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SCHWARTZ v. BOWMAN

July 19, 1965

Sandor SCHWARTZ, Plaintiff,
v.
Robert J. BOWMAN et al. and the Chesapeake & Ohio Railway Co., Defendants



The opinion of the court was delivered by: BRYAN

FREDERICK van PELT BRYAN, District Judge:

 Plaintiff, the holder of 100 shares of common stock of The Chesapeake & Ohio Railway Company (C.& O.), brings this derivative action on behalf of C. & O. against Alleghany Corporation (Alleghany), various persons who are or were officers and directors of either Alleghany or C. & O. or both and the executrix of a deceased director. C. & O. is named as a nominal defendant.

 Jurisdiction over the subject matter is alleged to be based on § 44 of the Investment Company Act of 1940, 15 U.S.C. § 80a-43, and diversity of citizenship, 28 U.S.C. § 1332(a).

 Service on defendants Eaton, Eaton, Jr., Tuohy, Murchison and the Young executrix was made outside the State of New York under purported authority of § 44 of the Investment Company Act. Defendants Kirby and Alleghany were both served in New York. The nominal defendant C. & O. appeared generally. The other defendants named have not been served.

 This litigation and the related case of Annenberg v. Alleghany and C. & O. (Civ. 135-152) were commenced in January 1957 and July 1958, respectively. Both cases attack the same transaction between Alleghany and C. & O., this case being brought by a stockholder of C. & O. and the other by a stockholder of Alleghany. Motions to dismiss on similar grounds in both cases were argued at the same time before me, and counsel in both submitted joint papers in opposition.

 Both cases relate to transactions in 1954 by which Alleghany relinquished control of C. & O. and acquired control of the New York Central Railroad Company (Central). Various questions involved in these two suits have been before the Interstate Commerce Commission, the Securities and Exchange Commission, federal district judges, a three judge court, the court of appeals for this circuit, the United States Supreme Court and the New York State Courts, on numerous occasions over a period of more than ten years. See Chesapeake & Ohio Ry. Purchase, 261 I.C.C. 239 (1945), 271 I.C.C. 5 (1948); Louisville & J.B. & R.R. Merger, 290 I.C.C. 725, aff'd, 295 I.C.C. 11 (1955); Alleghany Corp., 20 S.E.C. 731 (1945), 37 S.E.C. 424 (1956); Breswick & Co. v. Briggs, 130 F. Supp. 953 (S.D.N.Y.), 135 F. Supp. 397 (S.D.N.Y. 1955); Breswick & Co. v. United States, 134 F. Supp. 132 (S.D.N.Y.1955), 138 F. Supp. 123 (S.D.N.Y. 1956), (per curiam) rev'd, sub nom. Alleghany Corp. v. Breswick & Co. 353 U.S. 151, 77 S. Ct. 763, 1 L. Ed. 2d 726, (S.D.N.Y. 1957) rev'd, per curiam sub nom. Alleghany Corp. v. Breswick & Co., 355 U.S. 415, 78 S. Ct. 421, 2 L. Ed. 2d 374, (S.D.N.Y. 1958); Neisloss v. Bush, 110 U.S.App.D.C. 396, 293 F.2d 873 (D.C.Cir. 1961); Schwartz v. Bowman, 156 F. Supp. 361 (S.D.N.Y. 1957), appeal dismissed sub nom. Schwartz v. Eaton, 264 F.2d 195 (2 Cir. 1959); Zenn v. Anzalone, 1 A.D.2d 662, 146 N.Y.S.2d 286 (1st Dep't 1955) (per curiam), leave to appeal denied, 1 A.D.2d 773, 149 N.Y.S.2d 213 (1st Dep't 1956), 4 A.D.2d 945, 168 N.Y.S.2d 479 (1st Dep't 1957) (per curiam), 17 Misc.2d 897, 191 N.Y.S.2d 840 (Spec. Term, N.Y. County 1959), appeals dismissed without opinion, 11 A.D.2d 938, 210 N.Y.S.2d 748 (1st Dep't 1960); Freeman v. Kirby, 27 F.R.D. 395 (S.D.N.Y. 1961); Murchison v. Kirby, 27 F.R.D. 14 (S.D.N.Y.), 201 F. Supp. 122 (S.D.N.Y. 1961); Alleghany Corp. v. Kirby, 218 F. Supp. 164 (S.D.N.Y. 1963), aff'd, 333 F.2d 327 (2 Cir. 1964), aff'd en banc by an evenly divided court, 340 F.2d 311 (2 Cir.), cert. granted sub nom. Holt v. Kirby, 381 U.S. 933, 85 S. Ct. 1772, 14 L. Ed. 2d 698 (June 1, 1965), 344 F.2d 571 (2 Cir.), cert. granted sub nom. Holt v. Alleghany Corp., 381 U.S. 933, 85 S. Ct. 1772, 14 L. Ed. 2d 698 (June 1, 1965). *fn1" The issues have become increasingly complicated through this maze of litigation.

 On January 19, 1954, Alleghany sold 104,854 shares of C. & O. stock, which represented a controlling interest in C. & O., to defendant Eaton. On February 23, 1954, C. & O. sold 800,000 shares of Central stock to defendants Murchison and Richardson, who are alleged to be nominees of Alleghany. The sale of the Central stock enabled Alleghany to oust the then current management of Central and to obtain control of that railroad system on May 26, 1954.

 The complaint in the case at bar proceeds upon the theory that the sale of Central stock by C. & O. to Alleghany was void under § 47 of the Investment Company Act, 15 U.S.C. § 80a-46, because Alleghany was then an investment company which had failed to register with the SEC as the act required. It asserts a claim under the Investment Company Act for rescission of the Central transaction between Alleghany and C. & O.

 The complaint alleges that both the sale of C. & O. stock to Eaton and the sale of Central stock to Alleghany nominees were carried out pursuant to a conspiracy by the individual defendants and Alleghany to enable Alleghany to gain control of Central and for their own profit and aggrandizement. As part of the scheme Alleghany is alleged to have sold its block of 104,854 shares of C. & O. to Eaton at an inadequate price. By virture of the control of C. & O. thus obtained Eaton is alleged to have then caused C. & O. to sell to the Alleghany nominees the 800,000 shares of Central at an inadequate price.

 Plaintiff seeks to have the Central transaction set aside, and to compel the individual defendants and Alleghany to account to C. & O. for profits and damages. He also seeks to have Eaton account to C. & O. for alleged profits on his purchase of C. & O. stock from Alleghany on what is apparently a common law corporate opportunity theory.

 The answers admit the two transactions took place but in substance deny all other material allegations of the complaint, including the assertion of federal jurisdiction under the Investment Company Act and the sufficiency of the claim for relief under that act.

 Each of the defendants has moved for dismissal of the complaint and for summary judgment pursuant to Rules 12(b) and 56(b), F.R.Civ.P., on a variety of grounds, a number of which are common to all.

 Defendants all contend (1) that this court lacks jurisdiction to entertain the action because the subject matter is under the primary jurisdiction of the Interstate Commerce Commission and the action necessarily involves an attack on outstanding orders and decisions of the Commission with respect to that subject matter; (2) that under these orders and decisions of the ICC Alleghany was subject to regulation under the Interstate Commerce Act and therefore was expressly exempt from the Investment Company Act; (3) that assuming Alleghany was subject to the Investment Company Act, plaintiff has no claim for relief under that act and (4) that if there is no jurisdiction under the Investment Company Act or no claim for relief under that act, any pendent non-federal claim against defendants necessarily falls.

 I. The federal aspects of the complaint.

 The sole federal ground for relief alleged in the complaint is based on the Investment Company Act of 1940.

 The foundation on which the claim under the Investment Act rests is (a) that at the time C. & O. sold the 800,000 shares of Central to Alleghany nominees, Alleghany was an investment company required to register with the SEC under the Investment Company Act; (b) that Alleghany failed so to register; and (c) that in consequence the Central transaction was void under the terms of that act. Upon this foundation plaintiff asserts that a claim on behalf of C. & O. arose under the Investment Company Act for rescission of the Central transaction and an accounting by the defendants for profits and damages.

 Assuming the basic premises, there are, as the defendants urge, serious questions here as to whether plaintiff suing on behalf of C. & O. has status to sue under the Investment Company Act on transactions of this nature, and, even if he has such status, whether he is entitled to relief under that act absent a demonstrated causal connection between the violation of the act alleged and the damages suffered. See Barnett v. Anaconda Co., 238 F. Supp. 766 (S.D.N.Y. 1965), and cases there cited. Before such questions are reached, however, it must be determined whether the foundation on which the claim under the Investment Company Act is based is sound and, indeed, whether this court has jurisdiction to consider that question at all.

 Plainly, if Alleghany was not subject to the Investment Company Act when the transactions complained of took place, it was under no duty to register with the SEC, the basic premise falls and the claim under the Investment Company Act falls with it.

 Defendants assert that the ICC by a succession of orders and decisions has determined that at all times relevant here Alleghany was subject to regulation under the Interstate Commerce Act and was exempt from the Investment Company Act by its very terms and was not subject to SEC regulation or required to register with the SEC. These orders, say the defendants, confirmed by orders and action of the SEC, are binding on this court.

 If they are correct in this contention plaintiff's basic premise is wrong and the claim under the Investment Company Act cannot stand.

 Equally plainly, if this court has no jurisdiction in this action to pass on the question of whether Alleghany is subject to ICC Act regulation and therefore exempt from the Investment Company Act, plaintiff's basic premise must fall likewise with the same consequences. For in order to succeed on his theory plaintiff must necessarily have a determination from this court that Alleghany was subject to the Investment Company Act and failed to comply with the legal requirements thereunder. Unless the court has jurisdiction to make such a determination in this action the plaintiff cannot succeed under the Investment Company Act.

 The question of jurisdiction to entertain the action must come first.

 Defendants urge that under the Interstate Commerce Act the ICC has been entrusted with primary jurisdiction to determine the regulatory status of Alleghany and has determined that it was subject to Interstate Commerce Act regulation. The orders and decisions to this effect made by this public body in the public interest, whether right or wrong, say the defendants, may not be directly or indirectly attacked in a private litigation. They may be contravened or set aside only in an appropriate action under Chapter 157 of the Judicial Code, 28 U.S.C. §§ 2321-2325 (hereafter referred to for purposes of convenience as the Urgent Deficiencies Act) brought against the United States and in which the ICC may be heard as of right. Unless and until the controlling ICC orders and decisions are so reviewed and on review annulled or set aside, they are binding; and this court lacks jurisdiction to contravene them or to give any relief which would have that effect.

 Thus, the threshold jurisdictional question presented is three pronged:

 (1) Did the outstanding orders and decisions of the ICC determine that at all relevant times Alleghany was subject to regulation under the Interstate Commerce Act and was therefore, under the express terms of the Investment Company Act, not an investment company which was required to register with the SEC?

 (2) Does the private action at bar necessarily involve directly or indirectly an attack on the validity of such orders and decisions?

 (3) If so, has this court subject matter jurisdiction to grant relief under the Investment Company Act, the only federal basis for relief alleged in the complaint?

 (a) The outstanding orders and decisions of the ICC.

 Section 3 of the Investment Company Act of 1940, 15 U.S.C. § 80a-3, defines an "investment company" and then provides in subsection (c) that, notwithstanding that definition, "none of the following persons is an investment company within the meaning of this subchapter: * * * (9) Any company subject to regulation under the Interstate Commerce Act * * *."

 All parties are agreed that for some eight and a half years prior to January 19, 1954, Alleghany was considered as a carrier, was subject to regulation under the Interstate Commerce Act and was not an investment company subject to the requirements of the Investment Company Act. Orders of the ICC expressly placed it under Interstate Commerce Act regulation, and the SEC held that it was therefore exempt from the Investment Company Act.

 During that entire period Alleghany controlled C. & O., one of the leading eastern railroad systems. It also held a controlling stock interest in the Pittston Company, the owner of all of the stock of the United States Trucking Company, a major interstate trucking carrier, which, pursuant to ICC order, was held by an independent voting trustee. Alleghany also held a substantial stock interest in the Missouri Pacific Railroad Company, which was in reorganization under the Bankruptcy Act.

 On January 19, 1954 Alleghany sold its controlling interest in C. & O. to Eaton. On February 23, 1954 the transaction sought to be set aside took place when C. & O. sold 800,000 shares of Central to defendants Murchison and Richardson, allegedly as Alleghany nominees. The relevant time period here thus runs from January 19, 1954 to February 23, 1954.

 I turn then to the orders of the ICC which are detailed in the affidavits submitted in support of these motions to ascertain what the ICC determined as to the regulatory status of Alleghany at the times relevant here. In this discussion reference will also be made to orders and actions of the SEC bearing on the same subject matter.

 On September 5, 1944, Alleghany, which had been registered with the Securities and Exchange Commission as an investment company since 1940, applied to the ICC for approval of its acquisition of control over designated railway companies and of certain proposed financial transactions pursuant to § 5(2)(a)(i) of the Interstate Commerce Act, 49 U.S.C. § 5(2)(a)(i). That section provides for approval by the Commission

 
"[For] a person which is not a carrier to acquire control of two or more carriers through ownership of their stock or otherwise; or for a person which is not a carrier and which has control of one or more carriers to acquire control of another carrier through ownership of its stock or otherwise."

 Section 5(3) of the Act, 49 U.S.C.§ 5(3), provides that

 
"Whenever a person which is not a carrier is authorized, by an order entered under paragraph (2) of this section, to acquire control of any carrier or of two or more carriers, such person thereafter shall, to the extent provided by the Commission in such order, be considered as a carrier subject to such of the following provisions * * *."

 as may be applicable. The applicable Interstate Commerce Act provisions include §§ 20(1)-(10) and 20a(2)-(11), 49 U.S.C. §§ 20(1)-(10), 20a(2)-(11), which cover reports, records, accounting methods, issuance of securities and assumption of liabilities and fiduciary duties of officers and directors.

 On June 5, 1945 Division IV of the ICC approved Alleghany's application. Chesapeake & Ohio Railway Company Purchase, etc., 261 I.C.C. 239 (1945). The decision discussed in detail the prior connections between Alleghany and a number of carriers, the financial status of Alleghany and the questions of public interest involved in the application for control. It held (pp. 261-262):

 
"The comprehensive showing in the record on the question of public interest is convincing that Alleghany's application, as amended, should be granted. This is particularly true in view of said broad powers under the act to impose conditions and retain jurisdiction over the subject matter as a means of protecting the public interest.
 
* * *
 
"We further find that Alleghany should be considered as a carrier subject to the provisions of section 20(1) to (10) and sections 20a(2) to (11) of the act."
 
"* * * [We] shall retain jurisdiction to make such further order or modification of the order to be entered herein as may hereafter be necessary or appropriate."

 The order entered by the Commission on this decision provided that "unless and until otherwise ordered by this Commission Alleghany Corporation shall be considered as a carrier subject to" the provisions of the Interstate Commerce Act applicable under its decision.

 The order further provided, pursuant to the Commission's decision, that Alleghany deposit with an independent voting trustee the stock which it held in the Pittston Company as well as all voting stocks of any other carrier corporations subject to Interstate Commerce Act regulation except C. & O. and the Missouri Pacific, which was then in reorganization. Alleghany could regain its voting rights over the Pittston stock only upon a finding by ICC that it no longer controlled C. & O. If Alleghany acquired any voting stock in Missouri Pacific as a result of the reorganization that was to be placed in a voting trust also.

 Alleghany had also applied to the SEC for an order declaring that it had ceased to be an investment company within the meaning of the Investment Company Act since it was subject to Interstate Commerce Act regulation. After a public hearing the Commission granted the application, Alleghany Corporation, 20 S.E.C. 731 (1945), and issued an order declaring that Alleghany "has ceased to be and is ...


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