The opinion of the court was delivered by: WYATT
This is an action for damages under the Securities Exchange Act of 1934 (15 U.S.C. § 78a and following; the "1934 Act"). Jurisdiction is conferred on this Court by 15 U.S.C. § 78aa. It is conceded by all parties that there was a use of the mails in connection with the transaction in suit (Pretrial order, p. 2).
There is one cause of action in the complaint based on a sale by plaintiffs to defendants in 1961 of 62 1/2 shares of Class A common stock, par value $100 per share, of National Hospital Supply Co., Inc. (National), a New York corporation, whose offices were at 38 Park Row in the Borough of Manhattan.
The action was tried to the Court without a jury, no party having demanded a jury (Fed. R. Civ. P. 38(d)).
The 1934 Act (15 U.S.C. § 78j) makes it unlawful to employ in the purchase as well as in the sale of any security any "manipulative or deceptive device or contrivance" in contravention of any rule of the Securities and Exchange Commission (the SEC or Commission). The Commission has promulgated Rule 10b-5 (17 C.F.R. § 240.10b-5) which in effect made applicable under the Act the general antifraud provisions of Section 17(a) of the Securities Act of 1933 (15 U.S.C. § 77q(a); the "1933 Act").
It is well settled that there is a private action for damages for violation of Rule 10b-5. Fischman v. Raytheon Mfg. Co., 188 F.2d 783, 787 (2d Cir. 1951); see Colonial Realty Corp. v. Bache & Co., 358 F.2d 178, 181 (2d Cir. 1966). There is a contention in the pretrial order that plaintiffs also claim common law fraud but, assuming this to be so, it does not alter the dimensions of the problem.
National was incorporated in 1945 but apparently began business somewhat later.
Defendants Charles, William, Sidney and Henry Licht are brothers.
At all relevant times, Charles was president and director of National, William was vice-president and a director, defendant Bernstein was secretary-treasurer and a director, defendant Coviello (Director of Sales) and defendant Friedman (General Manager) were employees and familiar with the affairs of National, Sidney was a dentist and familiar with the affairs of National, and defendants Bluestone and Grapel were dentists, close friends of the Licht family and familiar with the affairs of National. Except that he was an original Class B stockholder, nothing appears as to any connection of Henry with National.
There were originally issued 600 shares of National, 250 of which were Class A, 250 of which were Class B, and 100 of which were Class C. The Class A and Class B stock each could elect two directors while the Class C stock could elect one director. The shares on original issue were sold for $100 each (Ex. C).
There was an agreement (Ex. C) among all stockholders, binding on heirs, etc., which required that before any stock could be sold it had to be offered at "book value" to the "remaining stockholders of all classes" and to the corporation.
On October 23, 1951, Alexander Gould, an original holder of 62 1/2 Class A shares transferred his 62 1/2 shares to Jack Urdang. The sale price is not known.
On November 5, 1952, Bertha Schultz, an original holder of 24 Class B shares, transferred her 24 shares to defendant Charles. The sale price is not known.
Solomon Raduns, an original holder of Class A shares, sold his 62 1/2 shares on November 20, 1956 to the following in the amounts indicated:
Esther Bernstein (wife of defendant
Sabina Licht (wife of
defendant Charles) 10
Defendant Coviello 42 1/2
The sale price is not shown but whatever the amount, presumably it was "book value".
On December 13, 1956, Urdang sold his 62 1/2 shares of Class A stock, on an offer to National and to other then stockholders. National itself bought 27 1/2 shares as treasury stock and the other 35 shares were bought as follows:
Sabina Licht 5
Defendant William 10
Defendant Coviello 20
The purchase price paid was $159.09 per share which was presumably "book value".
Emanuel Frank, an original holder of 62 1/2 Class A shares and a director, died on April 15, 1958. His 62 1/2 shares were inherited by his daughter, plaintiff Bernice, married to Robert Ross, and by his son, plaintiff Lawrence. There was delay in issuing new certificates to plaintiffs because the original certificate had apparently been lost.
Arthur Licht, one of the brothers and an original holder of 24 Class B shares, died and on September 15, 1959 his shares were transferred to defendant Charles and a new certificate issued in the name of Charles. The financial basis for the transfer is not known.
On September 15, 1959, a certificate for 31 1/4 Class A shares was issued in the name of each plaintiff. By September 15, 1959, the other 187 1/2 Class A shares were held as follows:
Defendant Friedman 62 1/2
Defendant Coviello 62 1/2
Defendant William 10
Esther Bernstein 10
Sabina Licht 15
In National treasury 27 1/2
By September 15, 1959, the 250 Class B shares were held as follows:
Defendant Charles 152
Defendant William 50
Defendant Sidney 24
Defendant Henry 24
By September 15, 1959, the 100 Class C shares were all held by defendant Bernstein.
There were no transfers of stock between September 15, 1959 and May 4, 1961.
After the death of Frank on April 15, 1958, there were no directors elected by the Class A stock. Until at least May 4, 1961, there were three directors: Charles and William (representing Class B stock) and Bernstein (representing Class C stock).
Between September 15, 1959 and May 4, 1961, there were - in addition to plaintiffs - only nine stockholders of National, of whom 5 were members of the Licht family, 2 were members of the Bernstein family, and the other two were Coviello and Friedman.
It seems clear that at all relevant times the Licht family controlled National, but there was harmony between them and the other insiders.
At all relevant times, Ross - husband of plaintiff Bernice - acted on behalf of both plaintiffs.
In June 1960, Ross offered the shares of plaintiffs for sale to the other Class A stockholders - defendant William, defendant Friedman, defendant Coviello, Sabina Licht and Esther Bernstein. The price asked was $12,797.50 in the aggregate, or $204.76 per share, said to have been "book value" (Ex. 8). Technically, this was not a compliance with the stockholders' agreement, under which the offer should have been to the holders of Class B and C stock also. In August 1960, plaintiffs offered their stock to the corporation for the same price (Ex. 9).
There were no replies to the offers to sell.
The more significant events then took place in 1961 and in recounting them here the month and the day will be given (in some instances only the month); it will be understood that the year referred to is 1961.
On Tuesday, January 3, Ross had lunch near the offices with Charles. Ross said that plaintiffs wanted to sell their stock. Charles asked what price they wanted. Ross said $10,000 (or $160 per share). Charles said he "thought he could get a buyer for $5000" (SM 47; SM refers to pages of the stenographic minutes), or $80 per share. They then "settled on the figure of $7,500" (SM 25) which is $120 per share for the 62 1/2 shares, meaning "It was left that he would try and get somebody to buy the stock at $7500 and that I would hear from him or his lawyer" (SM 25). Ross did not hear from Charles after January 3 nor did Ross and Charles ever have any other talk.
The findings as to the conversation between Ross and Charles on January 3 are based on the testimony of Ross, which is accepted as truthful and accurate, as well as on a stipulation of fact in the pretrial order (p. 2). The testimony of defendants is in many respects incredible and inconsistent and to the extent that it differs from that of Ross as to the January 3 conversation it cannot be accepted, nor may it be accepted as to much which followed.
It is entirely clear that there was no agreement in fact on January 3 or at any other time prior to May 4 for the purchase of the stock of plaintiffs. This is because there was no agreement in fact by Charles or by anyone else to buy the stock; Charles testified that he was not interested in buying the stock and "didn't know anybody" who was (SM 395). All Charles undertook to do on January 3 was, as Ross testified, to "try and get somebody to buy the stock at $7500" (SM 25). It is thus unnecessary to decide the hypothetical question, much discussed in the memoranda, whether an agreement in fact would have been void in law because of the statute of frauds.
The minute book of National contains minutes of a meeting purporting to have been held on January 3 (Ex. 15), in which minutes the following statements appear:
"Mr. Samuel Bernstein moved the adoption of the following resolution:
"RESOLVED, that Bernice Frank Ross and Lawrence H. Frank, owning jointly 62 1/2 shares of Class A common stock, having offered to sell the same in one single block or unit to the other corporate stockholders and each of the stockholders having rejected the purchase of said stock in a single block or unit, be it RESOLVED, that Morris H. Linderman, attorney, 225 West 34th Street, New York, N.Y., arrange for the purchase in blank of said 62 1/2 shares of stock in a single block or unit, for a group of personal friends of Dr. Sidney E. Licht, who have been acquainted with the Corporation.
" . . . This resolution was discussed, seconded and unanimously adopted."
The foregoing minutes were prepared long after January 3 and were backdated as part of the scheme later described.
At some time during January or February, Charles began to consider the possibility of selling shares of National stock through a public offering by underwriters and of having a group of insiders buy the shares of plaintiffs. While there is no direct evidence of this, it is a required inference from what actually took place.
In February, a banker introduced Charles to Irwin L. Germaise, Esq., an attorney. According to Charles and Germaise, they did not then have any business discussion. Charles must himself have had a public offering in mind at that time, however, and must have been discussing this with the banker because, according to Charles, the banker called Germaise over (in order to make the introduction) and after Germaise left, the banker told Charles that Germaise was a good lawyer, good at "public lettings and SEC work" and had been "formerly associated with the SEC" (SM 408). Moreover, in a letter to the SEC it was stated that in February Charles was referred to the Germaise firm "in connection with a proposed offering of securities pursuant to Regulation A under the Securities Act of 1933" (Ex. 16).
Next, Bernice Ross received a letter dated February 28 from Morris H. Linderman, Esq., a lawyer for National, by which alone he was paid. The letter (Ex. 10) said that the "proposed alternate purchasers" of the stock were away and that when they returned Linderman would "contact" Bernice. He referred to the purchasers as his "clients". He was unable as a witness to explain the expression "proposed alternate purchasers" (SM 130). Linderman was, of course, acting under the instructions of Charles who was proceeding cautiously as to whether and when to arrange for purchase of the shares of plaintiffs. The reason for the caution of Charles was that his ideas for a public offering had not yet matured.
In the middle of April, Charles was decided to attempt a public offering. He retained Germaise as counsel for this purpose and beginning in the middle of April the officers of National (Charles, William, and Bernstein) with Germaise, were active in preparing for the public offering.
Germaise in April introduced Charles and William to representatives of two underwriting firms, Edward Lewis Co., Inc. (Lewis) and Underhill Securities Corporation (Underhill). There were discussions in April with these underwriters, including discussion of (a) the necessity for a recapitalization of National so as to make available a number of new shares for sale to the public at $300,000 (the maximum permitted under Regulation A, cited hereinafter) and (b) the desirability of an increase of working capital by "a private offering of shares" which was to be at least "100 shares at $300 per share" (SM 505). The "100 shares" obviously referred to the old stock. The discussions with the underwriters dealt also, of course, with the price of the new shares to be offered to the public; this price was to be $3 per share or the equivalent of $600 per share of old stock.
At all times since January 3, Charles knew that plaintiffs were anxious to sell their 62 1/2 shares of old common stock for $120 per share and in substance Charles had an option to buy them at that price. Prior to the plan for a public offering, neither Charles nor any of the other defendants were interested in buying these shares; most of the defendants had refused to buy from plaintiffs. But with the prospect of a sale to the public at the equivalent of $600 per share, with the prospect of sales by a private offering at $300 per share, and with the improved outlook for National's business because of the additional working capital thus to be obtained, the picture changed completely. The purchase from the plaintiffs at $120 per share became most attractive.
When Charles realized in April that a private and a public offering would be attempted (and with at least some hope of the success which in fact it later had), Charles engaged with the other defendants in a scheme to divide the shares of plaintiffs among the insiders. It was realized that plaintiffs would not sell at $120 per share if they knew about the proposed private and public offering and that it would be risky for directors and officers to buy their shares openly from plaintiffs without disclosure. The scheme therefore was to use Sidney, Grapel and Bluestone as purported purchasers on a firm basis on January 3, to present these three as asking later to have their commitment reduced, to use Linderman as an isolating intermediary with plaintiffs and a conduit of the purchase price to them, and - once their shares were obtained - to divide them amongst the insiders on the basis that some of the insiders were acquiring from Sidney, Grapel and Bluestone as an accommodation to the latter.
Linderman in late April asked for the $7500 to be used to pay plaintiffs for their shares. He testified (SM 120-21) that he received checks from the following in the amounts indicated, payable to himself and not to plaintiffs:
Sidn ey Licht 1,000
He must have received these checks on or shortly after April 21; the check of Grapel appears to have been dated April 21 (SM 304, 307) but there is a reference to its date as April 31 (SM 302). Sidney denied sending anything to Linderman (SM 260-61) but, even if believed, this would not be any evidence of good faith but would make the explanations of defendants even more mysterious.
According to Linderman (SM 142), he thought at all times until May 4 that the purchasers were Sidney, Grapel and Bluestone. Why he should have received a check from Coviello if this were true, was not explained.
Linderman wrote under date of April 26 notifying plaintiffs that he was "prepared to close the purchase of the stock" (Ex. 11).
A special joint meeting of stockholders and directors of National was held on April 28. At this meeting and in obvious preparation for the public offering already under discussion, it was resolved to amend the certificate of incorporation to change the Class A, Class B and Class C common stock, par value $100, into one class of no par value common stock and to eliminate the classification of directors so that all directors would be elected by all stockholders. It is also recited that 5 shares of common stock were to be presented to a Dr. Florio, such stock to come from the 27 1/2 shares of Class A common stock in the corporate treasury.
The April 28 joint meeting of stockholders and directors is recited to have been held on waiver of notice signed by "all the stockholders". All of the defendants signed such a waiver, including Grapel and Bluestone, who in fact did not become stockholders until after May 4.
On May 1, Charles for National signed an underwriting agreement with Lewis and Underhill. This agreement, among other things, required the underwriters to use their best efforts to sell for account of National 100,000 shares of common stock, par value 10 cents per share, at $3 per share (equivalent of $600 per share of the original $100 par value stock). National agreed to qualify the shares for sale under Regulation A (17 C.F.R.§§ 230.251 and following) issued by the SEC under Section 3(b) of the 1933 Act (15 U.S.C. § 77c(b)).
On May 4, Ross went to Linderman's office and turned over to him the two stock certificates of plaintiffs, each endorsed in blank. Linderman delivered two of his own personal checks, one to each plaintiff in the amount of $3,750.
Linderman testified (SM 121-22) that he received from defendants $7600, then paid plaintiffs $7500 and then "drew a third check for $100 and returned it to ...