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

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Appendix
- **Published:** January 1, 1982

## Text

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 parag

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385009_0965%3A2. Public record. Not legal advice.