The opinion of the court was delivered by: LORD, III
JOSEPH S. LORD, III, Chief Judge.
Plaintiffs, present and former shareholders of Penn Central Company, move pursuant to F.R. Civ. P. 23 for an order declaring that the eighteen above-captioned actions may be maintained as class actions. Defendants
cross-petition for partial summary judgment in fourteen of the actions on the grounds that (1) the proposed class includes persons who have no cause of action under the federal securities law and (2) plaintiffs have failed to state a claim upon which relief can be granted.
Plaintiffs' complaints assert both derivative and direct claims against Penn Central companies, their present and former directors and officers, accounting firms, brokerage houses and others. We have previously dismissed plaintiffs as parties with respect to all derivative claims on behalf of Penn Central Co. in all cases on M.D.L. Docket No. 56 and with respect to all derivative claims on behalf of Penn Central Transportation Co. ("Transportation Co.") in thirteen actions. In Re Penn Central Securities Litigation, 335 F. Supp. 1026 (E.D. Pa. 1971). Therefore we will consider plaintiffs' and defendants' motions with reference only to those complaints or portions of complaints which allege direct claims by shareholders against defendants.
Plaintiffs' complaints basically assert the following direct claims:
During the period between February 1, 1968 and June 21, 1970,
defendants prepared and filed materials with the Securities and Exchange Commission and the New York Stock Exchange and released information to shareholders and the public concerning the financial condition and operations of Penn Central Companies
which were materially false and misleading. The various reports, statements, documents and press releases were intended to and did inflate the market price of Penn Central Co. stock and affect plaintiffs and the investing public in their decisions to purchase, sell and hold Penn Central Co. stock. Plaintiffs further allege that during the period between January, 1969 and May, 1970, various individual defendants who had knowledge of confidential material information concerning the deteriorating financial condition of the Penn Central companies sold substantial numbers of shares of stock without disclosing this information to the public. Finally, plaintiffs allege that during this period defendants issued certain false and misleading proxy statements which were intended to and did induce plaintiffs to vote in favor of management proposals. Defendants' actions are alleged to violate various provisions of the federal securities law including §§ 5, 11, and 17(a) of the Securities Act of 1933 ("Securities Act") [ 15 U.S.C.A. §§ 77e, 77k, and 77q(a)] and §§ 9, 10(b), 13(a), 14, and 18(a) of the Securities Exchange Act of 1934 ("Exchange Act") [ 15 U.S.C.A. §§ 78i, 78j(b), 78m(a), 78n, and 78r(a)].
Plaintiffs include individuals who purchased and/or sold Penn Central Co. stock in the open market during the period of defendants' alleged illegal acts and individuals who acquired their shares before and held them throughout this period ("holders"). Plaintiffs have proposed several definitions of the class which include holders as members. In their consolidated motion, defendants move for partial summary judgment on the ground that §§ 11(a) and 17(a) of the Securities Act and §§ 9(a) and 10(b) of the Exchange Act provide causes of action only for purchasers and sellers and therefore holders have not alleged a cause of action against defendants who are entitled to judgment as a matter of law. Defendants also maintain that § 13(a) of the Exchange Act does not provide a private right of action and therefore no plaintiff has a cause of action under this section. Finally, in their supplemental motions, defendants contend that plaintiffs have failed to state a cause of action under § 14(a) of the Exchange Act.
I. Purchaser-Seller Requirement of § 10(b)
Section 10(b) and Rule 10b-5, 17 C.F.R. § 240-10b-5, make unlawful the use of manipulative and deceptive devices "in connection with the purchase or sale of any security." In Birnbaum v. Newport Steel Corp., 193 F.2d 461, 464 (C.A. 2, 1952), cert. denied, 343 U.S. 956, 72 S. Ct. 1051, 96 L. Ed. 1356 (1952), the Second Circuit held that § 10(b) "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 10b-5 "extended protection only to the defrauded purchaser or seller." The developing case law on § 10(b) has not restricted the type of fraud prohibited to "practices usually associated with the sale or purchase of securities" but has expanded the Birnbaum definition to include "all fraudulent schemes in connection with the purchase or sale of securities, whether the artifices employed involve a garden type variety of fraud, or present a unique form of deception." A.T. Brod & Co. v. Perlow, 375 F.2d 393, 397 (C.A. 2, 1967); Superintendent of Insurance of State of N.Y. v. Bankers Life & Casualty Co., 404 U.S. 6, 92 S. Ct. 165, 30 L. Ed. 2d 128 (1971). Similarly the courts have given a liberal construction to what constitutes a purchase or sale for purposes of § 10(b). For example, an exchange of shares in connection with a merger or sale of assets has been held to be "in connection with the purchase or sale," SEC v. National Securities, Inc., 393 U.S. 453, 89 S. Ct. 564, 21 L. Ed. 2d 668 (1969), Dasho v. Susquehanna Corp., 380 F.2d 262 (C.A. 7, 1967), cert. denied, sub nom. Bard v. Dasho, 389 U.S. 977, 88 S. Ct. 480, 19 L. Ed. 2d 470 (1967); the issuance by a corporation of its own shares has been held to be a "sale" to which § 10(b) applies, Hooper v. Mountain States Securities Corp., 282 F.2d 195 (C.A. 5, 1960), cert. denied 365 U.S. 814, 81 S. Ct. 695, 5 L. Ed. 2d 693 (1961), Ruckle v. Roto American Corp., 339 F.2d 24 (C.A. 2, 1964); a minority shareholder in a company which underwent a short form merger has been held to be a forced seller even though he had not accepted defendant's tender offer or surrendered his stock, Vine v. Beneficial Finance Co., 374 F.2d 627 (C.A. 2, 1967), cert. denied, 389 U.S. 970, 88 S. Ct. 463, 19 L. Ed. 2d 460 (1967); a seller who was fraudulently induced to postpone his sale has been held to have a cause of action under § 10(b), Stockwell v. Reynolds & Co., 252 F. Supp. 215 (S.D.N.Y. 1965); and § 10(b) has been held to permit recovery for fraud in connection with contracts to purchase or sell securities even though the contracts are never consummated by actual purchases or sales, Commerce Reporting Co. v. Puretec, Inc., 290 F. Supp. 715 (S.D.N.Y. 1968).
The courts, however, have refused repeated requests to ignore the language of § 10(b) and discard the purchaser-seller requirement altogether. See Supt. of Insurance of State of N.Y. v. Bankers Life, supra; contra Tully v. Mott Supermarkets, Inc., 337 F. Supp. 834 (D.N.J. 1972).
"The courts have repeatedly held that one who retains his stock cannot bring himself under the provisions of Section 10(b); he must be a defrauded [purchaser or] 'seller' to qualify." Morrow v. Schapiro, 334 F. Supp. 399, 401 (E.D. Mo. 1971).
We conclude that a plaintiff seeking to recover damages
pursuant to § 10(b) and Rule 10b-5 must establish that under the expanded definitions of purchase, sale and fraud he has suffered injury as a result of deceptive practices in connection with his purchase or sale of securities. See Simmons v. Wolfson, 428 F.2d 455 (C.A. 6, 1970), cert. denied, 400 U.S. 999, 91 S. Ct. 459, 27 L. Ed. 2d 450 (1971); Iroquois Industries, Inc. v. Syracuse China Corp., 417 F.2d 963 (C.A. 2, 1969), cert. denied, 399 U.S. 909, 90 S. Ct. 2199, 26 L. Ed. 2d 561 (1970); Greenstein v. Paul, 400 F.2d 580 (C.A. 2, 1968); Edelman v. Decker, 337 F. Supp. 582 (E.D. Pa. 1972).
Plaintiffs in a number of actions before us acquired stock in a Penn Central company before and held it throughout the period of the defendants' alleged illegal activity. Defendants argue that these plaintiffs ("holders") do not have a cause of action under § 10(b) or Rule 10b-5 because they are not defrauded purchasers or sellers of any security. Holders maintain that they do qualify as purchasers and sellers because they exchanged their stock during the period in question in connection with two mergers; the February 1, 1968 merger of the Pennsylvania and New York Central Railroads ("1968 merger") and the October 1, 1969 "upwards merger" which resulted in the present corporate structure of Penn Central Co. and Transportation Co. ("1969 reorganization"). See In re Penn Central Securities Litigation, supra.
The exchange of shares pursuant to a merger has been held to constitute a purchase of new securities and a sale of the surrendered securities within the meaning of § 10(b). SEC v. National Securities, Inc., supra ; Mader v. Armel, 402 F.2d 158 (C.A. 6, 1968), cert. denied sub nom. Young v. Mader, 394 U.S. 930, 89 S. Ct. 1188, 22 L. Ed. 2d 459 (1969); Dasho v. Susquehanna Corp., supra ; Gerstle v. Gamble-Skogmo, Inc., 332 F. Supp. 644 (E.D.N.Y. 1971); Simon v. New Haven Board & Carton Co., 250 F. Supp. 297 (D. Conn. 1966); H. L. Green v. Childree, 185 F. Supp. 95 (S.D.N.Y. 1960). Defendants argue that this principle does not apply to the case before us because (1) holders do not allege that defendants violated the securities law in connection with the 1968 merger and (2) the 1969 "upwards merger" is not the type of merger to which § 10(b) applies.
Defendants' motions raise the issue of what factors qualify a merger as a purchase or sale for the purpose of § 10(b). In National Securities, the SEC alleged that defendants had made various fraudulent misrepresentations in proxy materials sent to the stockholders of an insurance company ("Producers") in seeking their approval of the merger of Producers with defendants' insurance company. The Supreme Court was faced with the issue of whether the purchase and sale requirement of § 10(b) extended statutory coverage to fraud in connection with stockholders' approval of a merger. The Court concluded that it did.
"* * * The deception furthered a scheme which resulted in their losing their status as shareholders in Producers and becoming shareholders in a new company. Moreover, by voting in favor of the merger, each approving shareholder individually lost any right under Arizona law to obtain an appraisal of his stock and payment for it in cash. * * * Whatever the terms 'purchase' and 'sale' may mean in other contexts, here an alleged deception has affected individual shareholders' decisions in a way not at all unlike that involved in a typical cash sale or share exchange. The broad antifraud purposes of the statute and rule would clearly be furthered by their application to this type of situation. Therefore, we conclude that Producers' shareholders 'purchased' shares in the new company by exchanging them for their old stock." SEC v. National Securities, Inc., supra, 393 U.S. at 467, 89 S. Ct. at 572.
The Exchange Act was designed
In National Securities, the Supreme Court concluded that a stockholder's exchange of shares pursuant to a merger is similar in both character and consequence to a purchase or sale of securities and therefore the purpose of the Exchange Act is furthered by applying § 10(b) to this type of securities transaction. The open market concept of the Exchange Act seeks to insure that investors make decisions concerning their securities transactions on the basis of full and accurate information about corporate affairs. In every case which has held that fraud or misrepresentation in connection with a merger is actionable under § 10(b), the complaint has alleged that misrepresentations in corporate releases, particularly proxy materials, have influenced stockholders to approve the merger in question. We would, therefore, expect that claims for violations of the securities law in connection with the 1968 merger would focus on the manner in which stockholder approval was obtained.
In order for plaintiffs to state a cause of action under § 10(b) in connection with the 1968 merger, plaintiffs must allege that defendants engaged in fraudulent activities which induced plaintiffs to exchange their shares pursuant to the merger.
None of the complaints which are the subject of defendants' motions for summary judgment states such a claim. Only two complaints, Cook v. Penn Central, Civil Action No. 70-2505, and Robinson v. Penn Central, Civil Action No. 70-2010, allege that defendants engaged in any fraudulent activity before the merger became effective on February 1, 1968; however, neither complaint alleges that any action of defendants injured holders in connection with the 1968 merger.
The Cook complaint alleges that beginning in 1967 and continuing through May, 1970, defendants issued misleading statements concerning the operation of the Pennsylvania Railroad Co., the New York Central Railroad Co., and the surviving Penn Central Co. These statements induced plaintiffs Cook and Small to purchase stock in the New York Central Railroad Co. in September and October, 1967 and in the Penn Central Co. in November and December, 1968.
The complaint does allege that beginning in 1967 defendants described "the anticipated advantageous affects [sic] of the merger * * * in such a way as to be misleading." (para. 11). However, plaintiffs do not claim that these statements caused them to approve the 1968 merger (assuming they held New York Central stock when the stockholders voted to approve the merger) or exchange their shares pursuant thereto. Rather plaintiffs claim that they purchased stock in the open market in reliance upon the truth of defendants' statements concerning the merger and the operations of the railroad companies. Furthermore, they define the class they seek to represent as
"* * * the class of stockholders of Penn Central who purchased stock of Penn Central in the open market, and retained or sold such stock being mislead [sic] to their damage by the material caused to be published and disseminated as hereinafter set forth, or by the artifically [sic] inflated market prices thereof at the time of purchase." Cook Complaint para. 8 (emphasis added).
The Robinson complaint alleges that "since the date of the approval of the merger" (January 15, 1968 according to paragraph 8 of the complaint) defendants engaged in enumerated fraudulent actions which violate § 10(b). See Count II, Robinson Complaint. It would seem obvious that if the fraud occurred after the merger was approved, it could not in any way be causally connected with the merger. Although the Robinson complaint is quite lengthy and specific, it does not contain any allegation which even suggests that plaintiffs were injured by fraud in connection with the 1968 merger. We recognize that a number of plaintiffs exchanged their stock in the New York Central for stock in the company created by the 1968 merger on February 1, 1968; however, this fact does not state a cause of action under § 10(b) absent any allegation that the exchange was the product of fraud practiced by defendants.
We therefore conclude that plaintiffs who were not open market purchasers or sellers during the period of defendants' alleged illegal activity as defined in plaintiffs' complaints have failed to state a cause of action under § 10(b) and Rule 10b-5 in connection with the 1968 merger. We note that the reply memorandum in support of defendants' supplemental motion states that the 1968 merger was approved by the shareholders of the respective railroads in 1962 and again in 1966. It may well be that there is no factual or legal basis for any cause of action under § 10(b) in connection with the 1968 merger. However, we cannot so conclude on the basis of pleadings and affidavits before us.
Plaintiffs have repeatedly indicated that they intend to file a consolidated complaint, and on December 6, 1971, we specifically granted leave to plaintiffs to file such a complaint. To date the complaint has not been filed. Despite plaintiffs' delay, we believe that the complex and substantial nature of their claims require that plaintiffs be given the opportunity to assert effectively all of their possible claims. We will therefore grant defendants' motion for summary judgment as to holders with respect to § 10(b) claims in connection with the 1968 merger without prejudice to their right to amend their pleadings.
Defendants maintain that the 1969 reorganization which resulted in the present corporate organization was a technical change in corporate structure with no economic consequences. Therefore, defendants argue that stockholders in approving the reorganization were not required to make the type of significant investment decision which § 10(b) and Rule 10b-5 are intended to protect and the reorganization does not qualify as a purchase or sale for the purposes of the section and the rule.
Plaintiffs contend that the reorganization resulted in stockholders "owning an equity security with considerable differences in rights, restrictions and priorities, in a different entity with a different asset and earning (or loss) structure, and in connection with a represented management program of diversification." Plaintiffs' Memorandum, p. 26. Plaintiffs conclude that the stockholders were required to make the type of investment decision within the statutory coverage of § 10(b); and therefore holder-plaintiffs do have a cause of action for fraud in connection with the 1969 reorganization.
This is a question of first impression. All decisions which have dealt with the application of § 10(b) and Rule 10b-5 to mergers have involved traditional merger situations in which two active corporations combine so that there is a change in the corporate assets represented by each share of stock. In voting on such a merger, stockholders are required to make decisions regarding the merits of transactions in securities. In order to determine whether the 1969 reorganization involved a change in the nature of the corporation and the rights of the stockholders comparable to that involved in a traditional merger or a purchase or sale, we must examine the character of the 1969 reorganization.
The reorganization plan was proposed by Railroad
(the surviving corporation of the 1968 merger) in order to further the company's program of diversification into non-railroad activities. On April 1, 1969, Railroad caused two new corporations to be formed under the Pennsylvania Business Corporation Law: Penn Central Holding Company ("Holding Co.") and PCT Company. Holding Co.'s directors and officers were all directors and officers of Railroad. Holding Co. was authorized under its articles of incorporation to issue 125 million shares; however, before the reorganization plan was consummated, Holding Co. had issued only three shares of common stock. These shares were purchased for one dollar ($1) each by Stuart T. Saunders, Alfred E. Perlman and David C. Bevan, all of whom were directors ...