Plaintiff argues that no rational debentureholder would have converted debentures because the market value of each debenture was approximately equal to the market value of the shares received in the conversion. But even if this were true, it does not show that the corporation was injured by the transaction. In any event public debentureholders did not act irrationally by changing their investment in the corporation from debt to an equivalent value of equity, measured by the market price.
While plaintiff describes the transaction as a "sale" of United Brands stock at an unfair price, the transaction did not deplete the assets of the corporation. Plaintiff argues that American Financial, by converting its debentures, purchased United Brands stock at a price of approximately $ 13.33 per share knowing that the stock was worth at least $ 19 per share. He says that if United Brands had mentioned the planned tender offer in its announcement of a temporary reduction in the conversion price, United Brands shareholders could have enjoined American Financial's conversion of the debentures at the unfair price.
Perhaps some debentureholders, knowing of the plans for a tender offer, would have been willing to convert each debenture into fewer shares. But if United Brands issued too many shares in the transaction, it was the minority shareholders who conceivably were injured by the dilution of their interests. The corporate entity United Brands, which paid out no money in the transaction, suffered no direct economic injury.
The court recognizes that defendants may have violated Section 10(b) and Rule 10(b)-5. Under the misappropriation theory adopted in this circuit, a person violates Rule 10(b)-5 by misappropriating material nonpublic information in breach of a fiduciary duty and uses that information in a securities transaction. United States v. Chestman, 947 F.2d 551, 566 (2d Cir. 1991) (en banc). The defendants allegedly misused confidential information belonging to United Brands when they converted debentures and purchased shares on the open market.
The issue is whether United Brands has a claim against defendants. This question of standing was not raised in many of the recent cases interpreting the anti-fraud provisions. Those cases were brought as criminal prosecutions or SEC enforcement proceedings. See, e.g., United States v. Newman, 664 F.2d 12, 17 (2d Cir. 1981); Carpenter v. United States, 484 U.S. 19, 108 S. Ct. 316, 98 L. Ed. 2d 275 (1987); United States v. Chestman, 947 F.2d 551 (2d Cir. 1991).
To determine whether a party has standing to raise a claim under Section 10(b), the court looks to federal rather than state law. See Drachman v. Harvey, 453 F.2d 722, 727-730 (2d Cir. 1971).
Plaintiff relies principally on Goldberg v. Meridor, 567 F.2d 209 (2d Cir. 1977), cert denied, 434 U.S. 1069, 55 L. Ed. 2d 771, 98 S. Ct. 1249 (1978). Analyzing whether a corporation can be deceived if its directors are parties to fraud, the court in that case stated the "widely recognized" proposition that:
there is deception of the corporation (in effect, of the minority shareholders) when the corporation is influenced by its controlling shareholder to engage in a transaction adverse to the corporation's interests (in effect, the minority shareholders' interests) and there is nondisclosure or misleading disclosures as to the material facts of the transaction.
Goldberg, 567 F.2d at 217.
The analysis in the Goldberg opinion relates to the meaning of "deception," and does not address the question whether the Section 10(b) claim was properly brought in a derivative action. The court does not interpret that case to find an identity of interest between the minority shareholders and the corporation such that an injury to one, the minority shareholders, is equivalent to an injury to the other, the corporation.
Misappropriation of confidential information belonging to the corporation does not give rise to a Rule 10(b)-5 claim on behalf of the corporation when it was not injured by the fraud. Because recovery under federal securities laws, unlike the common law, is limited by statute to actual damages, Sound Video Unlimited, Inc. v. Video Shack, Inc., 700 F. Supp. 127, 142 (S.D.N.Y. 1988), proof of injury is an element of the claim. See FMC Corp. v. Boesky, 727 F. Supp. 1182, 1188-1193 (N.D.Ill. 1989). In some cases confidential information may consist of trade secrets or other property generated by the business, the misappropriation of which injures the corporation. See Carpenter v. United States, 484 U.S. 19, 26-27, 108 S. Ct. 316, 321, 98 L. Ed. 2d 275 (1987) (Wall Street Journal reporter misappropriated from newspaper securities information before publication). But United Brands has not been deprived of the exclusive use of such property.
The debenture conversion caused no harm to United Brands corporation. It could not recover on its own behalf under Section 10(b) or Rule 10(b)-5. The result is no different when the claim is brought as a shareholder derivative suit.
B. The Open Market Purchases
Plaintiff fares no better to the extent that his federal claim is based on FMI's purchase of shares on the open market. That transaction may have injured public shareholders who sold shares to FMI at $ 15.81 per share when American Financial was planning a tender offer at $ 20 per share. But plaintiff has not shown that United Brands, not a party to the transaction, was thus injured.
Plaintiff relies on Diamond v. Oreamuno, 24 N.Y.2d 494, 301 N.Y.S.2d 78, 248 N.E.2d 910 (1969), and Brophy v. Cities Service Co., 31 Del. Ch. 241, 70 A.2d 5 (1949), in support of his argument that United Brands may require defendants to disgorge the profits earned by trading on the basis of inside information. But those cases involve common law claims. There is no equivalent derivative right under federal law. Haberman v. Murchison, 468 F.2d 1305, 1312 (2d Cir. 1972). Plaintiff's federal claim will be dismissed.
THE STATE LAW CLAIM
Although the court dismisses plaintiff's federal claim, it need not dismiss for lack of jurisdiction a valid pendent state law claim for breach of fiduciary duty. Plaintiff has standing to raise such a claim in federal court because the corporation, although not injured within the meaning of Section 10(b), may nevertheless have suffered an "injury in fact" meeting the constitutional standing requirement as a result of a violation of state common law. FMC Corp. v. Boesky, 852 F.2d 981, 993 & n.23 (7th Cir. 1988), on remand, 727 F. Supp. 1182, 1188-1193 (N.D. Ill. 1989).
But even if defendants acted on confidential information, which defendants dispute, plaintiff has not shown injury to the corporation.
Certain state courts have allowed a corporation to recover from its directors profits made by trading on the basis of inside information although the corporation suffered no direct injury from the breach of fiduciary duty. See Brophy v. Cities Service Co., 31 Del.Ch. 241, 70 A.2d 5 (1949); Diamond v. Oreamuno, 24 N.Y.2d 494, 498-99, 301 N.Y.S.2d 78, 81-82, 248 N.E.2d 910 (1969). Other courts have refused to adopt the "innovative ruling" of the New York Court of Appeals in Diamond. Schein v. Chasen, 313 So.2d 739, 746 (Fla. 1975) (rejecting Diamond approach); Freeman v. Decio, 584 F.2d 186, 196 (7th Cir. 1978) (interpreting Indiana law to reject Diamond). The courts of New Jersey, where United Brands is incorporated, have not stated whether they would adopt the Diamond rule.
The purpose of the common law claim recognized in the Diamond case was to deter the abuse of corporate office at a time when federal remedies had not yet proven effective. Diamond, 24 N.Y.2d at 502-504, 301 N.Y.S.2d at 84-86, 248 N.E.2d 910 . The court, acknowledging the possibility of double liability in theory, stated that in practice it was unlikely that public shareholders would bring a successful federal claim. Id. In any event, the court reasoned, "the mere possibility of such a suit is not a defense, nor does it render the complaint insufficient." Id. at 504, 301 N.Y.S.2d at 86.
In the years since the Diamond decision the class action suit under Rule 10(b)-5 has developed into an effective remedy for insider trading. In addition, under Section 16(b) of the Exchange Act, 15 U.S.C. § 78p, a corporation may recover "short-swing profits" realized by insiders trading in the corporation's stock. Under these circumstances a common law claim to recover profits from insiders presents an actual, and needless, risk of double liability. See Freeman v. Decio, 584 F.2d 186, 191-196 (7th Cir. 1978).
Defendants are also defending themselves elsewhere concerning the transactions at issue here. See In re United Brands Securities Litigation, No. CV 85-5445 (S.D.N.Y., filed 1985). In that case a class of former United Brands shareholders who tendered shares in the 1985 tender offer allege among other things that the defendants violated Section 10(b) and state common law by making material misstatements in the context of the tender offer. There is no reason why other groups of shareholders could not also have brought proper federal claims against United Brands, the directors, and others.
In light of these facts and the developments in federal law since Diamond, the court concludes that the New Jersey courts would not recognize a duplicative claim under common law for recovery of profits from insiders.
The complaint is dismissed. The Clerk of the Court shall enter judgment in favor of defendants.
Dated: Brooklyn, New York
June 2, 1992
EUGENE H. NICKERSON, U.S.D.J.
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