The opinion of the court was delivered by: TENNEY
In this civil action for money damages, plaintiffs allege a violation of Section 10(b) of the Securities Exchange Act of 1934 ("the '34 Act"), 15 U.S.C. § 78j and rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder. Plaintiffs also claim a cause of action in common law fraud for which they ask punitive damages.
Defendants have moved to dismiss the complaint pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure ("Rules") and for a protective order against discovery under Rule 26(c) pending determination of the motion to dismiss. Plaintiffs, in turn, have moved to compel discovery under Rule 37. For the reasons stated herein the motion to dismiss is denied; the cross-motions to stay or to compel discovery are therefore dismissed as moot.
Although defendants have submitted affidavits in support of their motion to dismiss, these fail to resolve all issues of material fact and thus cannot give rise to summary judgment under Rule 56. Therefore, matters outside the pleadings will be excluded in considering the motion to dismiss under Rule 12(b)(6), and the allegations of the complaint will be accepted as true.
The instant case raises an interesting issue: whether the redemption of convertible debentures in the ordinary course of their maturity can, under certain circumstances, effect a fraud cognizable under federal securities law.
Plaintiffs S. William Green, Justin Colin and Roger J. Hochstin owned convertible debentures of defendant Hamilton International Corporation ("HIC") having, in the aggregate, a redemption value of $300,000. The redemption date for the debentures was October 31, 1976. The debentures provided, however, that at any time before 3:00 p.m., E.S.T., on that day, they could be converted in whole or part into shares of HIC common stock at the conversion rate of $2.25 per share. Complaint para. 10. In the two weeks before the redemption date, HIC common stock was publicly trading at a price well below the conversion rate. Id. para. 12. It is alleged that defendant HIC knew during this period that plaintiffs would elect to redeem rather than to convert. Id. paras. 16-19.
Redemption actually occurred on November 1, 1976. Defendants insist that the one-day lapse was a matter of convenience, since October 31, 1976 was a Sunday; plaintiffs claim that the delay gave them a one-day extension on their conversion option. On November 1, 1976 defendant Household Finance Corporation ("HFC") delivered a written offer to HIC proposing to acquire the latter corporation by purchasing outstanding shares at $4.00 per share. News of this offer was released to the public on November 4, 1976. Plaintiffs, having surrendered the opportunity to purchase shares of stock at the equivalent of $2.25 per share when they redeemed their debentures and therefore having lost the chance to participate in the merger at the price of $4.00 per share, demanded rescission of the redemption transaction, which was refused. Plaintiffs then commenced this action, contending that HFC, HIC and MEI Corporation ("MEI"), the latter owning approximately 27% of HIC voting stock,
conspired to violate through silence the letter and spirit of section 10(b) and rule 10b-5 by concealing alleged pre-November 1 merger negotiations in order to prevent plaintiffs from acquiring information which would encourage them to convert rather than redeem. Defendants respond that the debentures were redeemed strictly according to their terms and without "prodding" by defendants. Defendants' Memorandum 6. Defendants acknowledge only that "HIC received the written offer of merger from HFC on November 1," 1976, assert that the decision to announce the HFC merger offer on November 4 was made in the exercise of "reasonable business judgment," id. at 7, and deny that under the circumstances they actually breached or could have breached any duty to plaintiffs.
The advantage to defendants accruing from plaintiffs' decision to redeem their debentures is obvious: HIC was not required to issue shares to cover a conversion and HFC was not required to consider the value of those shares in calculating its merger offer price. The question at bar is whether this advantage was gained at the expense of fidelity to the federal securities law.
Rule 10b-5 makes it unlawful for any person using the instrumentalities of interstate commerce
"(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances ...