The opinion of the court was delivered by: SWEET
Plaintiff The Seagrave Corporation ("New Seagrave") filed suit seeking damages pursuant to the federal securities laws. Defendants Vista Resources, Inc., et al. ("Old Seagrave") move to dismiss the complaint under Rule 12(b) (6) Fed.R.Civ.P., on the grounds that the complaint fails to state a claim on which relief can be granted and that this court lacks subject matter jurisdiction. The question presented by this motion is whether either stocks or promissory note transferred as part of a sale and purchase of assets, qualify as a "security" within the meaning of federal securities laws. Securities Act of 1933, § 2(1), 15 U.S.C. § 77b(1); Securities Exchange Act of 1934, § 3(a)(10), 15 U.S.C. § 78c(a)(10). For the reasons set forth below, I conclude that neither is a security within the meaning of the statutes, and consequently, defendants' motion to dismiss is granted.
The following facts are alleged in the pleadings and affidavits and are not in dispute. Old Seagrave, a publicly traded company with securities listed on the New York Stock Exchange sold a substantial portion of its assets and business to New Seagrave and transferred all the outstanding shares of stock of 29 of its subsidiary and sub-subsidiary corporations in exchange for $ 17,082,652 in cash and $ 3,000,000 in a promissory note secured by an irrevocable letter of credit. Additionally Old Seagrave retained $ 6,500,000 in cash, and New Seagrave assumed $ 29,000,000 in liabilities and agreed to compensate Old Seagrave for tax obligations.
New Seagrave is a closely held corporation, whose shares are owned by Burton I. Koffman ("Koffman"), his family, and a family-owned corporate affiliate. The Koffmans have invested in numerous public and private companies. Even when acquiring 100% of a company's stock, the Koffmans attest that, as a general rule, they do not participate in day to day management but rely on the existing management.
The purchase and sale of the present transaction resulted from a lengthy history of negotiations. In early 1978, Mr. Arnold A. Saltzman ("Saltzman"), on behalf of Old Seagrave, and Koffman began negotiations for the purchase of shares and control of Old Seagrave. Filings with the Securities and Exchange Commission ("SEC") of Form 10-K and Form 10-Q Reports were evaluated by Koffman. Old Seagrave's employment contracts with existing management provided the requested assurances that present personnel would continue to manage the corporation. When Saltzman and Koffman could not agree on the purchase price for the public stock in Old Seagrave, the parties reconstructed the transaction for the sale and purchase of Old Seagrave subsidiaries. Given the tax advantages of this plan, the parties were able to agree on a purchase price beneficial to both. Additionally at Koffman's choice, the business would continue to be run by existing management.
Although counsel for the Koffmans initially sought representation and warranties as to Old Seagrave's financial condition, Saltzman refused to provide the requested assurances. He argued that the renegotiated transaction did not entitle Koffman to disclosures greater than those available to a purchaser in a tender offer. Koffman ultimately directed his attorneys to accept the representations in Old Seagrave's 10-K and 10-Q Reports, without more. When Old Seagrave was unable to comply with the time limitations on SEC comments on its proxy statement relating to the transaction, Koffman exercised his right not to proceed with the closing.
Shortly thereafter, the Koffmans purchased shares of stock in Old Seagrave. On the Schedule 13D which was filed with the SEC, the Koffmans described themselves as "private investors." Saltzman inquired as to Koffman's intent and was informed that Koffman wanted no representation on the Board of Directors because the purchase of stock was for investment purposes. At that time, Koffman agreed to give Old Seagrave options to repurchase 200,000 of the shares. Shortly thereafter, Old Seagrave exercised these options.
In the fall of 1979, Saltzman and Koffman reentered negotiations concerning purchase of stock in Old Seagrave. As in the prior negotiations, they could not agree on a purchase price. Therefore, they again structured the transaction as a purchase of assets and stock of subsidiaries of Old Seagrave. Except for the exclusion of the leather business from the sale, the transaction was essentially the same as the previously negotiated one, including the provision for existing management to continue the business and the concomitant refusal to provide representations concerning the financial condition of the corporation other than material in the updated 10-K Reports filed with the SEC. After the shareholders of Old Seagrave had approved the transaction, the contract closed on September 30, 1980.
On June 2, 1981, Old Seagrave filed a complaint against New Seagrave in New York State Supreme Court, charging that New Seagrave failed to pay $ 1,628,298 owing under the purchase and sale agreement with respect to certain recorded tax obligations. On August 10, 1981, prior to filing this complaint in federal court, New Seagrave answered and counterclaimed in state court. The counterclaims allege the same facts that form the basis of the complaint here.
New Seagrave's complaint alleges among other things that the Old Seagrave 1979 10-K Report failed to disclose and misrepresented material information, that the 1980 10-Q Report was misleading, and that these fraudulent, false and misleading statements and omissions violated the federal securities laws. Old Seagrave asserts that the court has no jurisdiction since the stock transfer was merely an indicia of the transfer of ownership of the subsidiaries, and not a security transaction within the meaning of the federal securities laws, and the promissory note was a cash substitute and not within the statutory definition of a security.
Section 2(1) of the 1933 Act provides:
When used in this subchapter, unless the context otherwise requires -
(1) The term "security" means any note, stock, treasury stock, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profitsharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, gas, or other mineral rights, or, in general, any interest or instrument commonly known as a "security", or any certificate of interest or participation in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any of the foregoing. 15 U.S.C.A. § 77b (1971). (emphasis added)
Section 3(a)(10) of the 1934 Act is its equivalent. International Brotherhood of Teamsters v. Daniel, 439 U.S. 551, 556, n.7, 99 S. Ct. 790, 794 n.7, 58 L. Ed. 2d 808 (1979). Clearly both the stock and the note fall squarely within the definition by their terms. The issue turns on the effect of the underlined clause on a transaction in which stock is transferred in the course of a sale of a business.
The Supreme Court has rejected a literal approach to the application of the quoted section and has looked to the underlying transaction rather than labels placed upon the instruments involved. United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 850-51, 95 S. Ct. 2051, 2059, 44 L. Ed. 2d 621 (1975). Additionally, the Supreme Court has announced the test to determine under what circumstances an instrument is a "security" in Security & Exchange Comm'n v. W. J. Howey, 328 U.S. 293, 301, 66 S. Ct. 1100, 1104, 90 L. Ed. 1244 (1946). "The test is whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others." See International Brotherhood of Teamsters v. Daniel, 439 U.S. 551, 561, 99 S. Ct. 790, 797, 58 L. Ed. 2d 808 (1979); United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 852, 95 S. Ct. 2051, 2060, 44 L. Ed. 2d 621 (1975); Tcherepnin v. Knight, 389 U.S. 332, 338, 88 S. Ct. 548, 554, 19 L. Ed. 2d 564 (1967). Moreover, the court has determined that "form should be disregarded for substance and the emphasis should be on economic reality." Tcherepnin v. Knight, 389 U.S. at 336, 88 S. Ct. at 553. Although the Court has had occasion to extend the coverage of the securities laws to instruments not labeled in such a fashion as to place them within the statutory definition, ...