The opinion of the court was delivered by: BONSAL
Defendants move for an order pursuant to Rule 12(b) of the Federal Rules of Civil Procedure dismissing the complaint in the above entitled action on the ground that this Court has no jurisdiction over the subject matter and the complaint fails to state a claim upon which relief can be granted. In the alternative, defendants move for an order pursuant to Rule 56 of the Federal Rules of Civil Procedure granting summary judgment against the plaintiffs. Since the parties have submitted "matters outside the pleadings" both in support of and in opposition to the defendants' motion, the motion will be treated as one for summary judgment. (Rule 12(c), F.R. Civ. P.)
It appears that on December 15, 1965, Solitron Devices, Inc. (Solitron) offered $4,500,000 face amount of its 5% convertible debentures, convertible into shares of common stock of Solitron at a ratio of $105 per share pursuant to a registration statement filed with the Securities and Exchange Commission and effective on that date. It was stated in the prospectus that the debentures would first be offered solely to officers and employees of Solitron, then after five days, to other persons who had rendered particular assistance to Solitron or services to it in the past, and then after ten days, to any person on a "first come, first served" basis. According to the defendants, all the debentures were subscribed to within the ten-day period by offerees within the first two categories and no debentures were offered or sold to others. Certain of the subscribers allocated their subscriptions in part to members of their family or to family trusts.
Plaintiffs sue on behalf of themselves, representatively on behalf of all other Solitron shareholders similarly situated, and derivatively on behalf of Solitron, alleging that at the time the offer of convertible debentures was made the officers and directors of Solitron - defendants Benjamin Friedman, William Kearns, Raj Misra, and Paul Windels, Jr. - were in possession of material inside information concerning the affairs and prospects of Solitron, including knowledge that:
1. Solitron's net earnings for the third quarter and nine month period ending November 30, 1965 were substantially in excess of earnings for similar periods of the previous fiscal year;
2. Solitron's net income for the year ending February 28, 1966 would be almost double that of the previous year;
3. On February 28, 1966 Solitron would declare a 100% stock dividend; and
4. On February 28, 1966 Solitron would increase the cash dividend payable on its common stock.
Plaintiffs assert that had this inside information been disclosed to the public on or prior to the date of the offer, the fair market value of the convertible debentures with the $105 per share conversion ratio would have been approximately $7,000,000 or $2,500,000 more than Solitron received pursuant to the offer. Plaintiffs contend that by causing Solitron to issue the convertible debentures to themselves and to members of their families, the director defendants violated Section 10(b) of the Securities Exchange Act of 1934 (the 1934 Act) and Rule 10b-5 promulgated pursuant thereto. Plaintiffs further contend that the director defendants violated Section 10(b) and Rule 10b-6 by purchasing the Solitron debentures while participating in their distribution. Plaintiffs demand judgment that the director defendants be enjoined from exercising their conversion rights under the debentures and that their purchases be rescinded or that the director defendants be required to pay to Solitron the difference between the fair market value of the debentures at the time of the offering and the amount paid by them to Solitron.*
If directors cause a publicly owned corporation to issue its securities to them for a consideration which in the light of material undisclosed information known to them is inadequate, a stockholder may sue on behalf of the corporation for damages or other appropriate relief under Section 10(b). See, Vine v. Beneficial Finance Co., 374 F.2d 627 (2d Cir. 1967); S.E.C. v. Texas Gulf Sulphur Co., 258 F. Supp. 262 (S.D.N.Y. 1966); Simon v. New Haven Board & Carton Co., 250 F. Supp. 297 (D. Conn. 1966); New Park Mining Co. v. Cranmer, 225 F. Supp. 261 (S.D.N.Y. 1963). A corporation which issues its shares is a "seller" and a convertible debenture is a "security" as those terms are used in Section 10(b). Section 3(a) (10) of the 1934 Act, 15 U.S.C. § 78c(a) (10); Ruckle v. Roto American Corp., 339 F.2d 24 (2d Cir. 1964); Hooper v. Mountain States Securities Corp., 282 F.2d 195 (5th Cir. 1960); Heli-Coil Corp. v. Webster, 222 F. Supp. 831 (D.N.J. 1963), modified on other grounds, 352 F.2d 156 (3rd Cir. 1965). Therefore, the allegations of the complaint that the director defendants caused Solitron to issue to them and members of their families debentures convertible into shares of common stock at a price of $105 per share at a time when the directors knew that the fair value of the Solitron common stock was greatly in excess of the conversion price, state, on their face at least, a cause of action under Section 10(b) and Rule 10b-5.
In moving for summary judgment, the defendants contend that they have not violated Section 10(b) and Rule 10b-5 for the following reasons: (1) the allegedly undisclosed inside information was not material; (2) in any event, the information could not have been disclosed; and (3) the plaintiffs have failed to allege facts amounting to a deception.
Defendants argue that to be material, information must represent a significant departure from the corporation's previous activity or financial condition, that it must be "essentially extraordinary in nature" and "reasonably certain to have a substantial effect on the market price of the security if disclosed." S.E.C. v. Texas Gulf Sulphur, supra, 258 F. Supp. 262, 280, quoting, Fleischer, "Securities Trading and Corporate Information Practices: The Implications of the Texas Gulf Sulphur Proceeding " 51 Va. L. Rev. 1271, 1289 (1965). In this context, defendants contend that all of the allegedly undisclosed earnings figures were fully consistent with the corporation's past earnings performances as disclosed in the prospectus ...