Lumbard, Moore and Smith, Circuit Judges. Smith, Circuit Judge, dissenting. On Rehearing: Friendly, Chief Judge, and Smith, Kaufman, Hays, Feinberg, Mansfield, Mulligan, Oakes and Timbers, Circuit Judges.*fn*
This is an appeal from a judgment dismissing the complaint and the supplemental complaint (collectively referred to as "the complaint") in a shareholder's derivative action for alleged violations of § 10(b) of the Securities Exchange Act of 1934,*fn1 Rule 10b-5*fn2 promulgated thereunder, and of state corporate fiduciary law, the last of which claims are asserted under pendent jurisdiction. Judgment was entered without opinion by Judge Travia upon appellees' motion to dismiss under Fed.R.Civ.P. 12(b) (6) and 17(b).
This case presents three issues of not inconsiderable interest: (1) whether shareholders who held stock in "street name" at the time of the fraudulent transactions alleged in the complaint have standing to maintain a derivative action for violations of § 10(b) and Rule 10b-5, when state law (in this case California law) would require as a prerequisite to standing that derivative plaintiffs be "registered" or "record" owners at the time of the wrongs alleged; (2) whether a corporation's redemption of its convertible debentures is a "purchase" within the meaning of § 10(b) and Rule 10b-5, so as potentially to come within the sphere of securities transactions intended to be covered by the Exchange Act; and (3) whether the fraudulent transactions complained of, taken individually or collectively, are cognizable under § 10(b) and Rule 10b-5. We hold that appellants have standing; but we conclude that appellants have failed to state a claim for which relief can be granted under § 10(b) and that the judgment below must therefore be affirmed,*fn3 thus rendering it unnecessary for us to reach the question of whether the debenture redemption is a "purchase" within the meaning of the Exchange Act.
Plaintiffs-appellants, residents of New York, are shareholders of Harvey Aluminum Incorporated (Harvey Aluminum) and were shareholders, though not "record owners," of 100 shares of Harvey Aluminum stock at the times of the fraudulent transactions complained of. Defendants-appellees include Harvey Aluminum, as a nominal defendant, Harvey Aluminum's seven directors (four of whom were also officers) and Martin Marietta Corporation (Martin Marietta). Harvey Aluminum is incorporated and based in California; Martin Marietta is incorporated in Maryland and its principal place of business is in New York. Both Harvey Aluminum and Martin Marietta are publicly owned corporations listed on the New York Stock Exchange. Defendants-appellees Lawrence A. Harvey and Homer M. Harvey (the Harveys), two of the leading actors in the transactions in issue, were individually substantial and collectively controlling, shareholders of Harvey Aluminum and enjoyed the corporate positions of President and Director and Executive Vice President and Director of Harvey Aluminum, respectively.
As this is an appeal from a judgment of dismissal upon the pleadings under Fed.R.Civ.P. 12(b) (6), we assume the following allegations of fact to be true.*fn4 During November 1968, Martin Marietta determined that it would be to its interest to acquire control of Harvey Aluminum. In furtherance of this objective, Martin Marietta conspired with the Harveys to gain and secure control for Martin Marietta. The first phase of the plan called for the purchase by Martin Marietta from the Harveys of approximately 2.7 million shares of Harvey Aluminum Class B common stock, which represented approximately 40% of the outstanding voting stock, at a price of $40 per share. This price was some $11.20 per share over the then current market price and represented an aggregate premium of nearly $30 million. Phase One was completed in November 1968.
Phase Two called for continued use of the Harvey-Martin Marietta conspiracy: the Harveys remained in their positions as officers and directors of Harvey Aluminum "with the facade of acting solely in the interest of Harvey Aluminum and its shareholders when in fact they were acting under the domination and control of and in the interest of defendant Martin Marietta."*fn5 Specifically, the Harveys "recommended" to, and voted at, the May 23, 1969 Harvey Aluminum board of directors meeting that on June 27, 1969, Harvey Aluminum call its entire then outstanding issue of 5 1/2% convertible subordinated debentures due July 1, 1969, at a cost of $6.6 million. The action was approved. The call price of $105 exceeded the June 27, 1969 market value of the convertible debentures, and the conversion ratio to common stock was unfavorable. By causing holders to redeem their debentures at cost, thereby eliminating the possibility of a 222,000 share dilution through conversion to Harvey Aluminum Class A common stock, Martin Marietta increased its percentage holdings and secured its desired control position without having to acquire shares of common stock in the marketplace. Upon the successful completion of Phase Two, Martin Marietta assumed formal operating control of Harvey Aluminum by causing its designee to be elected president of the corporation.
Damage to Harvey Aluminum Alleged and Recovery Sought
Appellants claim that as a result of the conspiracy Harvey Aluminum has suffered damage in the amount of $6.6 million, the amount caused by appellees to be paid to the holders of the entire issue of convertible debentures outstanding pursuant to Phase Two. The alleged harm to Harvey Aluminum by the debenture redemption was caused by appellees' "defrauding," or acceding in the "defrauding," of Harvey Aluminum out of the use of its $6.6 million working capital at a time when it was borrowing and contemplating borrowing additional funds in a critically tight capital market with record high interest rates.*fn6 Moreover, as a result of the improvident redemption for wrongful purposes, Harvey Aluminum also allegedly lost the foreseeable opportunity to gain additional equity capital, free and clear of all expenses involved in going to the capital market, from debentureholders who subsequently, but for the redemption, might have decided to convert into common stock.
Appellants also seek to recover on behalf of Harvey Aluminum from Martin Marietta and the individual appellees the nearly $30 million premium paid and received in connection with Phase One, apparently on the theory that the otherwise lawful sale of the 2.7 million shares of Harvey Aluminum Class B common stock was "infected" with an overriding fraudulent purpose and thereby was made "in connection with" the subsequent "fraudulent" redemption transaction contemplated in Phase Two.
Appellants' capacity to sue derivatively on behalf of Harvey Aluminum is challenged on the ground that neither Fed.R.Civ.P. 23.1*fn7 nor the Exchange Act confers standing on beneficial shareholders*fn8 and that therefore state law must apply. It is suggested that California General Corporation Law § 834, which permits derivative actions by plaintiffs only if they are "registered shareholder[s] * * * at the time of the transaction[s] or any part thereof" of which they complain, controls the disposition of this case*fn9 and requires dismissal at the threshold. The questions of who is a "shareholder" for purposes of a derivative action brought under the Exchange Act and by reference to what law (procedural or substantive, state or federal) the answer to the principal question is to be determined, do not appear to have been answered in precedent to be found in reported appellate court decisions. We agree with appellees that Fed.R.Civ.P. 23.1 leaves open the question of who is a "shareholder,"*fn10 and that for state causes of action, standing is determined under state substantive law.*fn11 We believe, however, that Federal law must be consulted to decide whether there is standing to sue under the Exchange Act,*fn12 and that federal law confers standing upon beneficial shareholders such as the Drachmans.
Only two reported cases under the Exchange Act, both in the Southern District of New York, even raised the question under consideration. In the first, Treves v. Servel, Inc.,*fn13 the court held that "a shareholder need not be of record to maintain a derivative action"*fn14 brought under the Securities Act of 1933,*fn15 the Exchange Act and § 8 of the Clayton Act.*fn16 In support of its conclusion the court relied on the authorities collected in Marco v. Dulles;*fn17 but Marco was a derivative action founded solely on diverse citizenship*fn18 in which the court was squarely presented with the issue of whether the Marco estate's equitable ownership of stock was sufficient to confer standing to sue derivatively. The Marco court concluded, upon a review of the leading state and federal decisions on the subject, that
"under the law of the state of incorporation of the corporations involved here, as well as the law of New York, the standing of an equitable shareholder is recognized."*fn19
Although we think that Treves was correctly decided, that case which arose under the Securities Acts required for the reasons discussed below, that the court look explicitly to federal substantive law, or at least to federal policy to determine whether the state requirement was inconsistent therewith. The court's reliance on Marco, a diversity action under state law and hence requiring that state substantive law be applied, was therefore misplaced.
In the second case, Rosenfeld v. Schwitzer Corp.,*fn20 a shareholder derivative action based on § 14 of the Exchange Act*fn21 and diverse citizenship, the court raised but left open the issue decided here today, because the plaintiff there was "not disabled from maintaining a derivative action under [Indiana] state law."*fn22 Because California law, if applied, would bar this suit we are compelled to decide
"whether [§ 10(b)] of the Securities Exchange Act of 1934 impliedly prescribes separate federal standards for the status of shareholder seeking to vindicate those rights arising under the statute, and, if so, whether those standards are less stringent than the [here California] requirements."*fn23
The starting point in our analysis must be that appellants' derivative right of action to vindicate a federally created corporate right is one which is conferred solely by federal law. The remedial incidents of this federally created right must, of necessity, also be controlled by federal law,*fn24 because the policy of uniformity within the federal system at least with respect to the issue at bar is paramount to any interests to be served by conformity with the variousness of state rules.*fn25
That Congress intended to establish uniform enforcement of the Exchange Act is strongly indicated by § 27 of the Act,*fn26 which confers exclusive jurisdiction on the federal courts.*fn27 Moreover, although "Congress legislates against a background of existing state law,"*fn28 the Exchange Act also was enacted against a background of "a comprehensive body of federal law with respect to the bringing of derivative suits."*fn29 Indeed, the derivative suit was initially developed early on by the federal courts within their historic equity jurisdiction.*fn30 As this court noted in Fielding v. Allen:*fn31
"The [shareholder's derivative] action was early recognized by Chancery. It has long been familiar in the federal courts. And since the passage of the Act of March 3, 1875, 18 Stat. 470 [see 28 U.S.C. § 1331], conferring federal jurisdiction over cases arising under the Constitution and laws of the United States, many federal questions of importance have been raised in stockholder's derivative actions. Consequently, we think that the right of a stockholder to sue on his corporation's federal cause of action is ...