Appeal from so much of a judgment of the United States District Court for the Southern District of New York, Gerard L. Goettel, Judge, as dismissed claim under SEC Rule 10b-5, promulgated under 15 U.S.C. § 78j(b), on the ground that shares of stock purchased but unissued are not "securities" within the meaning of those provisions. Vacated and remanded.
Before: KAUFMAN, KEARSE, and ALTIMARI, Circuit Judges.
Plaintiff Martin Sulkow appeals from so much of a judgment of the United States District Court for the Southern District of New York, Gerard L. Goettel, Judge, as dismissed his complaint seeking damages from defendants Crosstown Apparel, Inc. ("Crosstown"), Dana Linden, and Michael Swartz for violation of Rule 10b-5, 17 C.F.R. § 240.10b-5 (1986), promulgated under the Securities Exchange Act of 1934 ("1934 Act" or "Act"), 15 U.S.C. §§ 78a-78kk (1982), on account of defendants' alleged fraud in connection with the sale to him of shares of Crosstown. The court dismissed this claim pursuant to Fed. R. Civ. P. 12(b)(6) for failure to state a claim upon which relief can be granted under Rule 10b-5, principally because the complaint failed to allege that any Crosstown shares were actually issued to Sulkow. The court declined to grant Sulkow leave to replead because at oral argument he admitted that Crosstown shares had never been issued to him. On appeal, Sulkow contends that the district court erred in ruling that the absence of the issuance of a stock certificate foreclosed his federal securities fraud claim. We agree, and we therefore vacate the judgment and remand for further proceedings.
The complaint included the following allegations. In February 1984, Linden and Swartz, each a major stockholder in Crosstown, represented to Sulkow that for the sum of $10,000 Sulkow could acquire one-third of the corporate stock of Crosstown and become a director of the company, if he would also act as a factor for corporate billings up to $25,000, "consistent with [his] independent business judgment as to the prudence of each billing or invoice to be factored." Linden and Swartz also represented that Sulkow would earn and draw a salary from Crosstown. In addition, defendants "represented that they had the expertise to manufacture garments necessary to conduct the business and also that they had entry to sufficient buying situations and that they had pending orders for goods." The complaint alleged that certain of these representations were made by "telephone, an instrumentality of interstate commerce."
In reliance on these representations, Sulkow invested $10,000 for the purchase of shares in Crosstown. Sulkow attached to his complaint a copy of an apparently updated document signed by Sulkow, Linden, and Swartz, bearing the heading "Memorandum of Shareholders' Agreement. -- three equal shareholders" (hereinafter "Shareholders' Agreement"). The Shareholders' Agreement, which listed a $10,000 "capital investment" from Sulkow, provided, inter alia, that "stock shares will bear a legend that they may not be transferred, encumbered, pledged or otherwise disposed of unless received back by the corporation subject, subject [ sic ] to a shareholder's [ sic ] agreement," and that "the agreement shall contain a reasonable buyout provision as well as estate considerations."
According to the complaint, each of defendants' representations was knowingly false and was made pursuant to a plan to induce Sulkow to purchase Crosstown securities and to deprive him of those shares and of the benefits of his bargain. Pursuant to their plan, defendants refused to pay Sulkow any salary, they sought to have him act as a factor for all transactions of the corporation regardless of his judgment as to their prudence, and they removed him as a director in September 1985. Sulkow alleged that defendants' actions constituted a violation of Rule 10b-5, as well as a violation of the Racketeering Influenced Corrupt Organizations Act ("RICO"), 18 U.S.C. §§ 1961-1964 (1982), and breached various common-law and state-law duties to him.
Defendants moved to dismiss the complaint for failure to state a claim and for lack of subject matter jurisdiction, and asked the court to impose sanctions on Sulkow pursuant to Fed. R. Civ. P. 11 for bringing a frivolous lawsuit.
In an oral ruling, the district court dismissed the complaint for failure to state a claim. With respect to the claim under Rule 10b-5, the court found the complaint deficient because "there can be no federal securities claim without securities," and
nowhere in the compliant does the plaintiff state that any securities were actually issued by Crosstown or that the plaintiff purchased such securities. Indeed, the defendants state that they know of no shares having been issued and that it was the responsibility of the plaintiff to cause the issuance of the shares, he being an attorney.
The complaint, therefore, is deficient in pleading a securities violation under Rule 10b-5 ...