The opinion of the court was delivered by: COOPER
Defendants move, pursuant to Rule 12(b)(6), F.R. Civ. P., to dismiss the complaint for failure to state a claim upon which relief can be granted.
This suit arises out of alleged fraudulent transactions of McDonnell Douglas Corp., ("Douglas") Merrill Lynch, Pierce, Fenner and Smith, Inc. ("Merrill Lynch") and a group of tippees ("the selling defendants") involving the sale of Douglas stock during June 20, 1966 to June 24, 1966 in violation of the Federal Securities Laws and the pertinent rules and regulations of the Securities and Exchange Commission. The complaint alleges that Douglas issued a report on June 7, 1966 indicating earnings of 85 cents per share on its stock for the first five months of its fiscal year 1966. In reality, it is claimed, Douglas' past earnings and future prospects were not that bright. On June 20, 1966, the President of Douglas disclosed to a Vice-President of Merrill Lynch
that his company's earnings for the first six months of fiscal 1966 had in fact fallen to 49 cents per share. Merrill Lynch, in turn, passed this information along to a restricted group of its customers, the selling defendants, who either sold shares of Douglas stock held in their own account or effected short sales. On June 24, 1966, after the stock had fallen from $87 per share (its June 24th price) to $76 per share, Douglas issued a news release and for the first time publicly reported the sharp drop in its earnings.
Plaintiff brings this action in its own behalf as an individual owner of 124 shares of Douglas stock and as a class action on behalf of all other persons who were stockholders of Douglas between June 20, 1966 and June 24, 1966. He alleges that the defendants' activities constituted violations of Section 17(a) of the Securities Act of 1933 (15 U.S.C. § 77q), Sections 10(b) and 15(c)(1) of the Securities Exchange Act of 1934 (15 U.S.C. §§ 78j(b), 78 O (c)(1)), and Rules 10b-5 and 15c 1-2 promulgated thereunder.
Defendants, in moving for dismissal assert that plaintiff's failure to "claim that they, or any of the Douglas stockholders they purport to represent, ever purchased or sold Douglas stock from or through these defendants or in reliance upon anything these defendants said or omitted to say" is a fatal defect in the complaint. (Memorandum in Support of Defendants' Motion to Dismiss, October 30, 1969, p. 3).
It is admitted that plaintiff's purchase of Douglas stock occurred prior to the events of June 1966, and that he sold its shares some six months after the June 24th public release. However, plaintiff argues alternatively that: (a) under "the provisions of Rule 10b-5 as it applies to the instant case * * * plaintiffs were [not] required to sell the stock to come within its provisions" but need only establish that material information was fraudulently withheld which would "have influenced an investors' judgment to buy, sell or hold such security" (Memorandum in Opposition to Motion to Dismiss. February 3, 1970, pp. 13-14); (b) "the failure by the defendants to disclose the material information in their possession coupled with their [defendants] sales of stock operated as a fraud and deceit * * * in connection with the purchase or sale of any security" (Memorandum in Opposition to Motion to Dismiss, February 3, 1970, p. 11); (c) plaintiff's eventual sale fulfilled the necessary transfer requirement. (Memorandum in Opposition to Motion to Dismiss, February 3, 1970, pp. 12-13). Section 10(b), in essence, accords the general investing public salutary protection from manipulative or deceptive schemes.
The crucial language of Rule 10b-5
with which we must grapple reads "* * * in connection with the purchase or sale of any security."
The single issue this Court must consider is whether plaintiff's position as a shareholder of Douglas stock at the time of defendants' alleged misrepresentations satisfies 10b-5's jurisdictional requirement that defendants' failure to disclose material information occur in " connection with the purchase or sale of any security." (emphasis added). Plaintiff's entire complaint falls upon his non-compliance with this requirement; 10(b) provides him his broadest remedies. Superintendent of Insurance of State of New York v. Bankers Life & Casualty Co., 300 F. Supp. 1083, 1094 (S.D.N.Y. 1969).
In Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2d Cir.), cert. denied, 343 U.S. 956, 72 S. Ct. 1051, 96 L. Ed. 1356 (1952), this Circuit, after extensive analysis of Section 10b-5's legislative history concluded that the
"section was directed solely at that type of misrepresentation or fraudulent practice usually associated with the sale or purchase of securities rather than at fraudulent mismanagement of corporate affairs, and that Rule X-10B-5 extended protection only to the defrauded purchaser or seller."
Birnbaum thus established the rule that a plaintiff could seek relief under 10(b) only if his injuries arose out of an actual purchase or sale.
Since Birnbaum, there has been substantial litigation concerning the continued validity of its holding. While the doctrine has been repeatedly reaffirmed, see e.g., Greenstein v. Paul, 400 F.2d 580 (2d Cir. 1968); O'Neill v. Maytag, 339 F.2d 764 (2d Cir. 1964); Christophides v. Porco, 289 F. Supp. 403 (S.D.N.Y. 1968); Chashin v. Mencher, 255 F. Supp. 545 (S.D.N.Y. 1965); Keers & Co. v. American Steel & Pump Corp., 234 F. Supp. 201 (S.D.N.Y. 1964), its initial area of applicability has been extended. Vine v. Beneficial Finance Co., 374 F.2d 627 (2d Cir. 1967); A.T. Brod & Co. v. Perlow, 375 F.2d 393 (2d Cir. 1967); Stockwell v. Reynolds & Co., 252 F. Supp. 215 (S.D.N.Y. 1965). A lengthy discourse on these numerous cases would add little in light of the extensive examination they have already undergone. See e.g., Cohen, The Development of Rule 10b-5, 23 BUS. LAW 593 (1968). Suffice it to note that while a clear majority of holdings resulted in dismissal of complaints because of a failure to satisfy Birnbaum's requirements, enough cases made substantial inroads on the doctrine (see, e.g., Vine, supra; Brod, supra), to lead one district court judge to suggest that "it may well be that purchaser-or-seller requirement of Birnbaum will not be followed when the question is next presented to the Court of Appeals." Entel v. Allen, 270 F. Supp. 60, 70 (S.D.N.Y. 1967); Lowenfels, The Demise of the Birnbaum Doctrine: A New Era for Rule 10b-5, 54 Va. L. Rev. 268 (1968).
However, in Greenstein v. Paul,
400 F.2d 580 (2d Cir. 1968), the court in answering the question as to whether there must be a sale of stock by a plaintiff before he can invoke the implied civil remedies afforded by 10(b) stated:
"It has long been the rule in this circuit that to maintain an action under § 10(b) of the Act and Rule 10b-5 of the Securities and Exchange Commission the plaintiff must have been a seller of the stock involved. Birnbaum * * *. Although criticized * * * it is ...