UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK
March 31, 1956
Norman HOWARD, on behalf of himself and other Stockholders of Circle Wire & Cable Corporation, Plaintiff,
Sol FURST, Max B. Cohn, Isadore J. Furst, Sol Cohn, Richard C. Noel, Mortimer Hays, F. Dewey Everett, Cerro de Pasco Corporation, and Circle Wire & Cable Corporation, Defendants
The opinion of the court was delivered by: WALSH
The defendants have moved to dismiss the action for lack of jurisdiction over the subject matter. Their motions are granted.
This is a derivative action brought by plaintiff in behalf of Circle Wire & Cable Corporation. The defendants are directors of Circle, the corporation itself, and the Cerro de Pasco Corporation. All of the parties are citizens of New York. The jurisdiction of this court is invoked under Section 27 of the Securities and Exchange Act of 1934, 15 U.S.C.A. § 77aa, on a claim that defendants solicited proxies in violations of Section 14(a) of the Act, 15 U.S.C.A. § 78n(a),
and Rule X-14A-9, 17 C.F.R. 240.14a-9.
The complaint is dismissed because the private action given by the Act is that of the individual stockholder not the corporation.
The complaint alleges that in order to secure stockholder approval for the sale of the corporation's assets to Cerro de Pasco, defendants solicited the votes of the stockholders by means of a proxy statement which was willfully and materially false and misleading in the following respects:
(1) It understated the cost and value of Circle's inventory by more than $ 8 million;
(2) As a result, it understated income for 1952, 1953, 1954 and the first nine months of 1955;
(3) It failed to disclose the private interest which directors Sol Furst, Max B. Cohn, Isadore, J. Furst and Sol Cohn and in concealing their previous understatement of corporate taxable income.
Under state law, the sale required consent of two-thirds of Circle's shareholders.
A shareholders' meeting was scheduled for November 28, 1955 for this purpose. Five days prior thereto this action was commenced but no temporary injunction was sought. At the meeting the required number of shareholders gave consent to the sale and it was promptly consummated.
The relief sought was a permanent injunction against the voting of the proxies, which is now impossible to grant; an injunction to restrain Sol Furst, Max B. Cohn, Isadore J. Furst and Sol Cohn from voting as stockholders and the voiding of their votes if cast; the declaration that the contract of sale between Circle and Cerro de Pasco is void; the rescission of that sale if consummated; damages from the individual defendants and Cerro de Pasco, if restoration of the status quo is impossible. Notice to Cerro de Pasco of the misleading nature of the proxy statement is alleged upon the basis of Cerro's own inspection of the various properties of Circle; it is not claimed that it participated in the distribution of the offending proxy statement.
It is my conclusion that Section 14(a) does create a private right of action for the stockholders it was designed to protect.
Willful violation of the statute or rules promulgated under it is made criminal.
In the absence of contrary implications, a criminal statute enacted for the benefit of a specified class creates a civil cause of action in favor of the members of that class.
Such a right of action has been found under comparable language of Section 6(b), 15 U.S.C.A. § 78f(b) for failure of a stock exchange to discipline a member known to have indulged in conduct contrary to Exchange rules required under the statute;
for violations of Section 7(c) and (d), 15 U.S.C.A. § 78g(c, d) prohibiting the extension of credit beyond limits prescribed by the statute and the rules of the Board of Governors of the Federal Reserve System;
for violation of Section 11(d), 15 U.S.C.A. § 78k(d) prohibiting certain transactions by persons who are both brokers and dealers;
for violations of Section 15(c), 15 U.S.C.A. § 78o(c), which prohibits fraudulent practices by brokers and dealers;
and most notably for violations of Rule X-10B-5, 17 C.F.R. 240.10b-5, Section 10(b), 15 U.S.C.A. § 78j(b) and related sections of the Securities Act of 1933 and the rules promulgated thereunder which make unlawful the employment of manipulative and deceptive devices in connection with the purchase or sale of a security.
The fact that three sections of the Act expressly provide for civil liability
has been held not to exclude by implication civil liability based upon acts made unlawful by other section.
In Subin v. Goldsmith, 2 Cir., 224 F.2d 753, 756, certiorari denied 350 U.S. 883, 76 S. Ct. 136, Judge Frank, in his dissent, concluded that a private right of action was created which could be sued on derivatively for the benefit of the corporation. Although the majority expressed doubt that Section 14 created any private substantive right, it did not pass on this question. 224 F.2d 774. The question of whether the action should be derivative or representative was not sharply presented or discussed. Diversity of citizenship was present. The majority had held that the allegations of the claim under the statute were insufficient even if the statute would support a private action of any kind. The complaint was so artfully drawn that it was not clear to the majority whether it alleged a derivative action or not. Judge Medina, speaking for the majority, said, at page 774:
'The amended complaint, for reasons which are far from clear, is divided into five Counts, the last four of which repeat and reallege in a bewildering manner certain selected paragraphs and groups of paragraphs of the first and other Counts. It is not even clear whether all, or only a few, or perhaps one, of the Counts are derivative. * * *'
It is my view that the right of action created by the statute and regulations is that of the individual stockholder not the corporation. The right given by the statute and regulations was an implementation of the shareholder's right to vote and in this case his right to consent or withhold consent to a particular transaction. These are rights of the individual stockholder not those of the corporation.
The class intended to be protected was the investor, the stockholder who was not associated with management. He was to be protected against misleading proxy solicitation from any source, even by persons hostile to management.
It was the individual investor who was without effective recourse prior to the enactment of the statute. There is no suggestion that Congress found the rights of the corporation, as already protected by derivative action, inadequately provided for. In fact, provision in this very section, expressly authorizing regulations for the protection of the issuer as well as the investor was stricken prior, to the passage of the Act.
Congress' failure to include the corporation is all the more understandable because the newly created right of action, being based on fault,
would not have liberalized in any substantial degree the right of recovery the corporation already had against its directors. Further, to have given a right of action to the corporation would have permitted the corporation to proceed against the distributor of anti-management proxy statements and thus have added to the hazards of members of the very class the statute was designed to protect.17a Previous cases which have sustained derivative actions under other provisions of the Securities and Exchange Act are readily distinguishable.
Plaintiff has asked leave to amend to allege the claim as a representative action on behalf of all stockholders similarly situated. Although this court would have jurisdiction of such a claim, this application must be denied because the present allegations of the complaint no longer state a claim for which relief may be granted to an individual stockholder. The federal right which the statute gives the stockholder is one which must not be confused with the rights given by state law to which it may be incidental. It is an implementation of his suffrage. It gives him a new tactical weapon for use in the campaign leading up to the crucial stockholders' meeting. If the management or any other stockholder circulates false or misleading proxy statements, a stockholder may compel the corporation to assist in the distribution of a corrective statement
and he may call upon this court to help him. If correction cannot be made in time, the court has undoubted power, in a proper case, to enjoin the holding of the stockholders' meeting until it can be made. This relief, which might have been available had there been timely application for a temporary injunction, has been lost by the laches of the plaintiff. The damages the stockholder incurs in compelling rectification of a misleading statement would seem to be recoverable from the person who violated the federal statute, but in the absence of such an expense the intrusion of misleading statements into the process of stockholder suffrage is impossible to measure in money damages.
Here the only injury alleged is the sale but there is no basis in the complaint for concluding that the sale was a violation of the federal statute.
There is no basis in the statute or its legislative history for an implication that Congress intended to give an individual stockholder, as an incident of his protection by proxy statement regulations, the right to rescind completed corporate transactions whenever based upon votes solicited by such statements, or the right to enforce the corporation's claim for waste.
The drastic nature of such relief and the ease with which it could have been expressly authorized if Congress had so intended all argue against such implication.
Even assuming that, under Bell v. Hood, 327 U.S. 678, 66 S. Ct. 773, 90 L. Ed. 939 and Fielding v. Allen, 2 Cir., 181 F.2d 163, certiorari denied, Ogden Corp. v. Fielding, 340 U.S. 817, 71 S. Ct. 46, 95 L. Ed. 600, plaintiff might recover under the federal statute for the loss of his opportunity to vote
or to withhold consent to the sale, he did not lose these rights. He was not misled himself by the proxy statement. On the contrary, he started this action before the voted. He can only rely upon some claim that the proxy statement so corrupted the notice of the shareholders' meeting that there was non-compliance with the New York law, in effect no submission of the question to the stockholders, including himself. This, however, would present a claim for violation of state rather than federal law. The claim would turn upon the interpretation of the state law not the federal. The questions of fact and law would be the same even though the federal statute had never been enacted. Under such circumstances the claim would not arise under the laws of the United States. See Gully v. First National Bank, 299 U.S. 109, 57 S. Ct. 96, 81 L. Ed. 70; Nelson v. Leighton, D.C. N.D.N.Y., 82 F.Supp. 661, 664; Miller v. Long, 4 Cir., 152 F.2d 196.
Accordingly, the complaint is dismissed.