The opinion of the court was delivered by: KNAPP
In this case we must decide
whether plaintiff has stated a claim under SEC Rule 10b-5, and are thus called upon to discern the outer reaches of the "judicial oak which has grown from little more than a legislative acorn". Blue Chip Stamps v. Manor Drug Stores (1975) 421 U.S. 723, 95 S. Ct. 1917, 1926, 44 L. Ed. 2d 539.
Plaintiff Bio-Medical Sciences, Inc. ("Bio-Medical") a New York corporation founded in 1967 by the late Berel Weinstein and controlled by him until October 18, 1974, filed a 14-count complaint in this court, naming the following defendants: the executors of Weinstein's estate, Weinstein's widow, and certain of Bio-Medical's former attorneys. Bio-Medical originally alleged violations of 1) Section 17(a) of the Securities Act of 1933, 2) Section 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 and 3) the common law. After defendants brought this motion to dismiss the complaint in its entirety, Bio-Medical consented to dismissal of all of the counts based on the 1933 Act, portions of the counts based on 10(b) and 10b-5, and one of the counts based on state law. Left for our consideration is the legal sufficiency of the remaining 10b-5 claims and the pendent state claims.
In the interest of brevity and clarity, we will describe in detail only those facts alleged by plaintiff which are relevant to the 10b-5 claims still being pursued. The facts supporting the pendent claims of breach of fiduciary duty
would become pertinent only if we were to determine that the 10b-5 claims are valid.
Berel Weinstein founded Bio-Medical in 1967 primarily for the purpose of developing and manufacturing a disposable thermometer for sale to hospitals and the general public. Until late in 1974 he served as president, chief executive officer and chairman of the board. Weinstein was active in all aspects of the company's operations, being the principal capital raiser, contract negotiator, public relations director and manager.
In 1969 Bio-Medical raised approximately $2 million through a public offering of its stock. In 1971 it sold $5 million of 6% convertible subordinated notes (the 1971 notes) to four institutional investors. In the spring of 1972, needing more capital to sustain operations which were still in the developmental stage, Weinstein initiated negotiations with a larger group of institutional investors. At the time of these negotiations, Bio-Medical had already entered into a valuable distribution contract with Johnson & Johnson, and several other firms had expressed some interest in its product. However Weinstein -- not content with relying upon this legitimate good news -- vastly exaggerated the interest displayed by these other firms, suggested that some of them were actually investing in Bio-Medical, and on at least one occasion buttressed his claims by concocting a fraudulent letter on the letterhead of one of these firms. In so doing Weinstein acted entirely on his own, and without the knowledge or complicity of the board of directors. As a result of his efforts Bio-Medical in the fall of 1972 concluded a $25 million
sale of 6 1/2% convertible subordinated notes (the 1972 notes).
In July 1974 the company was in dire financial straits, and Weinstein commenced negotiation with the holders of the 1972 notes for additional capital or other concessions. In the midst of those negotiations, Weinstein's fraud was uncovered. The noteholders, together with certain of Bio-Medical's directors, presented the facts of Weinstein's fraud to the SEC. Subsequently the SEC filed a complaint in this court against both the corporation and Weinstein personally,
alleging violations of Section 17 (a) of the 1933 Act and Section 10(b) of the 1934 Act.
Without admitting or denying liability, Bio-Medical and Weinstein consented to the entry of a consent judgment. Among other things, this judgment enjoined Weinstein from serving as director or executive officer of Bio-Medical.
Still in urgent need of capital, the newly elected executive entered into negotiations with the holders of all the company's notes -- the fraud-free 1971 notes as well as the tainted 1972 notes. With respect to the holders of 1972 notes, the company's objective was to obtain the waiver of rescission rights to which they believed Weinstein's fraud entitled them.
The renegotiation was successful, but Bio-Medical made valuable concessions to the noteholders. These included: payment of attorneys' fees with respect to all legal proceedings arising out of the fraud, restrictions on the corporation's working capital, and limitations on its ability to pay dividends or to purchase its own stock. In addition, the noteholders secured valuable conversion rights, which many of them exercised thus diluting the value of the company's capital stock.
It is the company's claim that this dilution of its stock and all the other disadvantages just mentioned resulted from Weinstein's fraudulent misrepresentations relating to the sale of 1972 notes, and that a 10b-5 claim against Weinstein is thus established. For reasons that follow, we disagree with this conclusion.
Our analysis must begin with a consideration of the recent major Supreme Court pronouncement concerning Rule 10b-5. Blue Chip Stamps v. Manor Drug Stores, supra. Although the holding itself is irrelevant to the problem at hand, the opinions seem to indicate a reluctance to expand the ambit of 10b-5 liability. We read the majority as well as the concurring opinions as a judicial indication that the "judicial oak" should be trimmed back rather than force-fed.
There can be no doubt that Weinstein's conduct with respect to the sale of 1972 notes gave rise to various violations of the securities laws. What is not so clear is that such conduct gave rise to a 10b-5 claim by Bio-Medical against Weinstein.