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FLUM PTNRS. v. CHILD WORLD INC.

February 23, 1983

FLUM PARTNERS, Plaintiff,
v.
CHILD WORLD INC., COLE NATIONAL CORP., CHF CORP. and NEW CHF CORP., Defendants



The opinion of the court was delivered by: WEINFELD

EDWARD WEINFELD, D.J.

 Plaintiff, Flum Partners, is an investment partnership whose managing and sole general partner, Jerome S. Flum ("Flum"), is an attorney who gave up the practice of law in 1968 to enter the investment market and has acted since as a self-described "sophisticated financial analyst." In a two-day period, June 24-26, 1980, he purchased for plaintiff 101,200 shares of Child World, Inc. ("Child World"), a publicly traded stock on the American Stock Exchange, for a total cost of $910,200 at slightly less than $9 per share. In January 1981, as a result of a private merger of Child World into a subsidiary of Cole National Corporation ("Cole"), plaintiff received $16.75 per share, a profit of $784,000.

 Despite this substantial profit in a seven-month period, plaintiff commenced this action against Child World and Cole, *fn1" upon allegations that the shares were worth more than it received and it was deprived of their true value by reason of a fraudulent scheme by the defendants whereby the market price of the shares was artificially depressed prior to the merger so that they were acquired at a lower price than would have been possible except for the fraud.

 The complaint contains three counts, discussed in detail hereafter. Count 1 alleges fraudulent and manipulative conduct by the defendants in violation of section 10(b) of the Securities Exchange Act of 1934 ("the Act"), *fn2" and Rule 10(b)(5) promulgated thereunder; *fn3" count 2 alleges fraudulent omissions and misstatements by defendants in violation of the proxy solicitation provision of section 14(a) of the Act *fn4" and Rule 14(a)(9) promulgated thereunder; *fn5" count 3 alleges violations by defendants of their fiduciary duties to plaintiff and common law fraud as pendent to the federal claims asserted in counts 1 and 2. Jurisdiction is grounded upon section 27 of the Act *fn6" and also upon diversity of citizenship.

 The defendants, based upon Flum's deposition testimony, exhibits offered thereat and other documents, move for summary judgment pursuant to Rule 56(b) of the Federal Rules of Civil Procedure upon the ground that there is no genuine issue as to any material fact and that they are entitled to judgment as a matter of law because (1) plaintiff's claimed injury was not caused by any of the federal securities laws violations alleged in the complaint; and (2) plaintiff's exclusive remedy with respect to its state law claims was an appraisal of its Child World stock. *fn7"

 Child World is a leading operator of retail toy supermarkets. Its operations center about large warehouses located in Massachusetts and Ohio, from which it supplied products to its retail supermarkets by the company's fleet of trucks. This method of distribution required that the retail markets be located in close proximity to the warehouses. By contrast, Child World's major competitor supplied its retail toy markets through a series of smaller warehouses located throughout the country affording greater geographic flexibility, increased operational efficiency and, according to plaintiff, the prospect of greater profitability.

 Flum, for some five years before the purchase of the shares that are the subject of this action, had made a close study of Child World on the basis of its annual stockholder reports, its Securities and Exchange Commission ("SEC") filings, and his contact with specialists in the toy supermarket retailing business. The purchase was made after he had concluded on the basis of information derived from publicly available documents and management officials of Child World that it intended to embark upon a new and aggressive expansion program by opening a large number of retail supermarkets throughout the United States and in close proximity to warehouses with the prospect of increased operating efficiency and greater effectiveness as a competitor in the market.

 On July 3, 1980, soon after plaintiff had acquired its shares, Child World filed with the SEC a preliminary prospectus for a public offering of $15,000,000 long-term subordinated debentures, the proceeds of which were to be used for expansion of its business by opening new retail stores and for general corporate purposes. On July 7, 1980, the contemplated offering was advertised in the Wall Street Journal. The subsequent withdrawal of this offering and another event -- the purchase of Child World shares by Cole and the merger thereafter of Child World into a Cole wholly owned subsidiary -- are at the hard core of plaintiff's security fraud and common law claims.

 Cole is a major retailer operating over 1600 specialty retail stores throughout the United States. On July 31, 1980 Cole indicated to Sidney Shneider ("Shneider") and Joseph Arnesano ("Arnesano"), founders of Child World and owners of fifty-one percent of the outstanding shares, its interest in acquiring them. On August 6 Child World announced a temporary postponement of the public offering of $15,000,000 because of unfavorable market conditions -- more particularly, high interest rates.

 Cole and Child World representatives conducted negotiations over a two-day period, on August 20 and 21, and consummated an agreement on August 21, whereby Cole purchased from Shneider and Arnesano 865,000 shares of Child World stock, or 41.3% of the outstanding shares, for $16.75 per share. These shares, together with those previously purchased by Cole in the open market between July 16-19, 1980, amounted to 42.7% of the outstanding shares. Shneider and Arnesano retained 9.6% of the total outstanding shares. The agreement provided that Cole was to propose a statutory merger whereby the remaining publicly held outstanding shares would be acquired at $16.75; further, that Shneider and Arnesano would recommend approval of the Cole merger proposal to Child World's Board of Directors and shareholders. The merger proposal was conditioned upon a five-year employment agreement between Child World and Shneider at an increase in salary from $160,000 to $225,000 per year. On August 21, 1980 Cole and Child World issued a public announcement of the purchase of the Shneider and Arnesano shares and the price paid therefor and that Cole intended to propose to the Board of Directors of Child World a statutory merger to acquire the balance of the outstanding shares at $16.75, the same price paid to Shneider and Arnesano.

 On October 21, 1980, Child World's Board of Directors approved an agreement of merger with Cole. On December 4, 1980, Child World mailed a proxy statement to its shareholders recommending approval of the merger. The statement informed the public shareholders that their affirmative votes were not needed since Cole, Shneider and Arnesano, who owned the necessary majority of shares required for approval, intended to vote in favor of the merger, which meant the merger would be approved. The minority stockholders also were informed of their right under Massachusetts Business Corporation Law *fn8" to an appraisal as an alternative to acceptance of the merger price and quoted the relevant section of the Massachusetts Business Corporation Law. This provided in general that in the event of an appraisal proceeding the shareholder was entitled to the value of the shares on the day preceding the announcement of the merger agreement -- in this case, August 20, 1980. The closing price on August 20, 1980 was $11.875, *fn9" which was $4.875 less than the price offered to the minority shareholders.

 On December 4, 1980 plaintiff wrote to the SEC stating its belief that the merger price of $16.75 was "grossly unfair to the minority shareholders." On January 6, 1981 plaintiff objected to the proposed merger and invoked its right to appraisal of its shares under the Massachusetts law. Later, plaintiff withdrew its demand for appraisal because, among other reasons, it decided a lawsuit was a preferable vehicle by which to challenge the fairness of the merger price. On January 15, 1981 the merger was approved and under its terms plaintiff received $16.75 per share. Thereafter, plaintiff commenced this action.

 However variously stated under the respective counts, the essence of the plaintiff's charges is that Cole, aided by Shneider, engaged in a manipulative or deceptive scheme to acquire the shares of minority shareholders at a price below their true value by fraudulent acts both prior to their acquisition of the shares and thereafter by ...


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