

class action certification, which was denied as a result of

an agreement between B & O and the Trustee under

2. 446 F.Supp. 656 (W.D. Pa. 1978).

curiam noted at 578 F.2d 1375

(aa Gir ad

Appendix A. la

the 1956 indenture that should plaintiffs prevail, all de-

benture holders similarly situated will be accorded the

treatme/ . required by any judgment in plaintiffs’ favor.“

Motions for summary judgment in favor of the defend-

ants were denied.“ Thus the consolidated cases went to

trial on amended complaints challenging the December

13, 1977 actions of the B & O Board of Directors. The

complaints alleged that those actions violated Section

10(b) of the Securities and Exchange Act, 15 U.S.C.

§78j(b), the contractual rights of the convertible deben-

ture holders under the provisions of the Indenture, their

rights as third party beneficiaries of the NYSE listing

agreements, the obligations of B & O under the rules of

the NYSE, and the fiduciary duties of directors and of

majority stockholders under Maryland law. The District

Court, over defendants’ objection, held that the converti-

ble debenture holders had standing to make these claims,

but rejected each of them. The court held that there was

an insufficient showing of scienter for a Section 10(b)

violation; that Section 6 of the Securities and Exchange

Act of 1934, 15 U.S.C. §78f, does not permit private en-

forcement of the NYSE rules; that the listing agreements

confer no rights on any party other than the NYSE; that

the indenture does not require notice of a dividend in

stock of a subsidiary; and that the December 13, 1977

14 Appendix A.

MAC transactions were entirely legal under Maryland

law.* Without ruling definitively, the court also ex-

pressed doubts about what relief would be proper assum-

ing liability had been established.

III.

A. Purchase or Sale

SEcTION 10(b) prohibits the use of manipulative or

deceptive devices or contrivances “in connection with

the purchase or sale of any security.” The District Court

held that a contract to obtain common stock in exchange

for the surrender of a convertible debenture is a contract

for purchase or sale of a security, and thus that the

debenture holders could sue. Defendants challenge that

holding. They place principal reliance upon Blue Chip

Stamps u Manor Drug Stores, 421 U.S. 723 (1975). That

case approved the earlier holding in Birnbuum u New-

port Steel Corp., 193 F.2d 461 (2d Cir.), cert. denied, 343

U.S. 956 (1952), that only purchasers and sellers of secu-

rities could bring a private damage action under Section

10(b). While Blue Chip Stamps u Manor Drug Stores

holds that mere offerees may not sue under Section 10(b),

the opinion of the Court carefully distinguishes the case

of persons holding actual contractual rights to buy and

sell securities. 421 U.S. at 749-50. There is no indication

that the Court intended to cast any doubt on the settled

rule that a contract to buy or sell securities is a purchase

or sale within the meaning of Section 10(b), and that a

party to such a contract has standing to sue for

Appendix A. 15a

damages.’ The indication is quite the contrary, for the

Court observed:

Unlike respondent, which had no contractual right

or duty to purchase Blue Chip’s securities, the

holders of puts, calls, options and other contractual

rights or duties to purchase or sell securities have

been recognized as “purchasers” or “sellers” of se-

curities for purposes of Rule 10b-5, not because of a

judicial conclusion that they were similarly situated

to “purchasers” or “sellers,” but because the defini-

tional provision of the 1934 Act themselves grant

them such status.

421 US. at 751.

Since we hold that the conversion option in a con-

vertible debenture qualifies as a contract for the pur-

chase or sale of a security, we need not reach the

plaintiffs’ alternative contention that the MAC dividend

is a purchase or sale which would satisfy Section 10(b).

See International Controls Corp. v. Vesco, 490 F.2d 1334,

1345 (2d Cir.), cert. denied, 417 U.S. 932 (1974) (a divi-

7. A Abd 15 International oe * Vesco,

593 F.2d 1 1 n.18 (2d Cir.), cert. US. 941

(1979); Davis v Davis, 526 F.2d 1286, 1289 n.4 (5th Cir.

1976); Fenstermacher v. Philadelphia National Bank, 493

F.2d 333, 336 n.4 (3d Cir. 1974): (oth Cir Sot); Green

Enterprives, 476 F.24 393, $96 1.8 9th Cir Green

8 437 F 723, *

. Genesco, [1976-77] Fed. Sec.

(CoH) 196 at 90 (S.D.N.Y. 1976). But

x, Rockwell International Corp 614 F.2d 418 (

Cn 1880) vacated upon rehearing en banc, 642 F.2d 929

(5th Cir. 1981), cert. denied, 50 U W. 3351 (U.S. Nov

3, 1981). If the vacated panel in Broad can be

1 that the holder of a debenture containing

ee ee ee

cline to follow

16a Appendix A.

dend in kind of shares of a spun off corporation qualifies

as a sale of securities).

B. Duty to Speak

The Bondholders contend that by fixing the dividend

date and the record date of the MAC dividend so as to

prevent them from exercising their conversion option in

time to participate in that dividend, the defendants vio-

lated Section 10(b) and SEC Rule 10b-5(a) and (c), 17

C.F.R. 240.10b-5(a) and (e) (1981). It is undisputed that

the defendants made a knowing decision to time the

December 13, 1977 transactions so as to prevent the

Bondholders from obtaining timely notice of them. De-

fendants contend that the decision was lawful because

they made no affirmative misrepresentation and because

they were under no affirmative obligation to speak.

In Chiarella u United States, 445 U.S. 222, 228

(1980), the Court observed that “one who fails to disclose

material information prior to the consummation of a

transaction commits fraud only when he is under a duty

to do so.” It held that a printer, who had no fiduciary

obligation to a corporation or its shareholders, and who

did not receive information as a result of the breach of

any fiduciary relationship, could not be liable for a crimi-

nal violation of Section 10(b). “He was not [the sellers’)

agent, he was not a fiduciary, he was not a person in

whom the sellers had placed their trust and confidence.”

445 U.S. at 232. The defendants contend that Chiarella

requires an affirmance, because like the printer who hap-

pened upon material market information, none of them

had a duty to speak.

To put that contention in context, we note that the

Bondholders were on December 13, 1977, holders of

options to acquire B & O equity securities, while C & O

Appendix A. 17

was a majority holder of those securities having voting

control of B & O. The convertible debentures were listed

on the NYSE, and the listing agreement applicable to

them imposed on B & O the affirmative duties (a) to give

ten days notice to the Exchange of a record date for a

dividend, and (b) to “afford the holders of its securities

listed on the Exchange a proper period within which to

record their interests and exercise their rights.” These

requirements of the listing agreement parallel those in

SEC Rule 10b-17, which provides:

(a) It shall constitute a “manipulative or decep-

tive device or contrivance” as used in section 10(b) of

the Act for any issuer of a class of securities... to

fail to give notice in accordance with paragraph (b)

of this section of the following actions relating to

such class of securities:

(1) A dividend or other distribution in cash or in

kind, except an ordinary interest payment on a debt

security, but including a dividend or distribution of

any security of the same or another issuer:

17 C.F.R. §240.10b-17 (1981). B & O is the issuer of the

convertible debentures, the MAC distribution is a divi-

dend of a security, and that dividend related to the con-

vertible debentures since it was material to a decision

about exercising the conversion option. The convertibie

debentures were not simple debt securities, for which the

information about dividends ordinarily would not be ma-

terial.

Whatever may be the fiduciary duty of majority

stockholders and corporate directors under Maryland

law to general unsecured creditors, we are here dealing

with securities having an equity option feature. Mary-

land follows the settled rule that a control stockholder

owes a fiduciary obligation not to exercise that control to

18a Appendia A.

the disadvantage of minority equity participants. Cooper-

ative Milk Service v. Hepner, 198 Md. 104, 81 A.2d 219,

224 (1951). Similarly, Maryland directors must act as

fiduciaries to all equity participants. Coffman v. Mary-

land Pub. Co., 167 Md. 275, 173 A.248, 254 (1934);

Lawson v. Baltimore Chemical and Paint Corp., 347 F.

Supp. 967, 975 (D. Md. 1972). Although no Maryland case

has been called to our attention presenting the precise

issue of fiduciary obligations to holders of securities con-

taining stock options, we would be very much surprised if

Maryland or any other state would today hold that no

such obligations were owed by an issuer of such securi-

ties and its directors. Moreover the scope of the obliga-

tion of the fiduciary depends upon the nature of the

interest of the beneficiary. If the beneficiary of a fiduci-

ary duty needs information in order intelligently to pro-

tect that interest, the withholding of it, especially when

withholding it confers advantage upon others (in this

case C & O and Chessie) is an obvious breach of duty.

The 1956 Indenture under which B & O borrowed the

sums evidenced by the convertible debentures was made

in New York and the loan transaction completed there. B

& O’s obligation, therefore, is a New York contract. The

law of that state is “that in every contract there is an

implied covenant that neither party shall do anything

which will have the effect of destroying or injuring the

right of the other party to receive the fruits of the con-

tract. Kirke La Shelle Co. u Paul Armstrong Co.,

263 N.Y. 79, 87, 188 N.E. 163, 167 (1933). See Van Gemert

u Boeing Co., 553 F.2d 812, 815 (2d Cir. 1977); Restate-

ment (Second) of Contracts §205 (1981). Defendants in

this case took steps to prevent the Bondholders from

receiving information which they needed in order to re-

ceive the fruits of their conversion option should they

Appendiz A. 19a

choose to exercise it. As a matter of New York contract

law, B & O had a duty to speak.

In the present context we do not look to the listing

agreement. Rule 10b-17, the Maryland law of fiduciary

obligations and the New York law of contracts as sources

of independent causes of action, though they well may

be. Rather we look to them as sources of a duty to speak,

breach of which under Section 10(b) and Rule 10b-5(a)

and (c) gives rise to a cause of action for fraud. Those

four independent sources of duty to speak in the circum-

stances of this case amply serve, separately or collec-

tively, to distinguish it from Chiarella v. United States,

supra. We need not consider other sources of such duty

relied on by the Bondholders.

C. Scienter

The defendants urge that even if they were under a

duty to speak, their decision not to do so in this instance

did not involve the scienter required by the Supreme

Court’s interpretation of Section 10(b). The District

Court, relying on Ernst & Ernst u Hochfelder, 425 US.

185 (1976), accepted this argument. It found that there

was a legitimate business purpose in removing the non-

rail assets from ownership and control of B & O.* That

finding is not relevant, however, for what is complained

of is not the formation of MAC or the decision to spin it

off, but the decision to do both while concealing those

steps from the Bondholders until it was too late for them

to participate by exercising conversion rights if they

chose to do so.

8. 509 F.Supp. at 1012-13.

20a Appendix A.

In this record, and indeed in the court’s findings of

fact, it is plain that the Restructuri:g Committee and B

& O’s Directors knew (1) that the information about the

dividend in MAC shares, or information about any other

dividend action after a lapse of sixteen years, was mate-

rial to the Bondholders; (2) that cutting off conversion

options would inure to the benefit of C & O, the majority

stockholder; and (3) that the decision not to announce

the dividend was intended to prevent timely exercise of

the conversion privilege. The decision to time the MAC

transaction so as to prevent notice to the Bondholders

until too late was both knowing and intentional. No more

is required by the governing cases. Aaron v. Securities

and Exchange Commission, 446 U.S. 680, 690 (1980);

Ernst & Ernst u Hochfelder, 425 U.S. 185, 197 (1976);

Cramer v. General Telephone & Electronics Corp., 582

F.2d 259, 273 (3d Cir. 1978), cert. denied, 439 U.S. 1129

(1979). Cf. McLean v. Alexander, 599 F.2d 1190, 1197 (3d

Cir. .1979).

The defendants insist that despite their intention to

prevent timely exercise of conversion rights prior to the

MAC dividend, they lacked the necessary scienter as a

matter of law for two reasons. First, they contend, they

had a valid business purpose in cutting off conversion

rights in that they desired to avoid having to file a reg-

istration statement for MAC stock. This is a business

reason, certainly, but not a valid one. Of course, the

removal of non-rail assets from the reach of the conver-

sion privilege, and the avoidance of the expense of pre-

paring and filing a registration statement, was good busi-

ness for some of the interested parties. Clearly, however,

it was bad business for the Bondholders. Any manipula-

tive act or practice can be justified by focusing only on

Appendix A. | 21a

the business purpose of the side of the transaction which

benefited from it.

Defendants’ second contention is that their reliance

on the advice of counsel employed by B & O and C & Ois

a complete defense. In this case it is not. A violation of

Section 10(b) does not require a specific intention to

break the law. It requires only knowing or intentional

actions which, objectively examined amount to a viola-

tion. See Securities and Exchange Commission u

Falstaff Brewing Corp. 629 F.2d 62, 77 (D.C. Cir.), cert.

denied sub nom. Kalmanovitz u Securities and Er-

change Commission, 449 U.S. 1012 (1980); Arthur Lipper

Corp. v. Securities and Exchange Commission, 547 F.2d

171, 181 (2d Cir. 1976), cert. denied, 434 U.S. 1009 (1978).

Advice of counsel may bear upon scienter in some cases:

where, for example, directors rely upon counsel to con-

duct a factual investigation of the truth of information to

be released; or where counsel mistakenly but in good

faith represent that some information is either immate-

rial or clear. In such instances the defendants may not

have an appreciation of the consequences of their con-

duct. But where, as here, they know the materiality of

the concealed information and intend the consequences

of concealment, advice of counsel that they will not incur

liability cannot be recognized as a defense. The court, not

counsel, must make that ultimate legal determination.

On the facts as found, therefore, the District Court

erred in ruling that the defendants lacked the scienter

required for a Section 10(b) violation.

We hold, therefore, that on the facts found by the

District Court, the December 13, 1977 transaction, de-

signed to deprive the Bondholders of timely notice in

order to exercise their conversion option if they should

22a Appendix A.

so desire was a manipulative or deceptive device or con-

trivance in violation of Section 100b).“

IV.

Our holding in Part III requires a reversal. The

Bondholders also contend that they proved a breach of

the Indenture, a claim as a third party beneficiary for

breach of the listing agreement and breaches of fiduciary

duty under Maryland law. In the District Court they

pleaded, as well, a cause of action under Section 6 of the

Securities and Exchange Act of 1934, 15 U.S.C. §78f. for

violation of the NYSE rules. They do not suggest, how-

ever, that the relief available under Section 10(b) is less

extensive than would be available under these alterna-

tive legal theories. Since it appears that no different

remedies would be available were we to decide in the

Bondholders’ favor on those alternative legal theories,

there is no reason to address them.

V

As a separate ground for affirmance, the defendants

urge that the Bondholders failed to prove damages and

have not to date exercised their conversion option Obvi-

ously the Bondholders could not be expected to exercise

a conversion option until they knew whether or not they

were entitled to participate in the distribution of MAC

stock. As to the speculative nature of the award of money

damages, the difficulty arises out of B & O’s conscious

choice to avoid making an evaluation of the B & O assets

9. The court’s finding thet Milton E. Eisenhower did

not participate in the December 13, 1977 is not

clearly erroneous; indeed it is not challenged. Thus the

judgment in his favor must be affirmed.

Appendix A. 23a

transferred to MAC as a contribution to capital. The

District Court speculated that devising an appropriate

remedy might be difficult. So it may be, but the Bond-

holders were the victims of a Section 10(b) violation, and

they are entitled to be heard about what the remedy

should be. Since the District Court did not rule on the

matter of relief, nothing is before us on that aspect of the

case which we can intelligently review. A remand is re-

quired so that the trial court can fashion an appropriate

remedy for the violation we have found

VI.

Except for the judgment in favor of Milton D. Eisen-

hower, the judgment in favor of the defendants will be

reversed, and the case remanded for a determination of

appropriate relief.

GarTH, Circuit Judge, concurring in part and concurring

in the judgment.

I agree that the judgment of the district court must

be reversed. However, in concluding that the defendants

violated Rule 10b-5, 17 C. F. R. §240.10b-5 (1981), I would

predicate their duty to disclose the Mid-Allegheny Cor-

poration (MAC) dividend solely on the provisions of Rule

10b-17, 17 C.F.R. §240.10b-17 (1981), rather than on the

complex of theories set forth in Part III-B of Judge

Gibbons’ opinion. I thus would not reach the question

whether the defendants had a duty to disclose under the

New York Stock Exchange (NYSE) listing agreement,

the Maryland law of fiduciary obligations, or the New

York law of contracts.

I.

Rule 10b-17 provides that the failure of an issuer to

give ten days’ prior notice of the declaration of a divi-

24a Appendix A.

dend relating to a publicly traded security constitutes a

“manipulative or deceptive device or contrivance” within

the prohibitions of section 10(b) of the Securities Ex-

change Act of 1934, 15 U.S.C. §78j(b) (1976). Here, it is

undisputed that while the common stock of the Ralti-

more & Ohio Railroad Company was not publicly traded

or listed on any national securities exchange (99.63 per-

cent of the common stock was owned by the Chesapeake

& Ohio Railway Company), the convertible debentures

were publicly traded and were listed on the NYSE. Thus,

1. The Rule states:

(a) Rn

tive device or contrivance” as used in section 10(b) of

traded by the use of any means or instrumen of

interstate commerce or of the mails or of

,

Appendix A. 25a

the B & O convertible debentures are a publicly traded

class of securities within the meaning of Rule 10b-17.* It

is also undisputed that the B & O failed to give ten days’

notice of its action in declaring the MAC stock dividend

to the National Association of Securities Dealers

(NASD), or te the NYSE in accordance with the proce-

dures set forth in the B & O’s listing agreement with that

contain requirements substantially comparable

. (J) of this

17 C.F.R. 6240. 10b-17 (1981) (emphasis added).

3. The NYSE listing agreement for the debentures,

ON Oe ee era & O on March 22,

incorporates by reference an earlier agree-

sent batten the B d and the NYSE, da dated

18, 1947. That earlier agreement provided:

26a Appendix A.

dividend was an action “relating to” the publicly traded

convertible debentures within the meaning of Rule 10b-

17. If Rule 10b-17 applies, a duty of disclosure arises, the

breach of which provides the predicate for a violation of

Rule 10b-5. See generally Chiarella v. United States, 445

U.S. 222, 235 (1980).*

II.

The defendants argue that the notice requirements

of Rule 10b-17 apply only to dividends declared on pub-

licly listed stock. Because the B & O’s common stock was

not publicly listed, the defendants argue, no notice was

therefore mandated.

The ration [B & O] will give the Exchange

at least ten ye notice in advance ofthe closing

transfer f a record

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action for under §10(b) of the ties Ex-

Shunge Act of 180%, 15 U 3

§240.10b-5 (1981), itself gives rise to an implied right of

88 §78}(b) (1976).

Appendix A. a

In my opinion, this argument contemplates too re-

strictive a reading of Rule 105-17. The Rule was meant to

protect the ability of investors to exercise their invest-

ment rights to the fullest. It does so by operating to

ensure that opportunities to exploit benefits associated

with security ownership will not be lost by the withhold-

ing of material information. As the SEC explained when

it proposed Rule 10b-17, in the absence of disclosure of

imminent dividend declarations, “purchasers and their

brokers may have entered into and settled securities

transactions without knowledge of the accrual of such

rights and were thus unable to take necessary steps to

protect their interests.” Securities Exchange Act Rel.

No. 9076, 36 Fed. Reg. 3430 (Feb. 17, 1971).

While it is true that the Rule makes no specific refer-

ence to convertible debentures as such, it without ques-

tion includes such instruments within its classification of

“securities publicly traded” and proscribes the failure to

give notice of dividends “relating to such class of securi-

ties.” See note 2 supra. I agree with the SEC that

[flor purposes of determining what information is

material to security holders, there is a significant

difference between the holders of simple debt securi-

ties and the holders of debt securities convertible

into stock. The latter own contracts to purchase the

stock on specified terms and at a specified price and,

as a result, have as great an interest in material facts

concerning that stock as do the stockholders.

SEC Amicus Brief at 19 n.17.

It is obvious that a stock dividend declared on com-

mon stock comes within the terms of Rule 10b-17. It

would be anomalous if a stock dividend which becomes

payable simply by the exercise of converting a debenture

28a Appendix A.

were not considered as relating to such class of (con-

vertible debenture] securities.” It seems to me that in the

context of Rule 10b-17, a dividend “relates to” a security

if the declaration of that dividend makes the security

significantly more or less valuable, whether by directly

increasing or decreasing the value of the security or by

enabling the holder of the security to take steps which

would either augment the security’s worth or prevent the

diminution of its value.

Here, the convertible debentureholders claim that

the value of the non-rail assets of the B & O which are

represented by the MAC dividend roughly approximates

$250 million. Prior to the declaration of the MAC divi-

dend, the debentures included the right to convert to

B&O common stock which represented both rail and

non-rail assets; after the dividend declaration, the deben-

tures were convertible into B & O common stock which

no longer represented the non-rail assets and only repre-

sented the rail assets. Tested by the definition set out

above, it is evident to me that the declaration of such a

dividend in which the convertible debentureholders

could shar: in both categories of assets by exercising

their conversion option, is an action which clearly “re-

lates to” this class of securities.

Accordingly, I agree with Judge Gibbons, who has

reached a similar conclusion in his opinion where he has

indicated that the MAC dividend “related to the con-

vertible debentures since it was material to a decision

about exercising the [debentures’] conversion option.”

Op. of Gibbons, J., typescript at 14-15. Under the analysis

I have suggested, the defendants had a duty under Rule

10b-17 to give advance notice to the NASD or the NYSE

(and through them to the convertible debentureholders)

of the declaration of the MAC dividend. The conceded

Appendix A. 29a

failure of the defendants to give such notice rendered

them liable in damages under Rule 10b-5. That being the

case, there is no need to consider whether any other

theory is viable which would impose a duty upon the

defendants to give notice to the holders of the converti-

ble debentures.

Accordingly, I join Judge Gibbons’ opinion except for

Part III-B, and concur in the reversal of the judgment

below.

Apams, Circuit Judge, dissenting.

The Supreme Court recently has made clear that

liability for nondisclosure of material information under

the federal securities laws cannot be imposed absent a

duty to speak. Chiarella v. United States, 445 U.S. 222,

235 (1980). Aware of this precept, Judge Gibbons has

pointed to no fewer than four possible sources from

which to derive a duty, on the part of The Baltimore and

Ohio Railroad, to notify its convertible debenture holders

prior to the declaration of the MAC dividend. Judge

Garth, concurring, has limited the duty analysis solely to

the provisions of Rule 10b-17; the holding of the Court,

therefore, rests on that narrow ground. Unlike my two

colleagues, I conclude that B&O was under no legal obli-

gation—pursuant to Rule 10b-17 or otherwise—to pro-

vide plaintiffs with advance notice of the MAC dividend.

I therefore respectfully dissent.

I

Convertible debentures frequently are characterized

as “hybrids,” embodying the attributes of both debt and

equity securities. See, e.g., Broad u Rockwell Interna-

tional Corp., 642 F.2d 929, 940 (5th Cir.) (en banc), cert.

denied, 102 S. Ct. 506 (1981); American Bar Foundation,

30a Appendix A.

Commentaries on Indentures 523 (1971); Note, Hoff and

Harff: Does the Convertible Debenture Holder Have

Standing to Maintain a Shareholder Derivative Action?,

26 Syracuse L. Rev. 730, 751 (1975). As such, they have

proven to be an attractive and effective means of corpo-

rate financing. Like most debt securities, convertible de-

bentures provide a fixed rate of return and assure the

investor priority, over common shareholders, in claims

on the issuer’s assets. Should the market price of the

common stock rise, however, the debentureholder may

exercise an option to convert the debt security in‘v

shares of common stock. “Thus there is the opportunity

to benefit from a re in stock prices from the compara-

tive safety of a debt... position.” Katzin, Financial and

Legal Problems in the Use of Convertible Securities, 24

Bus. Law. 359, 361 (1969).

From the corporation’s standpoint, the issuance of

convertible debentures can be similarly advantageous.

Primarily, the convertible securities provide a way to

stock prices.’” Fleischer & Cary, The Taxation of Con-

vertible Bonds and Stock, 74 Harv. L. Rev. 473, 474

(1961) (quoting Pilcher, Raising Capital with Converti-

ble Securities 61, 138 (1955) ). In addition,

the new funds will be contributing to income by the

time the debentures are converted. In the interim,

while the company is putting the new money effec-

tively to work, the charge takes the form of interest

—deductible for tax purposes—rather than a reduc-

tion in income per share. Thus the dilution of earn-

ings which traditionally accompanies an equity issue

is deferred until the firm is making more money.

Appendiz A. 3la

Id. (footnote omitted). Finally, because the conversion

feature is so attractive to investors, the issuer can often

offer the debentures at an interest rate lower than that

required on other debt securities. Katzin, supra, at 362.

But see Klein, The Convertible Bond: A Peculiar Pack-

age, 123 U. Pa. L. Rev. 547, 558-59 (1975) (referring to

this rationale as flimflam“).

Whatever financial advantages attach to the issuance

or purchase of convertible debentures, the legal status of

these hybrid securities remains inherently complex. As

debt securities, the debentures impose a specific set of

obligations on the corporation—namely, the regular

payment of interest and the repayment of principal upon

maturity. As equity securities, in contrast, the deben-

tures may require a broader range of duties from the

issuer. The difficulty lies not in the characterization of

the debenture as either debt or equity — for it is both —

but in determining, in each case, the extent to which the

The traditional view is that the convertible deben-

ture holder is a mere creditor until conversion, whose

relationship with the issuing corporation is governed by

32a Appendix A.

contract and statute. In an early Massachusetts decision,

for example, the court rejected a convertible note

holdsi‘s claim that he had an equitable intrest in newly-

is¢ued shares of stock. Pratt u American Bell Telephone

Co., 141 Mass. 225, 5 N.E. 307 (1886). The plaintiff was

“in po sense a stockholder,” declared the court; his

“rights and interest as a stockholder of the corporation

were postponed to the time when he made his option and

demanded his stock. Pending this time, the contract gave

him the right to payment of the coupons attached to the

notes, and nothing more.” 5 N.E. at 311.

Several years later, Juztice Holmes expanded upon

this principle, holding for the Supreme Court of Massa-

chusetts that the debenture holder had no right, apart

from contract, to object to corporate actions that dilute

or destroy the value of the conversion option:

the option] imposes no restriction upon the obligor

in regard to the issue of new stock, although the

issue may be upon such terms as to diminish the

value of the right. It leaves the management of the

company in accordance with its other interests

unhampered. It is simply an option to take stock as it

may turn out to be when the time for choice arrives.

The bondholder does not become a stockholder, by

his contract, in equity any more than at law...

... [TJhe contract does not prevent the corporation

from consolidating with another in such a way as to

make performance impossible, any more than it pre-

vents the issue of new stock in such a way as to make

performance valueless.

Parkinson u West End St. Ry. Co., 173 Mass. 446, 53 N. K.

891, 892 (1899). See also Gay v. Burgess Mills, 30 R.I. 231,

74 A. 714 (1909). And in Lisman u Milwaukee, L.8. & N.

Ry. Co., 161 F. 472 (E.D. Wis. 1908), aff'd 170 F. 1020 (7th

Appendix A. 33a

Cir. 1909), the court held that convertible debenture

holders could not complain when the railroad company in

which they had invested merged with another railroad.

The fact that the parties “were bound to” have antici-

pated such a consolidation when they entered into the

option contract was dispositive.

The rights and remedies of convertible debenture

holders have expanded since the turn of the century.

Most notably, the Securities Exchange Act of 1934 ac-

cords convertible debenture holders the federal statutory

rights of “equity security holders,”* able, for example, to

employ section 10(b) of the Act to protect against fraud

or manipulative devices. 15 U.S.C. §78j. Congress’s ex-

plicit recognition of convertibles as equity, as well as

debt, securities has had significant consequences. In

Kusner v. First Pennsylvania Corp., 531 F.2d 1234 (3d

Cir. 1976), for instance, this Court held that a convertible

debenture holder, who alleged that he had purchased the

securities in reliance on a false and misleading prospec-

tus, had standing to sue under section 10(b). Kusner

depicts the precise sort of situation in which a section

10(b) remedy is appropriate for debenture holders in

their role as equity investors. As the Court explained, in

such a case, the debenture holder’s need for accurate

information about the corporation was as pressing as any

34a Appendix A.

If during the conversion period the value of the com-

mon stock (a function of its market price and divi-

dend position) greatly exceeds the value of the fixed

payment and interest obligation, a holder probably

will exercise the conversion privilege. The possibil-

ity that the value of common stock will increase to a

point where it exceeds the value of the bond is the

sales feature with which the issuer obtained a lower-

than-market interest rate on the bond. Thus...a

misrepresentation in the prospectus that would be

material to a stock purchaser would be material to a

convertible bond purchaser. The convertible bond

purchaser may well have been defrauded of the in-

terest differential.

531 F.2d at 1238 (footnote omitted).

The mere availability of a securities act remedy for

fraud, however, does not answer the question whether

the common law rule of Parkinson remains the applica-

ble standard by which to judge whether or not a corpora-

tion has, indeed, acted fraudulently. That question was

addressed and analyzed perceptively in a recent en banc

Fifth Circuit decision, Broad v. Rockwell International

Corp., 642 F.2d 929 (Sth Cir.), cert. denied, 102 S. Ct. 506

(1981). There, the plaintiff debenture holders complained

that when the company in which they had invested was

acquired by another entity in a cash merger, they lost

their right to convert into common stock. The Court

concluded that the plaintiffs had received. all to

which they were contractually entitled under the Inden-

ture” and that, as a result, no violation of section 10(b)

could have occurred:

There is no doubt but that there was concerted, in-

tentional conduct by the defendants to bring about

the] result [about which plaintiffs complain]. But as

a matter of law, there was no violation of section

Appendix A. 35a

10(b) or Rule 10b-5 because there was no fraud. Sec-

tion 10(b) is aptly described as a catch-all provision,

but what it catches must be fraud. Chiarella u

United States, 445 U.S. 222, 234-35, . . . (1980) (crimi-

nal prosecution under section 10(b) and Rule 10b-5).

It is elementary that section 10(b) and Rule 10b-5

U.S. 462, ... (1977); Ernst & Ernst u Hochfelder,

425 U.S. 185, . . . (1976). The defendants’ conduct in-

did not in fact have.

642 F.2d at 963.

incl the rights of the issuer, the

sion ts of the investor, and any number of adminis-

trative or The indenture is usually

36a Appendix A.

Inasmuch as ownership of a convertible deben-

ture does not give the holder the rights of a share-

holder, the holder of a convertible debenture would

have almost no protection against acts by the Com-

pany which would adversely affect the value of the

common stock issuable on conversion, such as

split-up of shares, stock dividends, distribution of

assets, issuance or sale of other convertible securi-

ties, issuance of options, issuance or sale of common

stock at prices below the current conversion or mar-

ket price, merger, sale of assets or dissolution and

liquidation of the Company. Events of this type are

customarily described as “diluting” the value of the

conversion privilege, and if protection is desired

against such dilution, appropriate provisions must

be included in the indenture.

Commentaries, supra” at 527 (emphasis added) footnote

omitted). See also Broad u Rockwell International

Corp., supra at 943; Kessler v. General Cable Corp., 92

Cal. App. 3d 531, 155 Cal. Rep. 94, 99-100 (1979); 6A W.

Fletcher Cyclopedia of the Law of Private Corporations

§§2694-2694.1 (perm. ed. 1981). Such so-called anti-

dilution clauses” are thus among the most important of

the various contract provisions that can be negotiated

between the issuing corporation and the debenture

holders or their representatives.“ Commonly, they re-

quire the corporation to give the debenture holder ad-

Se ee 1-2 ( 06

a K

Se eee eno -

Appendix A. 37a

vance notice of specific acts that may erode or destroy

the conversion option, so that the investor can convert, if

he so chooses, prior to the act in question. Alternatively,

the anti-dilution clause can provide for the adjustment of

the conversion price to reflect the change in value. See

Irvine, Some Comments Regarding “Anti-Dilution” Pro-

visions Applicable to Convertible Securities, 13 Bus.

Law. 729 (1958). Less frequently, the anti-dilution provi-

sion is drafted to prohibit the corporation from taking

certain actions that may cause diminution in the value of

the conversion option. See Commentaries, supra, at 527-

28.

The conduct at issue in the present case — namely,

the transfer of B&O’s non-rail assets to MAC and the

distribution of the MAC stock to B&O’s common share-

holders — is clearly of the sort that could have been

addressed by the inclusion of an appropriate anti-dilution

provision within the indenture. Such a provision could

have taken any number of forms. In its Commentaries on

the Model Debenture Indenture provisions, for instance,

the American Bar Foundation noted that “[wjhen

dividends are declared and paid other than in

from such litigation have acted as

eh yt ye A Ae

been reduced to a minimum.“); 1 serene Ss Sr

2 Anti -· Dilution n Convertible

ri U. Chi,. L. Rev. 1, 29 (1965) (“The anti-

dilution in integral and necessary of

Sees ees

a a exercise in corporate It

e le

Tan of potential corporate sdect'the rights of the

ftion whlch might adver 1 te and

precise an instrument should be prepared with the

greatest care and diligence.“).

38a Appendix A.

shares of common stock or as normal cash dividends,”

the debenture holder’s conversion rights can be pro

tected against dilution “by providing for a reduction of

the conversion price to reflect the diminution of the cor-

porate assets resulting from such dividends.” Commen-

taries, supra, at 529. Moreover, the Bar Foundation con-

tinued, “[i}t is sometimes provided that, upon exercise of

his conversion rights, the debentureholder shall receive,

in addition to the shares to which he is entitled, the

amount of assets (or a sum equal to the value thereof)

which would have been distributed to him if he had exer-

cised his right to convert immediately prior to the record

date for such distribution.” Id.“ And at least one

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Appendix A. 39a

commentator has suggested that it is advisable to insert

in the indenture a provision giving holders of convertible

securities adequate notice in the event that “the Com-

pany shall propose...to pay any dividend payable in

stock of any class to the holders of its Common Stock or

to make any other distribution to the holders of its Com-

mon Stock (other than a cash dividend payable out of

earnings or earned surplus legally available for the

payment of dividends ...).” Kaplan, supra note 4, at 13

n.24 (emphasis added). Such a notice provision would

clearly encompass the kind of arrangement against

which Pittsburgh Terminal has complained in the case at

bar.

Significantly, although the commentators have been

careful to consider the situation in which a corporation

distributes its assets in forms other than ordinary cash

or stock dividends, the indenture at issue here contains

no such provision. While the indenture does address a

variety of potentially diluting acts — including a change

in the par value of the outstanding common stock; a

change of outstanding common stock from par to no par;

and a possible consolidation, merger, or sale of the com-

pany — we have been directed to no provision in the

indenture here that addresses the situation in which the

company spins off a portion of its assets to a subsidiary

Commentaries, supra, at 547 (emphasis added) (footnote

omitted). An alternate provision, addressing the situa-

tion in which the corporation distributes to its sharehold-

ers “evidences of its indebtedness or assets” excluding

dividends paid out of earned surplus, declares that “in

Lr

for the distribution of the corporation’s as-

— charehobders. Id. at 553.

40a Appendix A.

and distributes those assets, in the form of a stock divi-

dend, to its common shareholders. Plaintiffs are able to

point to only one section in the indenture that is even

arguably apposite. That provision, entitled “Notice to be

Given of Record Date for Stock Dividend, etc.,” provides

that:

The Company covenants and agrees that it will not

declare and/or pay any dividend on its common stock

payable in stock or create any rights to subscribe for

stock or securities convertible into stock unless in

any such case notice of the taking of a record date for

the determination of the stockholders entitled to

receive such dividend, distribution or right is given

at least ten days prior thereto by at least one publica-

tion in an Authorized Newspaper.

Indenture Article 5, Section 12 (appendix at 357a) (em-

phasis added).

Plaintiffs assert that the term “stock dividend” in the

table of contents, as well as the words “payable in stock,”

which are found in the body of the provision, suggest that

the clause is “in no way limited to the common stock of the

B & O,” but, rather, applies to distributions of MAC stock

as well. Brief of Appellant at 34. Plaintiffs also contend

that, even assuming the phrase “payable in stock” refers

only to B & O common stock, the provision violates the

New York® requirement of fair dealing. I find neither of

these two arguments convincing.

It is a well-established principle of New York corpo-

rate law that a “stock dividend” is “any dividend payable

6. As Judge Gibbons notes, the B & O indenture was

entered into in New York and must be construed under

the laws of that state. Typescript op. at 15.

Appendix A. 4la

in stock of the corporation declaring or authorizing such

dividend.” In re Fosdick’s Trust, 4 Misc. 2d 1003, 147

N. V. S. 2d 509, 514 (1955) (emphasis added), aff'd 3 App.

Div. 2d 1000, 165 N.Y.S. 2d 429 (1957), aff'd 4 N.Y.S. 2d

646, 176 N. V. S. 2d 966, 152 N.E.2d 228 (1958); 11 W.

Fletcher Cyclopedia of the Law of Private Corporations

§5359 (perm. ed. 1971). The declaration of such a divi-

dend generally is conceived of as a capitalization of sur-

plus, which neither depletes the assets of the corporation

nor increases the holdings of the stockholder. See

Gibbons v. Mahon, 136 U.S. 549, 559-60 (1890); Equitable

Trust Co. v. Prentice, 250 N.Y. 1, 164 N.E. 723, 725 (1928)

(Cardozo, C.J.) (“When a dividend is paid in cash, the

ownership of the corporate assets is changed; the com-

pany owns less, and the shareholder owns more, or some-

thing essentially different, though its value be no

greater. Upon the distribution of a stock dividend, owner-

ship of the assets is precisely as it was. ‘A stock dividend

does not distribute property, but simply dilutes the

shares as they existed before.“). Thus stock dividends

traditionally have been distinguished “from [dividends]

payable in the stock of a subsidiary” or another indepen-

dent corporation. Id.; see also Kellogg v. Kellogg, 166

Misc. 791, 4 N.Y.S.2d 219, 221, aff'd, 254 App. Div. 812, 5

N.Y.8.2d 506 (1938). The latter sort of dividend — stock

in subsidiaries or other corporations — is considered the

equivalent of a cash dividend — “diminish{ing] the prop-

erty of the corporation by exactly the amount paid out

and correspondingly increasing] the property of the in-

dividual stockholders... .” 11 N. Fletcher Cyclopedia of

the Law of Private Corporations §5355 (perm. ed. 1971)

(footnote omitted).

Applying these precepts to the case at hand, it is

clear that the distribution of the MAC stock was not a

42a Appendiz A.

“stock dividend,” as that term traditionally has been

defined. B&O was not capitalizing surplus; it was di-

vesting itself of a considerable portion of its assets. In

practical terms, the effect of the MAC dividend was no

different than if B & O had sold its non-rail assets for

cash and then distributed an extraordinary cash dividend

to its shareholders.’ See Venner v. Southern Pac. Co., 279

F. 832, 840 (2d Cir.), cert. denied, 258 U.S. 628 (1922).

Had the B & O indenture contained a more broadly in-

clusive notice clause, B & O might have been required to

inform the debenture holders prior to the declaration of

the MAC dividend. The sample provision quoted above,

for example, requires notice both for dividends “payable

in stock of any class” and for “any other distribution,”

excluding normal cash dividends. Kaplan, supra note 4,

at 13 n.24. But the fact remains that the B & O indenture

contains no such clause. Accordingly, the plaintiffs can-

not rely upon the terms of the indenture as a source of

B & O’s purported duty to speak.

Apparently mindful of the limited protection af-

forded to them by the indenture, the plaintiffs maintain

that, notwithstanding any lack of an adequate notice

provision within the indenture, New York’s law of fair

dealing required that in any event notice be given prior

to the declaration of the MAC dividend. Judge Gibbons

credits this argument, concluding that, in failing to give

notice, B & O violated the principle “that in every con-

7. Because it is the equivalent of an extraordinary

cash di the distribution of the MAC stock

is not

——— provisions of Article 5. Section 2 of the

fg which apply RN

Appendix A. 43a

tract there is an implied covenant that neither party

shall do anything which will have the effect of destroying

or injuring the right of the other party to receive the

fruits of the contract...” Typescript op. at 15-16 (quot-

ing Kirke La Shelle Co. v. Paul Armstrong Co., 263 N.Y.

79, 87, 188 N.E. 163, 167 (1933) ).

Such an analysis is clearly inappropriate. By its

terms, the principle of fair dealing expressed in Kirke

and quoted by Judge Gibbons applies only when one

party infringes the other’s rights “to receive the fruits of

the contract.” Here, under the well-settled Parkinson

doctrine, Pittsburgh Terminal had no right, under the

contract, to receive advance notice of the MAC dividend

because no anti-dilution provision to that effect had been

included in the indenture. Thus, the risk of dilution was

“inherent in the investment made by the holders of De-

bentures . IB & O] did nothing that could be described

as destroying or injuring the right of the other party to

receive the fruits of the contract,’ because . the bene-

fits that the holders of Debentures received were all the

rights to which they were contractually entitled.” Broad

v. Rockwell International Corp., supra at 958.

Van Gemert v. Boeing Co., 520 F.2d 1373 (2d Cir.),

cert. denied, 423 U.S. 947 (1975), appeal after remand,

553 F.2d 812 (2d Cir. 1977), a Second Circuit case relied

upon by Judge Gibbons, does not support a contrary

result. In Van Gemert, debenture holders complained

that Boeing had provided inadequate notice of its inten-

tion to redeem the debentures, thereby depriving the

investors of the opportunity to convert prior to redemp-

tion. The Second Circuit agreed. Observing that the

newspaper notice that was provided “may have con-

formed to the requirements of the Indenture,” the court

nonetheless concluded that such notice “was simply in-

44a Appendix A.

sufficient” under New York’s fair dealing law “to give

fair and reasonable notice to the debenture holders.” 520

F.2d at 1383. In its decision after remand, the court clari-

fied its earlier decision:

We did find significant . the fact that the deben-

tures did not explicitly set forth the type of notice

which appellants could expect if Boeing decided to

call the bonds. Without such a declaration, we held

as a matter of law that appellants were entitled to

expect that Boeing would employ a method of notifi-

cation reasonably calculated to inform the debenture

holders of the call.

553 F.2d at 815.

Van Gemert thus stands for the narrow proposition

that, if the debenture holders are contractually entitled

to notice, such notice must be “fair and reasonable.” But

Van Gemert in no way addresses the question posed to us

today: namely, whether the B & O debenture holders

were entitled to any notice at all. That question, as has

already been suggested, can be answered only by refer-

ence to the language of the indenture itself.

II.

The conclusion that B & O was under no contractual

obligation to provide advance notice of the MAC divi-

dend to its convertible debenture holders does not, of

course, end the inquiry. For while it is clear that, as a

general rule, the debenture holders’ rights are limited to

those specified in the indenture, the Court today has

determined that SEC Rule 10b-17 furnishes an indepen-

dent statutory source from which to derive a duty, on the

part of B & O, to provide notice of the MAC dividend. I

turn, therefore, to an examination of this issue.

Appendix A. 45a

Rule 10b-17 provides that

(a) It shall constitute a “manipulative or decep-

tive device or contrivance” as used in section 10(b) of

the Act for any issuer of a class of securities... to

fail to give notice in accordance with paragraph (b)

of this section of the following actions relating to

such class of securities:

(1) A dividend or other distribution in cash or in

kind, except an ordinary interest payment on a debt

security, but including a dividend or distribution of

any security of the same or another issuer:

17 C.F.R. §240.10b-17(1981) (emphasis added). Judge

Gibbons has concluded that Rule 10b-17 applies to the

situation at hand because B & O is the issuer of the

convertible debentures, the MAC distribution is a 4ivi-

dend of a security, and that dividend related to the con-

vertible debentures since it was material to a decision

about exercising the conversion option.” Typescript op.

at 14-15. Judge Garth, concurring exclusively on this

ground, stresses that, in his view, “a dividend ‘relates to’

a security if the declaration of that dividend makes the

security significantly more or less valuable...” Type-

script op. at 4-5. Because the B & O debentures were of

considerably less value after the declaration of the MAC

dividend, Judge Garth has concluded that the declaration

of the dividend “is an action which clearly relates to’”

that class of securities.

I do not disagree that the MAC dividend may have

been “material” to the debenture holders’ decision

whether or not to convert their securities into shares of

common stock. Nor do I take issue with Judge Garth’s

determination that the debentures were less valuable

after the declaration of the dividend. Nonetheless, in my

view, these considerations are not sufficient to establish

46a Appendiz A.

that the dividend declaration “related to” the class of

debenture securities as that term is used in Rule 10b-17.

Put simply, Rule 10b-17 never was meant to deal with a

situation similar to that before us today.

Nothing in the Commission’s “Notice of Proposed

Rule Making” or in the language of the rule itself sug-

gests that Rule 10b-17 was intended to override the com-

mon law and accord debenture holders significant addi-

record date’).” 36 Fed. Reg. 3430 (1971). In other words,

the Rule was designed to ensure that purchasers of se-

curities receive all the fruits of the transaction to which

they legally are entitled — namely, distributions made

8. The Rule presumably provides a for

as well. See Lutget u Vanderbilt Bank, F.2d

1035 (5th Cir. r

that has the intended scope of Rule

10b-17 I A Ae A

Rule 10b-17 the court described of claim for

which Rule 10b-17 was intended to relief”;

Appendix A. 47a

When an issuer establishes a record date it is, in

general, obligated to furnish the cash, securities, or

other property or property rights that are the sub-

ject of the distribution only to those persons owning

the underlying security as reflected in the issuer’s

records. However, not all transactions occurring

prior to that cut-off date can be settled and appropri-

ate changes effected on the issuer’s records to pro-

the asset to be distributed, it has therefore been the

48a Appendix A.

same time alert the seller to his obligation to turn

over the distributed property to the purchaser.

Id. at 3430-31 (emphasis added). The failure of publicly

held corporations to provide such notice

has had a misleading and deceptive effect on both the

broker-dealer community and the investing public.

As a direct result of such failure, purchasers and

their brokers may have enteryd into and settled se-

curities transactions without knowledge of the ac-

crual of such rights and were thus unable to take

necessary steps to protect their interests. Further,

sellers who have received the benefits of such rights

as recordholders on the specified record dete after

having disposed of their securities, have also dis-

posed of the cash or stock dividends or other rights

received as such recordholders without knowledge of

possible claims of purchasers of the underlying se-

curity to those rights.

Id. at 3430.

The differences between the scenario depicted by the

SEC and the present case could not be more obvious. In

the situation described by the SEC, the purchaser —

independent of Rule 10b-17 — has accrued the right to

receive certain benefits. In such a case, the Rule acts

simply to assure that these rights will not be impeded

because of the inadequacies inherent in corporate book-

keeping. Here, in contrast, the debenture holders have a

right to convert their debentures into shares of common

stock. That right has not been defeated. Under well-

established common low principles, however, they have

no right — unless otherwise specified in the debenture —

to notice of corporate actions that may affect the value of

the conversion option.

‘ TRH eee e

e Gael ti i 1

F 1 1

ant 21117477 i cH 1177 fe 1 i

1 Ee 3 111 35 ES Bra’ fi

111744477 e 33155 a

1 teal du: al 1

111i 4218555

Appendix A.

I therefore respectfully dissent.

A True Copy:

Teste:

Clerk of the United States Court of Appeals

for the Third Circuit

1

145 :

5la

APPENDIX B

In THE

UNITED STATES DISTRICT COURT

FoR THE WESTERN DISTRICT OF PENNSYLVANIA

PITTSBURGH TERMINAL CORP. Cony Gatien

V. 0.

BALTIMORE & OHIO RAILROAD Co. 77-1455

MONROE GUTTMAN, ET AL. 299

v. 0.

BALTIMORE & OHIO RAILROAD Co. 79-94

March 10, 1981.

OPINION

Knox, District Judge

A. Introduction and History of Case.

In the Pittsburgh Terminal case at Civil Action No.

77-1455 filed December 28, 1977, the plaintiff of whom

Monroe Guttmann, lead plaintiff in Civil Action No.

79-94 was president, filed a complaint against the Balti-

more and Ohio Railroad Company alleging that it was a

Pennsylvania corporation and that the defendant Balti-

more and Ohio Railroad Company (B & O) was a Mary-

land corporation with its principal offices in Baltimore.

The other defendant, Chesapeake and Ohio Railway

Company (C & O) was a Virginia corporation with its

principal place of business in Cleveland, Ohio and so was

the defendant Chessie System Inc., (Chessie) a Virginia

corporation with its principal offices and place of busi-

ness in Cleveland. The complaint alleged that plaintiff

52a Appendix B.

was the owner of certain B & O convertible 44%% deben-

tures Series A due January 1, 2010 in an amount in

excess of $50,000.

It was further alleged that as a result of certain

purchases by C & O during the period from 1960 to date,

99.63% of the B & O common stock was now owned or

controlled by C & O and that no dividends had beer. paid

on B & O common stock since 1961.

It was further alleged that on December 14, 1977,

without any notice to plaintiff or other persors similarly

situated, the B & O suddenly announced that it had de-

clared a dividend on its common stock on a share per

share basis on the stock of Mid-Allegheny Corporation, a

wholly-owned subsidiary, payable to shareholders of re-

cord on December 13, 1977. The action had been taken on

December 13, 1977, without prior notice to anyone in-

cluding particularly the convertible debentureholders of

whom plaintiff was one. He claimed that his was a viola-

tion of SEC Rule 10(b) and Section 10(b) of the Securities

and Exchange Act and that there had been a conspiracy

to defraud, deceive and mislead plaintiff with regard to

its right to convert its debentures. By having B & O

declare and pay a dividend the value of which was

undisclosed on December 13, 1977, plaintiff was thereby

deprived of the opportunity to make an intelligent deci-

sion whether to convert its debentures into common

stock and thus received the dividend. It was claimed that

this was also in violation of Article 5, Section 12 of the

Trust Indenture of which more hereafter and asked that

the defendants be enjoined from having the dividend of

Mid-Allegheny Corporation (hereinafter MAC) paid to

B & O shareholders without first affording plaintiff ade-

quate information and opportunity to determine whether

to convert its debentures into common stock and receive

Appendix B. 53a

the dividend. The complaint asked that a preliminary

injunction be issued thereafter to become permanent, to

restrain defendants from paying any dividends in the

future without first affording adequate information and

opportunity to decide whether to convert.

A hearing was held on the application for prelimi-

nary injunction and on March 7, 1978, the court issued a

preliminary injunction restraining defendants from pro-

ceeding with the dividend. On March 14, 1978, the de-

fendants appealed to the Court of Appeals for this

Circuit. On August 9, 1978, the granted preliminary in-

junction was reversed by the Third Circuit.

Since the defendants agreed to hold sufficient shares

of B & O and MAC stock in their possession to satisfy

plaintiffs’ claim in the event that it was ultimately deter-

mined that plaintiff was entitled to reasonable notice of

the dividend and plaintiffs elected to convert, the appeals

court held that no injunction was necessary. The grant-

ing of a preliminary injunction was reversed with

directions to the district court to take “such other steps,

if any, as may be required to implement the assurances of

defendart’s counsel that sufficient shares of B & O and

MAC will be available to satisfy any final judgment in

plaintiffs’ favor, all in accordance with the opinion of this

court”. A copy of the certified order was issued in lien of

formal mandate on August 9, 1978 and after various

arguments, the court, on March 27, 1979, entered an

order allowing the defendants to hold sufficient shares

pending the ultimate decision of the plaintiff's case and

whether it elected to convert.

On February 15, 1979, an amended complaint was

filed by Pittsburgh Terminal adding various other

allegations to the complaint and in the prayer for relief

there was included a prayer for damages (paragraph 4 of

54a Appendiz B.

the amended complaint) which the circuit had noticed

was lacking in the complaint as before it.

The case then proceeded through many tortuous

discovery procedures. Plaintiff's motion for partial sum-

mary judgment and motion of defendants for summary

judgment were briefed and argued and denied by orders

of June 24, and June 25, 1980, respectively except the

motion was granted to the extent of dismissing the ac-

tion as to Stephen Muller, Nicholas T. Camicia, and a

short time later Cyrus S. Eaton named as directors or

former directors of the B & O and the other defendants.

These directors were released because they were not

directors at the time the action was taken or as in the

case of Mr. Eaton it was not denied that he had no knowl-

edge and no participation in the declaration of the divi-

dend in question.

In the Guttmann case filed January 22, 1979, a suit

was brought by Monroe Guttmann in his own right,

Loretta Guttmann, Janet Rees and Evelyn Bittner. The

complaint alleged that Monroe, Loretta and Janet Rees

were residents of Pennsylvania and the holders of

$723,000 in face value of the 4%%. convertible deben-

tures due January 1, 2010, all of which were acquired

prior to December 13, 1977, the date of the dividend and

that plaintiff Evelyn Bittner was a resident of Pennsylva-

nia holding debentures in the face amount of $10,000

acquired prior to December 13, 1977. The defendants

were the same being the B & O, its directors, the C&O

and the Chessie System, Inc. The two cases have pro-

ceeded together and were tried together.

It should be noted that there is waiting in the wings

a third case, namely Lucille Lowry and Lowry Zweig

Corp. v. Baltimore and Ohio Railroad Company, Civil

Action No. 79-1504, filed October 22, 1979, over ten

Appendix B. 55a

months after the dividend in question had been declared.

The court has allowed the Lowry case to proceed as a

class action but has refused to consolidate it with the

Guttmann and Pittsburgh Terminal cases for the reason

that on June 16, 1980, the latter were ready for trial and

there were distinct factual issues in the Lowry cases

which should be heard separately. The court has refused

to allow a class action in the Pittsburgh Terminal or

Guttmann cases for the reason it appears that the facts

were not typical of facts related to other debenturehold-

ers and it appeared that the representation would be

inadequate. The motion for class certification was further

denied because the motion was made after the cases had

been pending for approximately two years in complete

violation of Rule 34(c) of this district court requiring

that motions to certify class actions be presented to the

court within 90 days of filing a complaint in a class

action.

In the Guttmann case as in the Pittsburgh Terminal

case, motions for summary judgment were filed by the

parties and both were denied. Thy case went to trial

non-jury for 4 days, July 21-24, 1980. Thereafter, briefs

and arguments were held together with a reargument on

one matter which the court felt was inadequately pre-

sented and the case is now ready for decision.

B. FINDINGS OF FACT.

(1) The Baltimore and Ohio Railroad Company is

incorporated under the law of Maryland with the princi-

pal office in Baltimore, Maryland.

(2) On December 13, 1977, 99.63% of the common

stock of the B & O was owned by the C & O.

56a Appendiz B.

(3) The C & O is a wholly-owned subsidiary of

Chessie.

(4) The Mid-Allegheny Corporation (“MAC”) on

December 13, 1977, was a wholly-owned subsidiary of the

B&O.

(5) Chessie Resources is a wholly-owned subsidiary

of Chessie formed for the purpose of developing non-coal

mineral real estate and timber lands of Chessie and its

subsidiaries.

(6) Plaintiffs were on December 13, 1977 and are

holders of certain B & O Convertible 4%% debentures,

Series A, maturing January 1. 2010.

(7) The plaintiffs are as follows:

A. Pittsburgh Terminal Corporation is a Pennsylva-

nia Corporation and holds $94,000 in face value of the

B & O Convertible 4%% debentures Series A, due Janu-

ary 1, 2010 at issue in this case. The $94,000 in deben-

tures were acquired prior to December 13, 1977.

B. Monroe Guttmann held on December 13, 7,

debentures in the face amount of $446,000 acquired prior

to December 13, 1977. Debentures in the face amount of

$9,000 acquired prior to December 13, 1977 were subse-

quently converted into B & O common stock.

C. Loretta Guttmann held on December 13, 1977,

debentures in the face amount of $226,000 acquired prior

to December 13, 1977. Debentures in the face amount of

$2,000 acquired prior to December 13, 1977, were subse-

quently converted into B & O common stock.

D. Evelyn Bittner held on December 13, 1977, de-

bentures in the face amount of $10,000 acquired prior to

December 13, 1977.

(8) Chessie was one of the last of the major railroads

in America to segregate its non-rail assets from its rail

assets.

(9) The Chessie Corporate Restructuring Committee

(the “Committee”) was officially formed in January,

1977.

(10) The Committee was composed of a number of

officers and employees of the B & O, Chessie and its sub-

sidiaries with various areas of expertise including the

law.

(11) One of the purposes for the formulation of the

Committee was to consider the transfer of the non-rail

assets of the B & O into a corporation not subject to the

jurisdiction of the Inte te Commerce Commission so

that, inter alia, they We d not be subject to the ICC’s

ban on transportations by a rail carrier of goods manu-

factured by the carrier or its subsidiaries and the ICC

requirement that it must approve all securities issued by

a carrier. This requirement renders impossible any joint

venture for the purpose of development of real estate by

the B&O such as the development of its Georgetown

property.

(12) The properties selected for transfer by the

Committee were those with potential for development.

(13) In deciding the method of transferring the non-

rail properties to a non-rail subsidiary, consideration was

given to selling the properties.

(14) The sale method of transfer was rejected be-

cause it would have required expensive and time-

58a Appendiz B.

consuming appraisals (as much as two years for the coal

properties alone) and would have required the transfer of

substantial amounts of cash and the payment by the

B & O of substantial transfer taxes with the risk that the

price for the sale would be unfair to the minority

shareowners.

(15) The method of transfer of the non - rail proper-

ties chosen by the Committee was transferral into a

wholly-owned subsidiary of the B & O followed by the

declaration of a dividend in its shares to the common

shareowners of the B & O.

(16) Whenever any properties were transferred that

had rail facilities of any nature, the B & O was granted a

permanent easement for the use of those rail facilities.

(17) On December 13, 1977, the B&O declared a

dividend in the shares of MAC. This dividend was part of

the corporate restructuring program of the entire

Chessie System which had begun in 1973 with the forma-

tion of Chessie.

(18) The effect of the transfer of the non-rail proper-

ties by the dividend route was that the B & O sharehold-

ers each retained their same proportionate interests in

both the rail properties retained by the B & O and the

non-rail properties transferred to MAC.

(19) Prior to the B & O dividend of the MAC stock in

December, 1977, the B&O had not paid any dividend

since 1961.

(20) The B&O had not paid any dividends during

the period from 1961 to 1977 in part because of its weak

financial condition and the need to replace a substantial

amount of its operating equipment, in part because of

substantial bond maturities and in part because of a re-

Appendix B. 59a

quirement in the convertible income bond indenture that

the B & O pay an amount equal to any dividend into the

surplus income sinking fund.

(21) During that same period and even before the

C& O had acquired a controiling interest in the B & O,

the C & O had provided the B & O with a significant in-

fusion of capital, without which the B & O could not have

remained in operation.

(22) Because it was difficult, if not impossible, to

value the MAC dividend in terms of fair market value,

the decision was made to call the convertible income

bonds, since without calling the bonds, it would not have

been possible to pay the MAC dividend.

(23) The convertible income bonds were called at a

price of $105 per $100 face value during the summer of

1977 at a time when the bonds were being thinly traded

at a price of $60 per $100 face value.

(24) At the time of the call of the convertible income

bonds, not all of the properties had been selected for

transfer by way of the MAC dividend.

(25) The convertible 44% % debentures, Series A, due

January 1, 2010, held by plaintiffs and involved in this

suit were issued in 1956 on an offer of exchange for

outstanding B & O convertible 4%% bonds.

(26) On or about January 1, 1956 the B&O had

entered into an indenture with the Chase Manhattan

Bank pursuant to which Chase acted as trustee for the

debenture issue.

A. Defendants did not file with the Chase Manhat-

tan Bank as Trustees of the Indenture dated 1/1/1956 for

the issue of debentures a copy of any published notice

60a Appendix B.

concerning the declaration of the MAC dividend on De-

cember 13, 1977.

B. Defendants did not advertise notice of the pro-

posed declaration of the dividend in MAC shares on the

& O common stock in a newspaper of general circula-

tion in the Borough of Manhattan, City and State of New

York printed in the English language.

(27) Under the terms of the indenture each $1,000

principal amount of debentures could be converted to 10

shares of common stock of B&O. In this respect the

indenture provides inter alia:

At the election of the holder thereof, any outstand-

ing debentures of Series A may (subject to the provi-

sions of this Article Five) be converted at their prin-

cipal amount into shares (fully paid and non-

assessable and of the par value of one hundred

dollars each) of common stock of the company, at any

time up to fifteen days prior to the date of the stated

maturity of such debentures, or if such debentures

shall be called for redemption, up to fifteen days

prior to the date fixed for such redemption at the

conversion price of $100 per share.

(28) In March, 1956, the B & O entered into a “‘list-

ing agreement” with the New York Stock Exchange re-

lating to the listing of these debentures with the Ex-

change. The B & O’s listing agreement provided:

The listing agreements set forth in the company’s

listing application A-12653 and A-15928 are incorpo-

rated herein by reference and made a part hereof...

(29) On or about April, 1977, Robert F. Hochwarth

and John A. Rogers, head of the Committee, both of

whom are attorneys, reviewed the terms of the converti-

ble debenture indenture, with specific reference to Arti-

Appendix B. 61a

cle 5, Section 12, and concluded that the indenture did

not require notice to the debentureholders of the declara-

tion of the MAC dividend. Section 12 provides as follows:

“The company covenants and agrees that it will

not declare and/or pay any dividend on its common

stock payable in stock or create any rights to sub-

scribe for stock or securities convertible into stock

unless in any such case notice of the taking of a

record date for the determination of the stockholders

entitled to receive such dividend, distribution or

right is given at least ten days prior thereto by at

least one publication in an Authorized Newspaper. A

copy of each such published notice shall promptly

after such publication be filed with the Trustee.”

The terms “Authorized Newspaper” are defined in Arti-

cle 1,

Section 1, 2 of the Indenture (P Ex 11) to mean:

“ ‘Authorized Newspaper’ means a newspaper of

general circulation in the Borough of Manhattan,

City and State of New York, printed in the English

language and customarily published on each busi-

ness day, whether or not published on Saturdays,

Sundays and holidays.”

(30) In arriving at this conclusion, Mr. Hochwarth

determined that the word “stock” in section 12 referred

only to the stock of the B & O and that the payment of a

dividend in kind of the stock of another corporation was

similar to a cash dividend. With this, the court agrees.

(31) In addition to Messrs. Hochwarth and Rogers,

Doyle Morris and Roland Donnem, also attorneys for the

B & O, were likewise consulted about these matters and

reached the same conclusions.

62a Appendiz B.

(32) Mr. Hochwarth in reaching his conclusion with

respect to the absence of need for notice to the deben-

tureholders took into account the fact that under the

applicable Maryland law, absent any action by the Board

of Directors, the payment date of a dividend was the

same as the declaration date.

(33) Mr. Hochwarth also considered the require-

ments of the New York Stock Exchange with regard to

the notice of certain dividends and concluded it was inap-

plicable because it requires 10 days notice only with

regard to a dividend declared on listed stocks and the

B & O common stock was not listed.

(34) Listing Agreement A-12653, referred to in the

B & O’s March, 1956 Listing Agreement, provided under

“AGREEMENTS” inter alia:

Section 1, Paragraph 2:

The Corporation will promptly notify the Ex-

change in the event that it or any company con-

trolled by it shall dispose of any property or of any

stock interest in any of its subsidiary or controlled

companies, when the disposal thereof will materially

affect the financial position of the Corporation or the

nature or extent of its operations.

Section III. Paragraph 4:

The Corporation will give the Exchange at least ten

days’ notice in advance of the closing of the transfer

books, or of the taking of a record of its stockholders

for any purpose.

(35) The A-12653 Listing Agreement under

“AGREEMENTS” also provided:

Section III, Paragraph 5:

the ownership of its securities listed on the Ex-

change; and shall give prompt notice to the Ex-

change of any such aciion; and shall afford the

holders of its securities listed on the Exchange a

proper period within which to record their interests

and to exercise their rights. . . .

(36) The B & O, like all other corporations that have

securities listed with the New York Stock Exchange, are

bound by the rules of the Exchange as well as their

“listing agreements”.

(37) Section A-2 of the Exchange Manual entitled

“Timely Disclosure“, states:

A corporation whose securities are listed on the New

York Stock Exchange, Inc., is expected to release to

for those securities. This is one of the most impor-

tant and fundamental purposes of the listing agree-

ment which each corporation egters into with the

Exchange.

(38) Defendants did not provide plaintiffs or the

other debentureholders notice of the December 13, 1977,

dividend-in-kind of Mid-Allegheny Stock.

(39) The Committee was advised by counsel that

making the MAC dividend payable on the same date as

the date of declaratior did not violate the terms of the

indenture under which the convertible debentures were

issued.

64a Appendix B.

(40) Mr. Donnem, as Senior Vice President, Law, and

General Counsel, has the responsibility to render legal

opinions concerning railroad activities to the senior

officers and directors of the B & O.

(41) Among those individuals to whom Mr. Donnem

conveyed his legal opinion concerning the legality of

making the declaration and payment of the MAC divi-

dend on the same date were Robert L. Hintz, Senior Vice

President of Finance for Chessie, B & O, and C & O and

Hays T. Watkins, Jr., Chairman and President of Chessie

System, Inc., Chairman of the Board of the C&O and

Vice Chairman of the Board of the B & O.

(42) A principal reason for making the payment date

of the dividend the same as the date of declaration was to

limit the number of shareholders who would receive the

MAC dividend in order to avoid the necessity of the

preparation and filing of a costly and time-consuming

registration statement with the Securities and Exchange

Commission (SEC).

(43) The plan of the B&O to declare and pay a

dividend on the same date was made known to outside

securities counsel for the B & O, the law firm of Hunton

and Williams, in advance of the December 13, 1977, dec-

laration, and they expressed no objection to the proposal.

(44) All of the properties transferred to MAC were

still owned by MAC or its subsidiaries except for those

which have been sold and as to those properties, an ac-

counting has been made to MAC for the amount of the

sale price so that the value of the M C shares remains

the same as it was on December 13, 197.

(45) Following the declaration of the MAC dividend,

the value of the remaining assets of the B & O was sub-

stantially over one billion dollars.

Appendix B. 65a

(46) In formulating the manner in which the MAC

dividend was to be declared, the convertible debentures

were considered by the B & O as part of its debt struc-

ture.

(47) Prior to the institution of these actions, in June

and July of 1977, plaintiff Monroe Guttmann

(“Guttmann”) wrote to his stockbroker and to the B&O

expressing his satisfaction with the policy of the B&O

of plowing back earnings into the company. He had also

asked information with respect to payment of dividends

and was rebuffed except that he was told he would be

notified if a dividend was declared.

(48) There was no testimony that plaintiffs would

have converted their debentures had they received ad-

vance notice of the declaration of the MAC dividend. To

this day we do not know if Guttmann and the other

plaintiffs wish to convert or not.

(49) The B&O has agreed with the trustee under

the Indenture that should plaintiffs prevail on the merits

of their claims, all debentureholders similarly situated

will be accorded similar treatment as required by any

judgment for the plaintiffs.

(50) Class action certification was denied April 3,

1980, by this court.

Additional Findings as to B&O Director-

defendants.

(51) The directors of the B&O did not intend to

defraud plaintiffs.

(52) The conduct of the directors of the B&O did

not constitute an extreme departure from the standard

of ordinary care.

66a Appendix B.

(53) Roland W. Donnem, Senior Vice President Law

and General Counsel, advised the directors of the B&O

that the indenture did not require notice to the converti-

ble debenture holders of the declaration of the MAC

dividend.

(54) Roland W. Donnem, Senior Vice President Law

and General Counsel, advised the directors of the B&O

that it was appropriate to have the declaration and pay-

ment of dividend on the same day.

(55) The directors of the B & O were informed of the

broad purposes of the management’s restructuring pro-

gram and kept advised as to its general progress at sev-

eral board meetings during 1977.

(56) Milton S. Eisenhower was not present at the

meeting of December 13, 1977, nor did he participate in

the December 13, 1977, action of the Board of Directors.

(57) None of the directors of the B & O were on the

Restructuring Committee.

(58) Article Eight of tne Indenture dated January 1,

1956 states:

“Immunity of Officers, Directors and Stockholders.

No recourse under or upon any obligation, cove-

nant or agreement of this Indenture, or of any deben-

ture or coupon, shall be had against any incorpora-

tor, stockholder, officer or director, as such, past,

present or future, of the Company, or of any suc-

cessor corporation, either directly or through the

Company, by the enforcement of any assessment or

by any legal or equitable proceeding or by virtue of

any statute or otherwise; it being expressly agreed

and understood that this Indenture and the obliga-

tions issued hereunder are solely corporate obliga-

Appendix B. 67a

tions and that no personal liability whatever does or

shall attach to, or be incurred by, the incorporators,

stockholders, officers or directors, as such, of the

Company or of any successor corporation, or any of

them, under or by reason of any of the obligations,

covenants or agreements contained in this Inden-

ture, or in any of the Debentures or coupons, or

implied thereform; and that any and all personal

liability of every name and nature, either at common

law or in equity, or by statute, or constitution, of

every such incorporator, stockholder, officer or direc-

tor, as such, is hereby expressly waived as a condi-

tion of, and in consideration for the execution and

issue of the Debentures and coupons.”

C. DISCUSSION.

(1) WHat Rm] ] CAN BE GRANTED?

The original complaint as filed by Pittsburgh Termi-

nal Corporation asked only that a preliminary injunction

be issued to be made permanent on final hearing enjoin-

ing the defendants from having the dividend of Mid-

Allegheny Corporation stock paid to B & O shareholders

without first affording plaintiff adequate information and

opportunity to determine whether to convert its deben-

tures to common stock and also to receive the dividend.

It was further asked that the defendants be enjoined

from having dividends paid in the future without first

affording plaintiff adequate information and opportunity

as to whether to convert and for such other and further

relief to be granted as may be necessary and proper.

The amended complaint asks that a detailed descrip-

tion of all assets of Mid-Allegheny Corporation as of

December 13, 1977, be supplied, that plaintiff be supplied

68a Appendix B.

with a detailed appraisal of the assets of Mid-Allegheny

and its subsidiaries and the value of Mid-Allegheny

Stock at the close of business on December 13, 1977, that

an order be entered permitting plaintiff and other deben-

ture holders to retroactively exercise their right to con-

vert into B & O stock “after receiving the data required

in paragraphs 1 and 2”. Further prayers were for dam-

ages, that an injunction issue against paying future

dividends without adequate notice and for costs and at-

torney’s fees and other appropriate relief. The complaint

in the Guttmann case, 79-94, contains similar prayers for

relief. In other words, what Pittsburgh Terminal and

Guttmann, its president, originally sought was sufficient

information so that they could make an intelligent deter-

mination as to whether or not to convert their deben-

tures into common stock of the B & O so as to receive the

dividend in kind in stock of Mid-Allegheny Corporation.

The circuit in considering the appeal taken from the

award of preliminary injunction commented on this as-

pect of the case and indicated that it would be sufficient

for the defendants to retain sufficient shares of B&O

and MAC stock to satisfy plaintiff’s claim in the event it

is ultimately determined that plaintiff was entitled to

reasonable notice of the dividend declaration and infor-

mation to enable it to decide whether to convert. The

circuit went on to say: “Given the limited objective of

plaintiff's complaint and defendant’s commitment

through their counsel, we conclude that there was no

irreparable harm giving rise to the need for a prelimi-

nary injunction.” Since the circuit opinion, the plaintiff

in Pittsburgh Terminal and the other plaintiffs in the

Guttmann case have raised their sights and are now

asking for damages, but we still do not know, despite the

large amount of discovery which has taken place in this

case, whether or not plaintiffs want to convert their de-

Appendix B. 69a

bentures into common stock or not. As was originally

foreseen, it was expected it would only take a short

period of time for the defendants to gather together

information with respect to the values of the assets of

the Mid-Allegheny Corporation and, of course, its liabili-

ties to determine at least the book value of MAC stock.

What plaintiffs were complaining about was that

they could not make informed decisions and after all this

discovery it appears they still do not have the informa-

tion upon which to make an informed decision as to

whether to convert or not. The holdings of Mid-

Allegheny Corporation and its subsidiaries are very large

as appears from the facts in this case. We have no infor-

mation as to the value of these assets which could form

the basis for any decree. There is nothing to base an

award on and without these figures we have no method of

determining what damages, if any, have been sustained

by the plaintiffs. It is true that the plaintiff has proved

general type of damages. Rochez Brothers v. Rhoades,

527 F 2d 891 (3d Cir 1975). Plaintiffs are asking for a

detailed description of the assets of Mid-Allegheny Cor-

poration, which apparently we have as a result of dis-

covery, but plaintiffs also go on and demand an appraisal

of these assets by the B & O to determine whether or not

they should convert. Testimony indicated that here have

been no recent appraisals.

We are confronted with vast acreages of property

including timber and coal mining properties in several

states, and also urban and water front real estate in

certain large cities which many railroads acquire over

the years. Some of these may be very valuable in the

future but to determine the value of them now is going to

be exceedingly difficult. The B&O claims that it will

take approximately ten years to have an appraisal of the

70a Appendix B.

assets of Mid-Allegheny and would cost many millions of

dollars. It is doubtful whether the court has the right to

order the B & O to make such appraisal and to proceed to

expend the money therefor. If this is true, plaintiff will

still not have sufficient information to intelligently deter-

mine whether or not to convert his stock. In other words,

in considering this case, we must also consider the possi-

bility that the suit will be futile.

On the other hand, we could hold that plaintiffs,

having been informed as to the items of property held by

MAC, can be given the opportunity to make the appraisal

themselves. They are entitled, of course, to such data as

the B & O has in its possession as to value but the values

are so speculative that it is impossible for the court to

make an award based upon them. The court felt it was

important to make these observations before proceeding

with the plaintiffs’ right to recover on the merits since

even if they do recover on the merits on the question of

liability, it is questionable what further we can do for

them at least until they make their own decision and tell

us whether they wish to convert or not.

(2) THe PURCHASER OR SELLER CONTROVERSY.

The defendants claim that the plaintiff in this case, a

holder of convertible debentures who has not converted

or attempted to convert them into stock, has no standing

as a purchaser or seller under the Federal securities

laws. Such finding is necessary in order to give effect to

Section 10(b) of the Securities and Exchange Act of 1934

(15 USC 78(j) )* and violation of Rule 10b-5? of the Com-

mission issued thereunder. The court held at the time of

hn — N —

any person. or , use any

means of instrumentality of interstate commerce ot of

ty on any national securities

Appendix B. Tla

its memorandum opinion on the issuance of a prelimi-

nary injunction that plaintiffs were holders of converti-

ble debentures which had not converted but that never-

theless the plaintiffs were sellers or purchasers for the

purpose of bringing suit in this case under the decision of

the Supreme Court in Blue Chip Stamps v. Manor Drug

Stores, 421 US 723 (1975). In Blue Chip, the court held:

“Blue Chips, supra, involved the offerees of a stock offer-

ing made pursuant to an antitrust consent decree. The

offerees had neither purchased nor sold any of the of-

fered shares and the court determined that the rule had

been clearly stated in Birnbaum v. Newport Steel Corp.,

193 F2d 461 (2d cir 1952) that a suit under 10(b) (5)

cannot be brought without the plaintiff having bought or

sold or having contractual rights for purchase or sale of

securities. The Supreme Court specifically said, how-

ever, at page 751:

exchange—* * * “(b) To use or employ, in vonnection with

the purchase or sale of any security red on a

national securities exchange or any security not so

istered, any manipulative or deceptive or contri-

vance in contravention of such rules and regulations as

the Commission may prescribe as necessary or appropri-

. eee ee oe Oe ee on of

vestors.”

2. Rule 10b-5 provides: “It shall be unlawful for any

KA means or

tality of interstate commerce or of the mails or

of any facility of any national securities exchange, (a) to

— any , scheme or artifice to defraud, (b) to

any untrue statement of a material fact or to omit

LINK

statements made, in the light of the circumstances under

which they were made, not misleading, or (e) 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.”

72 Appendix B.

“Unlike respondent, which had no contractual right

or duty to purchase Blue Chip’s securities, the

holders of puts, calls, options, and other contractual

rights or duties to purchase or sell securities have

been recognized as ‘purchasers’ or ‘sellers’ of securi-

ties for purposes of Rule 10b-5, not because of a

judicial conclusion that they were similarly situated

to ‘purchasers’ or ‘sellers’, but because the defini-

tional provisions of the 1934 Act themselves grant

them such a status.”

It would seem that this would be sufficient since the

convertible debentures constitute a contract permitting

the holder of the same to convert into common stock of

the B & O and thus there is a contract right to acquire

B & O stock which should be held as a contract of pur-

chase or sale under 10b-5.

The defendants relied strongly upon Broad v. Rock-

well International Corp., (N.D.Tex. 1977 Federal Securi-

ties Law Reporter, 196193), which has since been af-

firmed in this respect by the Court of Appeals for the

Fifth Circuit at 614 F2d 418 (March 24, 1980).

When this matter was first presented in this case, I

specifically declined to follow Broad v. Rockwell and held

that the best exposition in this area relative to rights of

convertible debenture holders was contained in the deci-

sion of Judge Tenney of the Southern District of New

York in Green v. Hamilton International Corp., 437 FS

723 (9/29/77).

In the companion case of Lowry and Lowry Zweig

Corp v. B&O, W.D.Ps. No. 79-1504 in memorandum

opinion dated June 17, 1980, this court again refused to

follow Broad v. Rockwell which had been affirmed by the

Fifth Circuit on March 24, 1980. At that time we said:

Appendix B. 73a

We have examined Broad v. Rockwell International

Corporation, supra, with care and note that it was a

merger case wherein in the merger agreement the

debenture holders still retained the right to convert

into cash but were denied the right to convert into

stock and it was held that they had no standing

under Blue Chips.”

The court admitted that it had not been willing to extend

the definition of purchaser or seller to the extent the

Second and Third Circuits had citing, inter alia, Penn

Central Securities, 494 F2d 528 (3d cir 1974). As a result

the defendant’s motion for summary judgment in Lowry

was denied and the same is true as to the motions for

summary judgment filed by the defendant itself and by

the directors.

In view of the fact that we have recently reviewed

this whole matter and remain unconvinced thet the con-

tract to obtain common stock in exchange for a converti-

ble debenture is not a contract for purchase or sale

within the meaning of 10b-5 we again hold that the

plaintiffs do have standing as purchasers and/or sellers

to bring this suit.

(3) SCIENTER.

The requirement that scienter must be shown by the

plaintiff is most clearly enunciated by the Supreme Court

in the case of Ernst & Ernst v. Hochfelder, 425 US 185, 47

L Ed 2d 668, 96 S Ct 1375 (1976). In this case, the court

clearly held that Section 10(b) of the Act “was addressed

to practices that involved some element of scienter and

could not be read to impose liability for negligent con-

duct alone”. Referring back to Footnote 12 the court

held:

T4a Appendix B.

In this opinion the term ‘scienter’ refers to a

mental state embracing iitent to deceive, manipu-

late, or defraud. In certain areas of the law reck-

lessness is considered to be a form of intentional

conduct for purposes of imposing liability for some

act. We need not address here the question whether,

in some circumstances, reckless behavior is suffi-

cient for civil liability under Section 10(b) and Rule

10b-5.”

The court thus held that scienter, which is required

for recovery under 10b-5, refers to intent to deceive,

manipulate or defraud and the question of liability for

recklessness was left open. The matter again appeared in

the decision in Santa Fe Industries, Inc. v. Green, 430 US

462, 51 L Ed 2d 480, 97 S Ct 1292 (1977) where the court

pointed out that the act itself makes it unlawful for a

person to use or employ any manipulative or deceptive

device or contrivance in contravention of the commis-

sion’s rules and that it is required that there be an arti-

fice to defraud which operates or would operate as a

fraud or deceit.

While the question of liability for recklessness as

opposed to intentional deception or misrepresentation

was not answered in Ernst & Ernst, the matter soon

came before our circuit in Coleco Industries, Inc. v.

Berman, 567 F2d 569 (3d cir 1977) wherein the Court of

Appeals for our circuit held that a plaintiff suing under

Section 10(b) and Rule 10b-5 must prove injury resulting

from a conscious deception or from a misrepresentation

so recklessly made that the culpability attaching to such

reckless conduct closely approaches that which attaches

to conscious deception. The court refused to further re-

fine the bounds of recklessness but held that there was

insufficient evidence in the case before it.

Appendix B. T5a

The court further went on to define recklessness in

McLean v. Alexander, 599 F2d 1190 (3d cir 1979) wherein

it held that the burden of proof of scienter was upon the

plaintiff and approved the language that scienter re-

quires “a conscious deception or a misrepresentation so

recklessly made that the culpability attaching to such

reckless conduct closely approaches that which attaches

to conscious deception.” The court further approved a

quotation from the Seventh Circuit in Sunstand Corp. v.

Sun Chemical Corp., 553 F2d 1033 (7th cir 1977) that

“reckless conduct may be defined as highly unreasonable

conduct involving not merely simple or even inexcusable

negligence but an extreme departure from the standards

of ordinary care which presents a danger of misleading

buyers or sellers that is either known to the defendant or

is so obvious that the actor must have been aware of it.”

Approaching the question in this case from the point

of view of the standards thus laid down we do find that

the defendants relied upon the advice of their attorn vs

and also upon the advice of outside counsel, a di n-

guished firm in the securities field in Richmond, Vir-

ginia. It does not appear that any of these attorneys had

any apparent conflicting interest although, since all but

the Richmond firm held the position of house counsel we

must subject their opinions to close scrutiny. At this

point we note the case of Drachman v. Harvey, 453 F2d

722 (2d cir 1972) wherein the Second Circuit pointed out

that in a situation such as we have here between con-

vertible debenture holders and common stock holders

there are conflicting rights and the Board of Directors

must give due consideration to the conflicting rights of

both parties.

In short, in order to succeed here, we must find that

plaintiffs have carried their burden of showing a plan to

76a Appendix B.

deceive and deny rights to the convertible debenture

holders bearing in mind that the payment of dividends is

ordinarily in the discretion of the Board of Directors

unless engaged in some illegal enterprise.

In the case at bar, we find no design to depress the

stock of B & O despite inferences which the plaintiffs say

should be drawn from the evidence in this case. There

was a statement in the record that the officers of B&O

had stated in 1975 that they would never declare a divi-

dend in common stock of B & O but it must be recognized

that this at most would be regarded as a loose statement

subject to change by events at any time. We also find that

there was a legitimate business purpose in this case. The

corporation planned to remove the non-rail assets of

B&O from supervision of the Interstate Commerce

Commission with respect to financing and also to spin off

the non-rail assets so that they could be managed by

someone skilled in development of other types of real

estate and not hamper the operation of the railroad with

plans for unrelated property and the taxes which must be

paid thereon and other expenses in connection there-

with.

In the preliminary injunction opinion in this case, we

stated we could not then determine the question of

whether there was intentional fraud or recklessness or

mere negligence. Also in plaintiffs’ motion for partial

summary judgment we said that we could not determine

scienter on such a motion since it involved a question of

fact as to purpose and intent and also the defense of good

faith might be operable. We further indicated that there

might be legitimate purposes shown to segregate the

non-rail assets from the rail assets. Another business

reason for the spin off of the non-rail assets was the fact

that ICC restrictions prevented the possibility of forming

Appendix B. 7a

joint ventures (Tr. 285, 397). We thus find that a legiti-

mate business purpose was being followed in declaring

this dividend in kind and removing the non-rail assets

from the ownership and control of the B & O. See Sec v.

Texas Gulf Sulphur, 461 F2d 833 (2d cir 1968). Before all

the circumstances had developed, the court indiczted at

the preliminary injunction that from the showing made

there was a likelihood of success on the merits. This was

before we had held a full hearing on the merits and all

the testimony as to the background and purposes of man-

agement was before us. We now hold that there is no

evidence of misleading or deception or misrepresenta-

tions or use of manipulative devices which would furnish

a cause of action under 10b-5. There has been no showing

of manipulation by insiders here or trading in shares or

offers to trade based upon insiders’ information.

We should point out that we do agree with the Fifth

Circuit in Broad v. Rockwell International, 614 F2d 418

(5th cir 1980), wherein it was held thai reckless conduct

describes an extreme departure from standards of ordi-

nary care which presents a danger of misleading buyers

or sellers as either known to defendant or is so obvious

that defendant must have been aware of it. They held,

however, in that case where the rights of convertible

debenture holders to participate in a merger were shut

off that there was insufficient evidence of scienter to

justify recovery.

We will therefore hold for the defendants with re-

spect to the question of scienter. We find that the defend-

ants were engaged in a legitimate business purpose with

respect to corporate planning and no intention has been

shown by the plaintiffs of intent to defaud them or fail-

ure to investigate the procedures before they were

adopted. It should be remembered always that there was

78a Appendix B.

still a small number of minority shareholders of B & O

Railroad Company and they were not deprived of any

rights of dividends in kind in Mid-Allegheny Corpora-

tion.

(4) CLamms UNDER Stock EXCHANGE PROVISIONS AND

LISTING AGREEMENTS.

In the complaint as originally filed in this case, claim

was made under the rules of the New York Stock Ex-

change and the listing agreement between B & O Rail-

road Company and the Exchange and also for violation of

Section 6 of the Securities and Exchange Act of 1934, 15

USC 78(f). While over two years passed nothing much

was made of this cause of action until it appeared in a

motion by plaintiff for partial summary judgment.

The court denied plaintiff's motion for partial sum-

mary judgment based on this claim in the memorandum

dated June 24, 1980. In that memorandum, we indicated

kerage houses and the New York Stock Exchange itself.

No case had been cited where a security holder could

bring suit against his own company for such a cause of

action.“

3. “There is a further claim by plaintiffs for sum-

ar Sees Se Se Seow te ve notice of the

in of dividend in *

Appendix B. 79a

We have now received not only the evidence neces-

sary to decide this claim but also, not being satisfied with

basis of the exchange rules or the listing agreement can

* 4. re

— 2 1 — -¢ the latter

80a Appendix B.

It is noted that section 6 does not explicitly grant a

private cause of action to persons such as plaintiffs who

are security holders of corporations whose securities are

listed on the exchange. Such a cause of action, if it exists

at all, must be implied under Court v. Ash, 442 US 66

(1975). As many times stated by the court, the question is

whether a private cause of action is created expressly or

by implication and what must ultimately be determined

is whether congress intended to create the private rem-

edy asserted. Transamerica Mortgage Advisers v. Lewis,

444 US 11 (1979); Touche Ross v. Redington, 442 US 560

(1979). It must be admitted as argued by the defendants

that in recent years the court has shown a tendency away

from a private cause of action where congress, well

knowing how to create one, did not do so in so many

words. See Collins v. Signetics Corp., 605 F2d 110 (3d cir

1979) where our own circuit held that we must respect

recent Supreme Court teachings that militate against

excessively expansive readings. In Landy v. Federal De-

posit Insurance Corp., 486 F2d 139 (3d cir 1973), our

circuit cautioned against expansive reading implying pri-

vate causes of action. In Jablon v. Dean Whitter & Co.,

614 F2d 677 (9th cir 1980), it was held there was no

private cause of action to be implied under Section 6 and

this has been the holding of our companions in the East-

ern District. See Lenowitz v. Philadelphia Stock Ex-

change, FS (E.D.Pa. Dec. 2, 1980, No. 79-4269);

Hoover v. E.F. Hutton & Co., Inc., FS (E.D.Pa.

Jun. 24, 1980, No. 79-3475) and Rankl v. Elkins Stroud

Supplee and Co., FS (E.D.Pa. June 12, 1980, No.

79-3187)

We therefore hold that the purpose of Section 6 was

to regulate the stock exchanges themselves and dealings

Appendix B. 81a

between them and their broker- members and there is no

implied private cause of action under this section.

(b) Private Cause oF ACTION BasED Upon Lr.

AGREEMENT.

The listing agreement covering B & O Convertible

4% Debentures Series A due January 1, 2010, is dated

March 22, 1956 and bears the stock exchange No. of

A-16166. The debentures as described vn page 3 thereof

under the heading “Indenture Provisions” provide that

they shall be converted at the principal amount thereof

into shares of the par value of $100 each in common stock

of the company at any time up to 15 days prior to stated

maturity or date of redemption at the conversion price of

$100 per share. It is provided on page 2 that “the listing

agreements set forth in the company’s listing applica-

tions A-12653 and A-15928 are incorporated herein by

reference and made a part hereof.”

Referring back to A-12653 dated February 18, 1947,

covering certain issues of first mortgage bonds, refund-

ing mortgage bonds and convertible income bonds due

February 1, 2010, on pages 11 and 12 are two causes

which have caused the court some trouble. Paragraph 5

on page 11 reads as follows:

“5. The Corporation will not make, nor will it permit

any subsidiary directly or indirectly controlled by it

to make, any substantial charges against capital sur-

plus, without notifying the Exchange. If so requested

by the Exchange, the corporation will submit such

charges to stockholders for approval or ratification.”

Paragraphs 4 and 5 on page 12 provide as follows:

“4. The Corporation will give the Exchange at least

ten days’ notice in advance of the closine of the

82a Appendix B.

transfer books, or of the taking of a record of its

stockholders for any purpose.

“5. The Corporation will publish promptly to the

holders of any of its securities listed on the Ex-

change any action taken by the Corporation with

respect to dividends or to the allotment of rights to

subscribe or to any rights or benefits pertaining to

the ownership of its securities listed on the Ex-

change; and shall give prompt notice to the Ex-

change of any such action; and shall afford the

holders of its securities listed on the Exchange a

proper period within which to record their interests

and to exercise their rights; and shall issue all such

rights in form approved by the Exchange and will

make the same transferable, payable and deliverable

in the Borough of Manhattan, in the City of New

Tork.“

The court does hold that II(5) on page 11 and ITI(4) and

(5) on page 12 have to do with bookkeeping and operat-

ing procedures between the stock exchange and the com-

pany aud do not confer any private rights of action upon

the stockholders. See Hughes v. Dempsey Tegler and Co.,

534 F 2d 156 (9th cir 1976); Lang v New York Stock

Exchange, 548 F 2d 61 (2d cir 1977).

We find no precedent where any court has ever held

against a stock exchange based upon a third party benefi-

ciary theory as proposed by the defendants here.

Supplementing the listing agreement is the stock

exchange manual which clearly shows that the listing

agreements are for setting forth the relations between

the companies and the stock exchange and not to give

rise to third party causes of action by a security holder

against his own company.

Appendix B. 83a

As pointed out by the defendants, the third party

beneficiary doctrine to apply in any situation must dem-

onstrate (1) that there is a legally enforceable contract,

(2) that it was breached and (3) that plaintiff was in-

tended by the makers of the contract to benefit by it. We

hold that this contract was to regulate relations between

the company and the stock exchange inter se se, that

there was no intent to create a third party cause of action

in the security holders and, in any event, in this particu-

lar case, if notice had been given, it would not have

helped the plaintiffs in any respect because they would

not have been able to make an intelligent determination

as to whether to convert or not to convert within 10 days

or whatever time might have been allotted since they

have not been able to make that determination within

the 3 years this case has been pending. The reason this

cannot be done is inherent in the fact that no intelligent

evaluation of the stock of Mid-Allegheny Corporation

can be made even at this time or, if one is to be made, it

will take years and cost millions of dollars to do it. In

many respects these paragraphs of the listing agreement

are vague in that they do not make it clear whether the

exchange must be notified before an action is taken or it

can be notified in a reasonable time thereafter. See also

Restatement of Contracts Section 133.5 We agree that

there is no evidence of any intent to make a gift from the

New York Exchange, the promisee in this agreement to

the plaintiffs nor are they creditor beneficiaries under

5. 5133. Definition of Donee Beneficiary, Creditor

PN Incidental Beneficiary.

will benefit T ——

a „

son is, except as stated in Subsection (3): 2

84a Appendix B.

the second paragraph of the Restatement. See MacKubin

v. Curtis Right Corp., 190 Md 52, 57 A 2d 318 (D. Md.

third party beneficiary claim under this listing agree-

ment. It should be further pointed out that the stock

due nor su or asserted to be due from the prom-

isee to the ;

(b) a creditor beneficiary if no to make a

appears from the terms of in view of the

the promisee to the ,ora t of the

beneficiary the promisee w Aye 7.

by the Statute of Limitations or by a in bank-

(c) an incidental beneficiary if neither the facts

stated in Clause (a) nor those stated in Clause (b) exist.

6. §147. Effect of a Promise of Incidental Benefit.

Appendix B. 85a

We therefore hold that there is no liability under the

listing agreement and the same is doubly true with re-

spect to liability on the part of the directors. See A. B.

Corporation v. Futrovsky, 267 A 2d 130 (Md. 1970).

It should be noted that ten years after the listing

agreement covering the convertible debentures here in-

volved the company suspended trading in its common

stock. This is not considered of importance because the

listing agreement covering the convertible debentures is

still in effect. We therefore hold for the defendants on the

matters of the listing agreement and the New York Stock

Exchange Rules under Section 6 of the Securities and

Exchange Act.

D. CONCLUSIONS OF LAW.

(1) Piaintiffs do have standing to sue under Section

10(b) and Rule 10b-5 because they had a contract to

purchase and sell.

(2) Plaintiffs have failed to establish that the corpo-

rate c2fendants had the requisite scienter to establish a

violation of Section 10(b) and 10b-5.

(3) The shareowners of the B & O elect its Board of

Directors and that Board has the right and obligation to

determine whether the assets of the company remain

invested with the company or are distributed back to its

shareowners. (Tr. 600)

(4) The B & O’s declaration of a dividend payable to

shareholders of record on the same date as the date of

declaration was in accord with the applicable Maryland

law.

(5) The B & O’s declaration of a dividend payable to

shareholders of record on the same date as the date of

86a Appendix B.

declaration was in accord with the terms of the Inden-

ture under which the B & O convertible debentures were

issued.

(6) The Indenture does not require that any notice

be given debentureholders of a dividend payable in the

stock of a company other than the B & O because such a

dividend is the equivalent of a cash dividend although

payable in kind.

(7) Plaintiffs have failed to prove that they have a

right to proceed on an implied cause of action for any

breach of any listing agreement with the New York Stock

Exchange or the Rules of said Exchange.

(8) Plaintiffs have failed to prove that they were

damaged in any way by the declaration of the MAC divi-

dend.

(9) Convertible debentureholders are general credi-

tors of a corporation and have no call on any particular

assets of the corporation.

(10) Plaintiffs have failed to prove that they would

have converted their debentures had they received ad-

vance notice of the declaration of the MAC dividend.

(11) Plaintiffs failed to establish that the defendant

directors had the requisite scienter to establish a viola-

tion of Section 10(b) and Rule 10b-5.

(12) The defendant directors are relieved of any con-

tractual liability to plaintiffs by virtue of Article Eight of

the Indenture.

(13) Plaintiffs failed to establish that director

Milton S. Eisenhower, who did not attend or participate

in the December 13, 1977, meeting of the B & O Board of

Appendix B. 87a

Directors, had the requisite scienter to establish a viola-

tion of Section 10(b) and Rule 10b-5.

WILLIAM W. Knox

U.8. District Judge

CC: Counsel of record.

PITTSBURGH TERMINAL CORP. | ne Batten

v. 0.

BALTIMORE & OHIO Ran ROAD Co 77-1455

JUDGMENT ORDER

AND Now, to wit, March 10, 1981, for reasons set

forth in the accompanying opinion.

Ir Is ORDERED that the causes of action set forth in

the above entitled cases be and the same hereby are

dismissed.

Ir Is FURTHER ORDERED that judgment be entered in

favor of the defendants and against the plaintiffs.

WILLIAM W. Knox

U.8. District Judge

90a Appendix C.

§240.10b-17 Untimely announcements of record dates.

(a) It shall constitute a “manipulative or deceptive

device or contrivance” as used in section 10(b) of the Act

for any issuer of a class of securities publicly traded by

the use of any means or instrumentality of iterstate

commerce or of the mails or of any facility of any na-

tional securities exchange to fail to give notice in accord-

ance with paragraph (b) of this section of the following

actions relating to such class of securities:

(1) A dividend or other distribution in cash or in

kind, except an ordinary interest payment on a debt

security, but including a dividend or distribution of

any security of the same or another issuer;

(2) A stock split or reverse split; or

(3) A rights or other sub: tion offering.

(b) Notice shall be deemed to have been given in

accordance with this section only if:

(1) Gives to the National Association of Securi-

ties Dealers, Inc., no later than 10 days prior to the

record date involved or, in case of a rights subscrip-

tion or other offering if such 10 days advance notice

is not practical, on or before the record date and in

no event later than the effective date of the registra-

tion statement to which the offering relates; and

such notice includes:

(i) Title of the security to which the declara-

tion relates;

(ii) Date of declaration;

(iii) Date of record for determining holders

entitled to receive the dividend or other distri-

bution or to participate in the stock or reverse

split;

Appendix C. 91

(iv) Date of payment or distribution or, in

the case of a stock or reverse split or rights or

other subscription offering, the date of delivery;

(v) For a dividend or other distribution in-

cluding a stock or reverse split or rights or other

subscription offering:

(a) In cash, the amount of cash to be

paid or distributed per share, except if exact

per share cash distributions cannot be given

because of existing conversion rights which

may be exercised during the notice period

and which may affect the per share cash

distribution, then a reasonable approxima-

tion of the per share distribution may be

provided so long as the actual per share

distribution is subsequently provided on the

record date.

(b) In the same security, the amount of

the security outstanding immediately prior

to and immediately following the dividend

or distribution and the rate of the dividend

or distribution.

(c) In any other security of the same

issuer, the amount to be paid or

sat the Gein ad the Gictiinh os tatanillion.

(d) In any security of another issuer, the

name of the issuer and title of that security,

the amount to be paid or distributed, and the

rate of the dividend or distribution and if

that security is a right or a warrant, the

curities not covered under paragraphs

(bX1Xv) (b) through (d) of this section) the

92a Appendix C.

identity of the property and its value and

basis for assigning that value;

(vi) Method of settlement of fractional inter-

ests;

(vii) Details of any condition which must be

satisfied or Government approval which must be

secured to enable payment of distribution; and in

(viii) The case of stock or reverse split in

addition to the aforementioned information:

(a) The name and address of the trans-

fer or exchange agent; or

(2) The Commission, upon written request or

upon its own motion, exempts the issuer from com-

pliance with paragraph (bX1) of this section either

unconditionally or on specified terms or conditions,

as not constituting a manipulative or deceptive de-

vice or contrivance comprehended within the pur-

pose of this section; or

(3) Given in accordance with procedures of the

national securities exchange or exchanges upon

which a security of such issuer is registered pursuant

to section 12 of the Act which contain requirements

substantially comparable to those set forth in para-

graph (bx1) of this section.

(c) The provisions of this rule shall not apply, how-

ever, to redeemable securities issued by open-end in-

vestment companies and unit investment trusts regis-

tered with the Commission under the Investment

Company Act of 1940.

17 CFR. §240.10b-17 (1981)

Appendix D. 93a

Appendix D

UNITED STATES COURT OF APPEALS

For THE THIRD CIRCUIT

Nos. 81-1674 and 81-1675

PITTSBURGH TERMINAL CORPORATION,

Appellant

V.

THE BALTIMORE AND OHIO RAILROAD COMPANY, et al.

(D.C. Civil No. 77-1455)

Appellees

MONROE GUTTMANN, LORETTA GUTTMANN, JANET REES

and EVELYN BITTNER,

Appellants

V.

THE BALTIMORE AND OHIO RAILROAD COMPANY, et al.

(D.C. Civil No. 79-0094)

Appellees

SUR PETITION FOR REHEARING

Present: Surrz, Chief Judge, ALDISERT, ADAMS, GIBBONS,

HuNTER, GARTH, SLOVITER and BECKER, Circuit

Judges

94a Appendix D.

The petition for rehearing filed by the Baltimore and

Ohio Railroad Company, The Chesapeake and Ohio Rail-

way Company and Chessie System, Inc. in the above

entitled case having been submitted to the judges who

participated in the decision of this court and to all the

other available circuit judges of the circuit in regular

active service, and no judge who concurred in the deci-

sion having asked for rehearing, and a majority of the

circuit judges of the circuit in regular active service not

having voted for rehearing by the court in banc, the

petition for rehearing is denied.

By the Court,

JOHN J. GIBBONS

Judge

Dated: July 9, 1982