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LEWIS v. ADLER

March 16, 1971

Harry LEWIS, Plaintiff,
v.
Louis S. ADLER et al., Defendants


Lasker, District Judge.


The opinion of the court was delivered by: LASKER

LASKER, District Judge.

In this shareholder's derivative suit the individual defendants move to dismiss the first cause of action in plaintiff's complaint for failure to state a claim on which relief can be granted, Rule 12(b)(6), F.R. Civ. P., or, in the alternative, to grant summary judgment for the defendants on the first claim under Rule 56, F.R. Civ. P. The plaintiff opposes these motions and has moved separately for summary judgment under Rule 56, F.R. Civ. P., against defendant Sol Blaine on the second cause of action of the complaint, which relates solely to Blaine. *fn1"

 Jurisdiction is founded on § 27 of the Securities Exchange Act of 1934, 15 U.S.C.A. § 78aa. The complaint alleges violations of §§ 10(b) and 16(b) of the 1934 Act, 15 U.S.C.A. §§ 78j(b) and 78p(b), and of Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5 (hereinafter § 10(b), § 16(b), and Rule 10b-5).

 FACTS

 1. The § 10(b) Claim

 Plaintiff, a citizen of New York State, is and has been a shareholder of Transcontinental Investing Corporation ("TIC") since before 1965. TIC, a Delaware corporation, has its principal place of business in New York City and at all times mentioned in the complaint traded its stock on the American Stock Exchange. All the individual defendants herein were directors of TIC at the time of the actions complained of.

 TIC was organized in 1960 with all the individual defendants, except Blaine, constituting its board of directors. In the spring of 1963 TIC added to its diverse investments its acquisition of North American Acceptance Corporation ("North American"), a consumer finance company owned in part by Blaine. At this time Blaine entered into a ten-year employment agreement to serve as the president and chief executive officer of North American. Among the terms of this employment agreement was the grant of a restricted stock option (Option I) to Blaine providing for the purchase of 35,000 shares of TIC stock; this option was never exercised.

 As North American prospered, TIC began to involve Blaine in many other aspects of TIC's operations. Blaine became a director of TIC shortly after the acquisition of North American. His contribution was deemed valuable by the TIC board, and they decided to extend his employment agreement in 1967. The new agreement, running to 1976, increased Blaine's salary and granted him a new stock option to be governed by the provisions of TIC's Qualified Stock Option Plan, which had been established in 1965. This new stock option (Option II) was made subject to the approval of the shareholders, and provided opportunity for the purchase of 100,000 of TIC's shares at a price of $1 per share.

 A proxy solicitation by TIC's management seeking the necessary approval of Option II was prepared and mailed to the shareholders. Provision was made for vote on the proxy at a special shareholders meeting in lieu of the annual meeting to be held in the spring of 1967. At the time of the proxy solicitation mailing, the price for TIC stock had risen to $4-5 per share from a price of $1.75 per share at the time that Option II was included in the employment agreement. At this point, reportedly because of the increase in the market price, Option II was renegotiated by the company and Blaine, and reduced to 50,000 shares.

 Between the mailing of the proxy and the shareholders meeting on June 28, 1967, TIC stock rose further in price to $5.50-$6 per share, and the contract of employment was amended by the company and Blaine to delete provision for Option II altogether on June 27, 1967.

 TIC's president, Robert K. Lifton, made these facts known at the shareholders meeting on June 28, 1967, and, although sufficient votes (in person or by proxy) were available to approve Option II, the shareholders were advised that the option had been withdrawn and the matter was removed from the agenda. The president of TIC states in his affidavit on this motion that the "entire series of amendments was negotiated at arm's length between Mr. Blaine and TIC's management. Indeed, throughout Mr. Blaine was represented by his own counsel and TIC by its corporate counsel." (Affidavit of Robert K. Lifton, sworn to April 14, 1970).

 On June 29, 1967, TIC's stock option committee, composed of defendants Lifton, Weingrow and Hechler, issued Blaine a qualified stock option (under the company's Qualified Stock Option Plan) for 50,000 shares of TIC stock at the then market price of $5.6875 per share (Option III). The members of the stock option committee controlled in roughly equal proportions 25% of the outstanding TIC shares, and they were the controlling shareholders of TIC. By the provisions of the Qualified Stock Option Plan no owner of more than 5% of TIC's stock can be granted an option. On February 4, 1969, Blaine purchased 50,000 shares of TIC stock in exercise of Option III at the $5.6875 fixed price.

 These events took place during a period of growth for TIC. The corporation had a net income for the year ending December 31, 1965 of $1,504,000; net income for the next year was $1,324,000. TIC's earnings for the first half of the year 1967 were reported by its president at the June 28, 1967 shareholders meeting. He stated that those earnings were as good as 1966 and would probably pass the previous year's if the trend then apparent continued. The trend did continue, and the net earnings for the year ending December 31, 1967 were $3,513,000. TIC continued to invest in diversified enterprises with such a large measure of success that net earnings for 1968 at year's end were $6,260,000. The TIC prospectus for 1969 at page 6 discussed the fluctuations in its net income, and recited, as one of five factors in explanation, "the increase in volume of loans and consequently interest income of North American Acceptance Corporation through the year 1966 and its decline in 1967 and the first six months of 1968 * * *"

 2. The § 16(b) Claim

 Prior to Blaine's exercise of Option III on February 4, 1969, he had made several sales of the TIC stock which he then owned; he also made sales after exercising the option. On September 24, 1968, he sold 1,000 shares of TIC stock; on December 13, 1968, he sold 600 shares. Blaine reported on his SEC Form 4 for December 13, 1968, that he transferred 259 shares of TIC stock. The Atlanta Jewish Welfare Fund, he later explained, received 200 of these shares as a gift, with the balance donated to the Jewish Home. (Affidavit of Sol Blaine, sworn to June 11, 1970). A further transfer, reported on November 1, 1968, set forth the sale of 1,000 shares. Although reported on an SEC Form 4 bearing the November 1, 1968 date, Blaine avers that "this sale simply didn't take place, though I acknowledge that it appears on my Form 4 for that month. Some months earlier, in the spring of 1968, I had sold 1,000 TIC shares; I overlooked filing a Form 4 with respect to the sale at that time." (Id.)

 Blaine also disposed of 5,000 TIC shares on February 21, 1969. The lower market value price within six months of this transaction was $14.25. Blaine admits such a transfer of stock took place, but states: "It was a private transfer in which I sold 5,000 TIC shares to an acquaintance at their cost to me -- $5.6875 per share -- to compensate him for a large loan he had made at an earlier time." (Id.) While the plaintiff had indicated a selling price for this transaction at $24.125, Blaine indicates that such a price is merely "the market price shown in the newspapers," and not the actual sale price. (Id.)

 CONTENTIONS OF THE PARTIES

 A. the Plaintiff

 Four key grounds emerge from the complaint and allegedly constitute § 10 (b) violations:

 (a) The TIC board failed to vote the proxies of the shareholders authorizing the grant of Option II to Blaine as embodied in the employment contract. *fn2"

 (b) The TIC board made false and misleading staements and omitted to set forth material facts regarding the option arrangements, i.e., (i) that cancelling Option II was at the expense of and to the detriment of TIC, (ii) that the tax advantages were lost to TIC because Option II was cancelled, (iii) that inside information revealed that the first six months of 1967 would show much greater profits than the same period in 1966, that the 1967 earnings per share would double over the 1966 earnings, that TIC stock could be predicted to rise considerably in value when this information was revealed, and that such information was not disclosed, (iv) "that the cancellation of the Restricted option [Option II] was a prerequisite for any exercise by Blaine of the Qualified Stock Option [Option III]," (par. 18(b) of complaint), and (v) that Option II "contained restrictions which made it inexpedient for Blaine to exercise" it to take advantage of inside information, and that Option III "would permit him to exercise his option at any time he desired." (Par. 18(d) of complaint). The misstatements and omissions are alleged to have occurred partially in connection with the June 1967 shareholders meeting and in the Form 8-K report.

 (c) The third ground alleged to constitute a § 10(b) violation is that the prospect of TIC's growth constituted inside information withheld from shareholders and used to grant Blaine's option. Plaintiff therefore argues that Option III should be cancelled under the ruling of Securities and Exchange Commission v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968).

 (d) The final ground is that Option III was granted without separate consideration and that the shares purchased in exercise of Option III were acquired for insuficient consideration.

 The actions, plaintiff urges, worked a fraud on TIC and violated § 10(b) and Rule 10b-5. Plaintiff also alleges State common law claims that defendants violated their fiduciary duty to TIC and its shareholders by causing the sale of TIC stock for inadequate consideration, and that the unjust enrichment of Blaine should be returned to TIC as damages. He also seeks cancellation of Option III and other relief.

 Plaintiff opposes the motion to dismiss the first cause of action, arguing that the complaint establishes a claim under § 10(b) or, in the alternative, that a good cause of action for common law breach of fiduciary duty or corporate waste is stated, and that this court may retain jurisdiction of the latter under the doctrine of pendent jurisdiction. Plaintiff also has asserted diversity jurisdiction.

 The second cause of action is against Blaine alone. It alleges that he made five sales of TIC stock within six months of the exercise of Option III on February 4, 1969, and seeks recovery of short swing profits under § 16(b). Plaintiff moves ...


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