The opinion of the court was delivered by: POLLACK
Plaintiffs, two California residents, in October, 1961, each purchased five shares of Class B non-voting stock in a New York, over-the-counter stock broker-dealer corporation, the defendant, Ruffer, Ballan & Co., Inc. Each plaintiff paid $12,500 for five shares. Approximately five years after these purchases, in 1966, the plaintiffs brought this suit for rescission and the recovery of the money paid for the stock alleging that they were fraudulently induced to make this investment in 1961; that they were fraudulently induced to consent to recapitalization of the corporation and sign corporate documents to effect an amendment to the charter of the corporation in 1962; that they were refused delivery of their stock certificates; that no permit for the 1961 or 1962 transactions was obtained from the California Securities Commission although required by California law; and that the sale to the plaintiffs was made in violation of Section 10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78j and Rule 10(b) 5 of the General Rules and Regulations issued thereunder.
The plaintiffs came in contact with the defendants through one, Larry Smith, who was at the time, the manager of the Beverly Hills, California branch of Hemphill, Noyes & Co., members of the New York Stock Exchange. Plaintiff Alfred Holiday is a brother-in-law of Larry Smith and bases his claims of fraud on statements made to Smith.
The plaintiff, Andrew A. Sandor is a physician. He was very active as a speculator in the stock market and had established connections in New York with a network of 15 to 20 brokerage houses. He was a sophisticated investor before and since the transactions herein involved. From 1963 until mid-1967 he was a financial advisor registered with the Securities and Exchange Commission. He was recently written up very extensively in a national publication as one with uncanny ability to trade and his specialties are described as: "otolaryngology and hot new issues"; "Dr. Andrew A. Sandor looks for new issues that promise quick gains." His mode of operation was to jump in and out of new issues very quickly. "Some of his trusted brokers, in fact, have his standing order to put him in a new issue and take him out of it the same day - so long as there's a profit." Dr. Sandor readily concedes that he's been hurt in new issues, particularly in 1962.
It was the lust for new issues which led Dr. Sandor to the defendants. He thought he saw through them a means of learning of new offerings in which he could speculate. The parties learned of each other in the following way.
Dr. Sandor met the defendant Charles Ruffer socially in California in either 1960 or 1961. Ruffer had made known to his friend Larry Smith that he planned to go into the over-the-counter brokerage business in New York and asked him if he had any interest in going into it. Dr. Sandor was apparently a client of Smith and Smith mentioned this opportunity to Dr. Sandor, who expressed an interest in putting in some capital since he saw the proposed new venture as a vehicle which might provide Dr. Sandor with access to new security offerings. Seemingly, Smith also spoke of the proposed new firm to his brother-in-law, the plaintiff, Holiday.
There were at least two usual ways in which a brokerage firm could be organized; either as a limited partnership, with general partners to operate the business and limited partners to provide capital at interest and possible profit shares; or, as a corporation with limited liability for everybody. The individual defendants chose the corporate form.
Accordingly, the individual defendants formed a New York corporation, the corporate defendant herein which was registered with the SEC to engage in business as a broker-dealer. The corporation employed two retail salesmen and they and the individual defendants who were officers of the corporation made up its organization and together with the two plaintiffs became the stockholders of the business.
Dr. Sandor testified that he knew that Ruffer and Ballan were knowledgable and competent and had a following in the brokerage field. He hoped that with favorable markets the new firm would make money.
The investments by the six stockholders in about June of 1961 represent all the capital contributed to the corporation which is reflected in stock issued by the corporation as follows:
Amount Class B Issued
Paid Non-Voting Class A Voting
Andrew A. Sandor $12,500 5
Alfred Holiday 12,500 5
Leonard Gappelberg 10,500 4.2
Robert Schwartz 1,000 .4
Charles Ruffer 3,125 11.25 30
Eli Ballan 3,125 11.25 30
The stockholders of the corporation entered into a stockholders' agreement placing restrictions on the sale of their stock and providing among other things for options to the corporation on the shares of any stockholder seeking to dispose of his investment and if not exercised by the corporation then options to the remaining stockholders on any stock offered for sale.
The corporation started doing business in September, 1961. Most of the business done was a brokerage commission business, not dealer transactions and there was very little underwriting. The total revenues until April 30, 1962 were about $48,400 for a net loss of $654.72.
In June, 1962 the stock of the corporation was reclassified into one class of voting shares to be issued for each share outstanding, so as to retain the same proportionate capital interests. This step was with a view to seeking new capital for the firm by a public offering of its stock. Other incidental changes were made in the charter also, all with consent of 100% of the stockholders. June, 1962 was a period of a sharp break in the stock market and many small firms had been going out of business. The purpose of the corporate steps was to create capital to take advantage of what seemed a recent market turn around. The officers believed that success could be achieved with additional capital. However, no new capital was thereafter acquired and the business history, except for a profit of $165.00 in 1964 and $1,700.00 in 1965 showed losses in each subsequent year of operations and was finally terminated in about November, 1966.
Pursuant to the amendment of the Certificate of Incorporation on or about November 2, 1962, the capital structure of the corporation reflected the following stockholders and their common stock ownership in the corporation:
(a) Andrew A. Sandor, 12,500 shares of common stock.
(b) Alfred Holiday, 12,500 shares of common stock.
(c) Leonard Gappelberg, 10,500 shares of common stock.
(d) Robert Schwartz, 1,000 shares of common stock.
(e) Charles Ruffer, 103,125 shares of common stock.
(f) Eli Ballan, 103,125 shares of common stock.
At no time did the defendants obtain from the Commissioner of Corporations of the State of California any permit to solicit for sale, offer, sell, or issue shares of the Class B stock or common stock of the defendant corporation.
The Class B stock and the common stock issued to each plaintiff were kept at the premises of the defendant corporation in New York and never delivered to plaintiffs in California.
Andrew A. Sandor resold a portion of his stock interest in the corporation for $7,500 in December 1964 to William Schworer, Campbell Lukas, Esq., and Malcolm Lukas, Esq. This sale took place in California and all parties to such transaction were residents of the State of California and none of these parties obtained a permit from the Commissioner of Corporations in the State of California to commence and effectuate such sale.
Self-evidently, the shares of the stockholders in the corporation became worthless at least as early as 1966.
The plaintiffs contend that to induce them to participate in the brokerage firm, the defendant, Ruffer in substance falsely represented that
(a) Ruffer and Ballan had great contacts and the Company was certain to make a great deal of money;
(b) Ruffer was investing all of his assets in the Company;
(c) the plaintiffs, as purchasers of the Company's stock, would be in a favored position with respect to allotments of new "hot" issues;
(d) the Company would split its stock and "go public" in the near future ...