UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK
July 19, 1965
Lester, et al., Plaintiffs,
Preco Industries, Inc., et al.,Defendants
Palmieri, District Judge.
The opinion of the court was delivered by: PALMIERI
PALMIERI, District Judge.
This is an action brought pursuant to the Securities Act of 1933 and the Securities Exchange Act of 1934.
The individual defendants Bellis, Davis and Zeidman have moved for an order pursuant to Fed. R. Civ. P. 12(b) dismissing the action against them on the grounds that this Court lacks jurisdiction over them, that venue does not properly lie in this Court, and that plaintiffs have failed to state a claim upon which relief can be granted. In the alternative, these defendants move for an order pursuant to Section 11(e) of the Securities Act of 1933, 15 U.S.C. § 77k(e) requiring plaintiffs to file an undertaking for the costs of these defendants. The corporate defendant Preco Industries, Inc. (Preco) and individual defendant Stern have moved only for an undertaking pursuant to Section 11(e) in the sum of $10,000 for payment of the costs of this suit, including reasonable attorneys' fees.
The facts alleged in the complaint are as follows. The defendant Preco is a corporation engaged in the business of selling custom built swimming pools. In late 1961, a public offering of Preco shares was held and the plaintiffs made purchases. (The prospectus indicated that the individual defendants were all directors of Preco.) The registration statement filed with the Securities and Exchange Commission purportedly contained untrue statements of material facts and omitted to state material facts required to be stated therein. The particular allegations in which the statement is said to be deficient are set forth below at pp. 8-10.
The complaint herein sets forth six counts, five of which purportedly state causes of action. Count I is based on Section 11 of the Securities Act of 1933, 15 U.S.C. § 77k. Count II is based on Section 12 of that Act, 15 U.S.C. § 77 l. Count III is based on both Sections 11 and 12. Count IV is based on Section 10 of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) and Rule X-10(b)-5, 17 CFR 240, 10b-5, promulgated thereunder. Count V is based on Section 17 of the Securities Act of 1933, 15 U.S.C.§ 77q. Count VI merely states that the action is brought on behalf of all other persons similarly situated to the plaintiffs.
First, the jurisdiction and venue of this Court will be considered. Jurisdiction of this Court is proper - both subject matter and personal. 15 U.S.C. §§ 77 v (a), 78aa. The venue provisions under the two Acts differ. The 1933 Act provides as follows:
Any such suit or action may be brought in the district wherein the defendant is found or is an inhabitant or transacts business, or in the district where the offer or sale took place, if the defendant participated therein, . . . .
Since in this case the defendants Bellis, Davis and Zeidman concededly are not found in this district, nor are they inhabitants of or transacting business in this district, venue is properly laid here only if: (1) This is the district where the offer or sale took place, and (2) the defendant participated therein.
The 1934 Act provides:
Any suit or action to enforce any liability or duty created by this chapter or rules and regulations thereunder, or to enjoin any violation of such chapter or rules and regulations, may be brought in any such district or in the district wherein the defendant is found or is an inhabitant or transacts business, . . . .
Thus, only one requirement is necessary and possible here: (1) That the act or transaction constituting the violation took place here.
With respect to the Counts under the 1933 Act, the defendants have urged that venue is improper in that both of the necessary prerequisites are lacking. As to the first - that the offer or sale took place in this district - the plaintiffs Lester and Abco Industries, Inc. have submitted affidavits which sufficiently establish that they purchased shares here. Cf. Rosenberg v. Globe Aircraft Corp., 80 F. Supp. 123, 125 (E.D. Pa. 1948); Moore v. Gorman, 75 F. Supp. 453 (S.D.N.Y. 1948).
As to the second - that the defendants participated in the sale - a more difficult question is presented. The plaintiffs argue that the defendants Bellis, Davis and Zeidman may be found to have participated in the sales by virtue of their alleged control of Preco at the relevant times. It is clear that when a company participates in a sale, any person who is equally liable under Section 15 of the 1933 Act, 15 U.S.C. § 77 o,1 is likewise a participant for venue purposes. Brown v. Cornelis de Vroedt, Inc., CCH Fed. Sec. L. Reps. P90,866 (S.D.N.Y. 1958); 3 Loss, Securities Regulation 2008 (2d ed. 1961). The plaintiff alleges that the defendants constituted a controlling group by virtue of their status as directors or large stockholders. What constitutes control is one of the most difficult questions in securities law. It is a question, furthermore, which is central to establishing substantive liability of these defendants under certain of the counts (e.g., Count II which is based on Section 12 of the 1933 Act.) It is axiomatic that a court cannot pre-try a substantive issue on a preliminary motion such as this. Cf. Smithers v. Smith, 204 U.S. 632 (1907); Wright, Federal Courts 93-4 (1963). Thus, since the facts alleged about defendants Bellis, Davis, and Zeidman could put them in a position of control, the allegations are sufficient to satisfy the venue requirements of the 1933 Act. See Rosenberg v. Globe Aircraft Corp., supra; Miller v. Hano, 8 F.R.D. 67 (E.D. Pa. 1947), 2 Loss, supra at 781-2.
As for venue under the 1934 Act, that too is proper. Actual sales to plaintiffs took place in this district. See Thiele v. Shields, 131 F. Supp. 416, 420 (S.D.N.Y. 1955). Also see Coburn v. Warner, 110 F. Supp. 850 (S.D.N.Y. 1953), indicating that compliance with the venue provisions of the 1934 Act is sufficient to sustain the entire lawsuit.
Thus having determined that jurisdiction and venue are proper, the question is now reached as to whether a claim for relief has been stated. The defendants have argued principally as to Count IV - i.e., that brought under the 1934 Act. Their contention as to the Counts brought under the 1933 Act revolves around the alleged failure of the plaintiffs to link the defendants to the sales in question. This argument has been sufficiently disposed of in the venue discussion above.
With respect to Count IV, the defendants Bellis, Davis and Zeidman urge in essence that the plaintiffs are attempting to bring a stockholders derivative action for various breaches of fiduciary duty. Such an action, it is argued, is not contemplated by Section 10(b) and Rule X-10(b)5. The allegations of the complaint in question are as follows:
a. Defendants planned to and did in fact open a PRECO office in Washington, D.C. which involved substantial risks and expenditures of funds and in fact PRECO lost considerable monies on such opening and was eventually forced to close the same at a loss.
b. Defendants planned to and did in fact purchase, rent, and invest in new buildings and real estate for PRECO.
c. Defendants planned to and did in fact purchase or lease for PRECO two Cadillac convertible automobiles which were not necessary for PRECO's business and were used often for purposes not related to PRECO's benefit.
d. Defendants planned to and did pay excessive legal fees to Davis, Bellis & Kolsby, Esqs., attorneys for PRECO, in which firm the defendant ISADORE BELLIS was a partner.
e. Defendants planned to and did in fact raise the salaries and paid excessive salaries to the officers and directors of the company, both directly and indirectly.
f. Defendants planned to and did in fact siphon off corporate funds of PRECO improperly to the detriment of the stockholders by means of fictitious or inflated claims for expenses incurred on behalf of PRECO.
g. The defendants did not plan to and did not in fact conduct the business of PRECO in accordance with accepted corporate practice for a publicly held company, but in fact conducted the business of PRECO so that, among other things, directors' meetings were not held, or were held infrequently, irregularly, and without proper notice to all directors, stockholders' inquiries were ignored or put off, and the provisions of the corporate bylaws and charter were not complied with.
h. The defendants, after offering the stock to the public at $4.00 per share, planned to and did buy it back at a depressed price, well below the offering price, and accomplished the same, purchasing substantial quantities of stock from the public through an intermediary without revealing that they were the principals involved in the purchase.
i. The defendants planned to and did in fact enter into transactions involving PRECO and themselves or companies controlled by them or in which they were interested.
Every one of these allegations is a typical, common law charge of breach of fiduciary duty in the management of a corporation, and is not normally covered by the securities laws. Howard v. Furst, 238 F.2d 790 (2d Cir. 1956); Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2d Cir. 1952). The sale of the securities is only incidental to a major mismanagement issue. See Pettit v. American Stock Exchange, 217 F. Supp. 21, 25 (S.D.N.Y. 1963). Each item complained of occurred after the filing of the registration statement and the issuance of the prospectus and the sale of the stock.
The question presented to this Court, then, boils down to whether allegations of evil intent, purportedly entertained when the registration statement was filed but not carried out until a subsequent time, are sufficient to convert what would otherwise be a stockholders derivative suit into a suit for violation of the 1934 Act. It is the conclusion of this Court that they are not.
At issue here is the ancient and troublesome problem of the sufficiency of pleadings. In Nagler v. Admiral Corp., 248 F.2d 319 (2d Cir. 1957), the Court of Appeals for the Second Circuit stressed the liberal approach to modern pleading. But here is a case where the plaintiffs have attempted to stretch this notion to the point of creating a federal cause of action, by the expedient of conclusory allegations, where one would not otherwise exist. Cf. Klebanow v. New York Produce Exchange, 344 F.2d 294, 299 (2d Cir. 1965).
The cases of O'Neill v. Maytag, 339 F.2d 764 (2d Cir. 1964), Howard v. Furst, 238 F.2d 790 (2d Cir. 1956), cert. denied, 353 U.S. 937 (1957), and Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2d Cir.), cert. denied, 343 U.S. 956 (1952), make it clear that the 1934 Act was not directed at fraudulent mismanagement of corporate affairs. If the complaint in question were upheld, these holdings could be very easily frustrated.
This is not a case like Ruckle v. Roto American Corp., 339 F.2d 24 (2d Cir. 1964), where the defendants had failed to disclose the existence of facts. What the defendants here allegedly failed to disclose was their intent in certain regards. Nor is the case like Pettit v. American Stock Exchange, supra, where massive stock frauds were alleged, involving continuous purchases and sales of unregistered stock, accomplished by rigging the market and concealing vital facts from investors. The fraud alleged there preceded and was contemporaneous with the stock sales in question. It was not, as here, something done after the sales and sought to be given retroactive effect by use of the words "plan to" in the plaintiffs' pleading.
The acts complained of here can be made the subject of a stockholders derivative action. The plaintiffs should not be allowed to avail themselves of the benefits of a suit brought under the Securities Act - and those benefits are substantial, including liberal rules for service of process and venue, and possibly different rules with respect to burden of proof.
The motion of the defendants Bellis, Davis, and Zeidman to dismiss Count IV for failure to state a claim for relief is granted. These defendants did not raise the same contentions with respect to the Counts brought under the 1933 Act. Those Counts are not dismissed, but the parties may, if they are so advised, move within twenty (20) days of the filing of this opinion, to dismiss those Counts for the same reasons that Count IV has been dismissed. The plaintiffs will also be permitted to file an amended complaint, if they can, within twenty (20) days, setting forth facts sufficient to sustain a cause of action under the Securities Acts, as interpreted herein.
Pending further action of the parties, the motion of defendants Bellis, Davis, and Zeidman for an undertaking is held in abeyance. It is unnecessary, at this time, to consider the statute of limitations question.
The defendants Preco and Stern have moved only for an undertaking for costs. They have not sought a dismissal of the action as to them. In view of the Court's rulings on the merits of the action, however, the motion of defendants Preco and Stern for an undertaking for costs is granted in the amount of $5,000.00.
Submit order on notice in accordance with the rulings set forth in this opinion.