facilities of First Securities and Sheridan Bogan and was aided by offers quoted in the 'pink sheets' of the National Quotation Bureau, on information furnished by the broker defendants.
The amended complaint alleges (paragraph 16) that the purchase of 15,000 shares of Class A Common stock of Manganese for $ 1 a share was a fraud by Selheimer and Shull on Manganese which was being created by them for the purpose of selling its stock publicly at $ 3 per share so that in the after market the shares purchased by them at $ 1 could be disposed of at the higher prices which otherwise would have accrued to the corporation; (paragraph 24) that Selheimer and Shull were insiders who improperly used their position to make a personal profit not enjoyed by their fellow stockholders; and (paragraph 25) the issuance of 15,000 shares to Selheimer and Shull and 3,000 shares to Selheimer's relatives and the subsequent sale of those shares of stock by Selheimer, First Securities Corporation and Sheridan Bogan constituted a fraudulent scheme perpetrated on Manganese in violation of fiduciary duties and in violation of Section 10(b).
For the purpose of these motions, I accept as true the allegations of the amended complaint. I assume further, that the amended complaint sufficiently alleges that defendants engaged in deceptive or manipulative practices in connection with the sale of Manganese stock to the public. The issue here is whether plaintiff has alleged facts sufficient to support a claim on behalf of his predecessor in interest, Manganese. In order for plaintiff to state a claim under Section 10(b) and Rule X-10B-5, he must show that Manganese was a defrauded seller. Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2nd Cir., 1952). It is not sufficient to show that a third person, in a separate transaction, was defrauded. Slavin v. Germantown Fire Ins. Co., 174 F.2d 799 (3rd Cir., 1949).
The allegations of the amended complaint, hereinabove outlined, do not set forth any 'manipulation' or 'deception' practiced against Manganese by the defendants in the purchase of 15,000 shares of stock from Manganese. Such allegations as fall within the proscription of Section 10(b) and Rule X-10B-5 pertain to frauds practiced on those third persons who subsequently purchased the stock of Shull, Selheimer and Selheimer's relatives. The fraud perpetrated on such purchasers, without more, does not constitute fraud against the corporation, and the rights which may exist in those purchasers against the defendants under Section 10(b) and Rule X-10B-5 do not accrue to the issuing corporation's benefit. The bald assertion that the purchase of initial issue shares at $ 1 with the intention to sell them later at a profit was a 'fraud' on Manganese does not furnish a sufficient factual foundation for a charge of fraud. The absence of factual averments to support such a charge is understandable for it is hard to see how the corporation was defrauded or harmed by what is alleged to have been done by the defendants. If anything, Managanese, however innocent, was a beneficiary of the deception practiced on the public in the sale of its stock at the price of $ 3 and more per share.
The inability to show harm to the issuing corporation notwithstanding fraud practiced on others, was one of the touchstones of decision in Slavin v. Germantown Fire Ins. Co., supra. In that case plaintiffs, in a shareholders' derivative suit, alleged a cause of action under Section 10(b) and Rule X-10B-5. The basis for the claim was the alleged fraud perpetrated by one Rosenlund in securing from third persons warrants to purchase stock in the corporation. The court rejected the contention that the corporation was entitled to relief under Section 10(b) and Rule X-10B-5, stating at page 807:
'Dominating the plaintiffs' general argument are references to fraud committed by Rosenlund upon his assignors, and the creation, by Rosenlund, of a situation making statements in the prospectus false. With respect to the former, obviously the right of redress, if any, belongs to the assignors, and not to the corporation. With respect to the latter, similarly, the right of redress, if any, would seem to belong to those who purchased the securities.'
Nor does it help for plaintiff to allege that Selheimer and Shull were 'insiders' who breached fiduciary duties owed to Manganese
and profited thereby. Section 10(b) and Rule X-10B-5 were not designed for that purpose as pointed out by Judge Augustus Hand in Birnbaum v. Newport Steel Corp., supra. Judge Hand reviewed the history and purpose of Rule X-10B-5, pointing out that prior to its adoption there was no prohibition against fraud on a seller of securities by a purchaser unless the purchaser was a broker or dealer. The rule was adopted only to close that loophole. In answer to the contention that Section 10(b) and Rule X-10B-5 should not be so narrowly construed, Judge Hand said, 193 F.2d at pages 463-464:
'* * * appellants argue that such an interpretation of the Rule is too narrow to carry out the broad purpose of the Act to protect investors 'from exploitation by corporate insiders.' * * * We do not doubt that Congress was at least partially motivated by such a purpose in enacting the Securities Exchange Act of 1934, * * * However, the precise question here is whether Section 10(b) of that Act and the Commission's Rule X-10B-5 were the means chosen to further that end, and we are of the opinion that the legislative 'history' and 'purpose' quoted by appellants are not persuasive that they were. When Congress intended to protect the stockholders of a corporation against a breach of fiduciary duty by corporate insiders, it left no doubt as to its meaning. Thus Section 16(b) of the Act of 1934, * * * expressly gave the corporate issuer or its stockholders a right of action against corporate insiders using their position to profit in the sale or exchange of corporate securities. The absence of a similar provision in Section 10(b) strengthens the conclusion that that section was directed solely at that type of misrepresentation or fraudulent practice usually associated with the sale or purchase of securities rather than at fraudulent mismanagement of corporate affairs, and that Rule X-10B-5 extended protection only to the defrauded purchaser or seller.'
Here the amended complaint fails to place plaintiff's predecessor in the category of defrauded seller and it is, therefore, fatally deficient. Plaintiff's difficulty throughout has been that he was misconstrued the scope and purpose of Section 10(b) and Rule X-10B-5. His construction would entitle Manganese, the issuing corporation, to claim the fruits of the fraud and deception which he contends was practiced by defendants on purchasers of Manganese stock. I read no intent in the legislation or the Rule to confer such a benefit on the issuing corporation.
Defendants' motions to dismiss will be granted.