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IN RE PENN CENT. SECS. LITIG.

November 19, 1973

In re Penn Central Securities Litigation; Byron Williams et al.
v.
Pennsylvania Co. et al.


Joseph S. Lord, III, District Judge.


The opinion of the court was delivered by: LORD, III

JOSEPH S. LORD, III, District Judge:

 Intervenor-plaintiffs Lawler and Foster ("plaintiffs"), who have filed a Second Amended Complaint on behalf of all plaintiffs, are shareholders of Great Southwest Corporation ("GSC"). *fn1" Plaintiffs allege that defendants, by virtue of numerous acts and omissions, have violated §§ 10(b) and 14(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j and n and Rules 10b-5 and 14a-9 promulgated by the Securities and Exchange Commission under those sections, 17 C.F.R. 240.10b-5 and 17 C.F.R. 140.14a-9, as well as § 1 of the Sherman Anti-trust Act, 15 U.S.C. § 1, and §§ 4 and 8 of the Clayton Antitrust Act, 15 U.S.C. §§ 15 and 19. They have also brought state law claims under the doctrine of pendent jurisdiction. Some of the claims asserted by plaintiffs are brought derivatively on behalf of GSC; others, for which they have moved for a class action determination, are brought by plaintiffs as purported representatives of a class of GSC shareholders.

 This complaint is now the subject of several motions, either filed or joined in by most defendants, to dismiss pursuant to F.R. Civ. P. 12(b)(6) and 12(b)(1), to strike pursuant to F.R. Civ. P. 12(f) and for a more definite statement under F.R. Civ. P. 12(e) and Local Rule 45 of this court. Certain defendants have also moved to dismiss for lack of jurisdiction over the person, improper venue and insufficiency of process, F.R. Civ. P. 12(b)(2), 12(b)(3) and 12(b)(4).

 The defendants named in the complaint are: Pennsylvania Company ("Pennco"), a wholly-owned subsidiary of the Penn Central Company; GSC, a Texas-based land development company; Glore Forgan Wm. R. Staats, Inc., an investment banking firm, and its corporate successors Glore Staats Corporation and DuPont-Glore Forgan, Inc. (collectively referred to herein as "Glore"); Glore Forgan Staats & Company ("Glore Forgan Staats"), an Illinois investment partnership; 51 individual defendants who are or have been affiliated with Glore or Glore Forgan Staats, and/or have been distributees of their assets or of GSC capital stock obtained by Glore Forgan Staats as the result of an alleged merger between GSC and Macco Corporation ("Macco"), a California land development corporation, see infra, § III; 14 past directors of GSC; Peat, Marwick, Mitchell & Co. ("Peat, Marwick"), a public accounting firm which certified GSC's financial statements during the period relevant to this litigation; and two banks named only in connection with one common law fraud allegation.

 I. Motion to Dismiss all Claims Brought Derivatively on Behalf of GSC for Failure to Comply with F.R. Civ. P. 23.1.

 Defendants Gorman and Rauch, joined by defendants Carter, Kyger and Stewart, have moved to dismiss all of plaintiffs' derivative claims for failure to state with the particularity required by Rule 23.1 their reasons for not demanding that the GSC Board of Directors prosecute those claims.

 Because "it is normally the directors, not the shareholders, who conduct the affairs of the company," IN RE KAUFFMAN MUTUAL FUND ACTIONS, 479 F.2d 257, 263 (C.A. 1, 1973), the directors, not the shareholders, ordinarily conduct litigation on the corporation's behalf. In order that the directors may have the opportunity to perform their customary function, a shareholder seeking to press a claim on behalf of the company must first demand that the directors take the action desired. Only in circumstances where the demand would be futile or obviously unavailing is a shareholder excused from making such a demand. See generally Note, "Demand on Directors and Shareholders as a Prerequisite to a Derivative Suit," 73 Harv. L. Rev. 746 (1960); 3B MOORE'S FEDERAL PRACTICE para. 23.1.19 (2nd ed., 1969). It has long been settled law, now codified in Rule 23.1, that a shareholder who fails to make a demand on the directors must allege the reasons for his failure "with particularity." E.g., Hawes v. Oakland, 104 U.S. 450, 461, 26 L. Ed. 827 (1881).

 Plaintiffs have not demanded that the directors bring the derivative claims. Their reasons for not demanding action, which moving defendants argue are not stated with sufficient particularity, appear in para. 7(c) of the complaint:

 Courts have generally been liberal in excusing demand and have normally applied to Rule 23.1 the flexible standards of modern notice pleading. Liboff v. Wolfson, 437 F.2d 121 (C.A. 5, 1971); deHaas v. Empire Petroleum Co., 435 F.2d 1223 (C.A. 10, 1970). However, the First Circuit has recently rejected the liberal approach of other courts, choosing instead to construe Rule 23.1's requirement of particularity as a zone of specificity carved out of the world of modern notice pleading. In re Kauffman Mutual Funds Actions, supra.

 
"Rule 23.1 is not an ordinary, but an exceptional rule of pleading, serving a special purpose, and requiring a different judicial approach. * * * [It] is clear that the 'particularity' must appear in the pleading itself; the stockholder may not plead in general terms, hoping that, by discovery or otherwise, he can later establish a case." 479 F.2d at 263.

 Even a full acceptance of the First Circuit's reading of Rule 23.1 does not, however, lead inexorably to dismissal of the derivative claims asserted here. The holding of Kauffman relevant to the complaint before us is that "[ an ] allegation of domination and control, unsupported by underlying facts, does not satisfy the requirement of particularity. " 479 F.2d at 264. In Kauffman the underlying facts not only did not support but directly contradicted the plaintiffs' allegations that the board of directors of the mutual funds on whose behalf the plaintiffs sought to sue was under the domination and control of certain investment advisers, named as defendants. The plaintiffs apparently claimed that the board was in the hands of directors affiliated with the defendant investment advisers; the court, however, found that there could not be such domination and control because it was "conceded" that "the self-interested, affiliated director-defendants constitute less than a majority of the membership of the board." Id. Although the First Circuit found the Kauffman complaint defective, it did not hold that simple allegations of domination and control are invariably insufficient. Such allegations, according to Kauffman, may meet the requirements of Rule 23.1 if facts are alleged in the complaint which lend support to the protestations of domination and control.

 Underlying facts supporting plaintiffs' otherwise conclusory allegations of Pennco's domination and control of the GSC board do appear in the complaint before us and we conclude that plaintiffs have met the standards of Rule 23.1. *fn2" The dual service of Mr. Palmieri is not conclusive evidence that Pennco so controls the GSC directors that demand would be futile, since demand is to be made on the directors and not on the chief executive officer. It does suggest, however, that if the GSC directors would have their company run by the man who runs Pennco, the main defendant in this litigation, they would not be overly sympathetic with a shareholder demand that they also sue Pennco. The crucial fact alleged in the complaint, though, is that Pennco controls the vast majority of GSC's total voting stock. In 1964, Pennco came into control of over 80% of GSC's outstanding shares. (Complaint, para. 12). Although the complaint contains no allegations with respect to Pennco's current ownership and control of GSC stock, it is reasonable to infer, especially for purposes of deciding whether a complaint may withstand a motion to dismiss, that Pennco retains control of a majority of GSC's voting stock. *fn3" A majority shareholder, particularly one owning a very substantial majority of the corporation's stock, has complete control of the selection of directors. The fact of Pennco's position as an overwhelmingly dominant shareholder is sufficient to support a conclusion that Pennco dominates the GSC board, whoever its members might be, and therefore that a demand on those directors to sue the stockholder that put them in their positions would be futile. What a judge said long ago in another case applies with equal force here: "Every sensible man, out of a court of justice, knows would never be complied with." Young v. Alhambra Min. Co., 71 Fed. 810, 812 (N.D. Ill. 1895), quoted in 3B Moore's Federal Practice para. 23.1.19 at 23.1-255 (2nd ed., 1969).

 II. Motions to Dismiss Count I

 In Count I, plaintiffs seek treble damages under § 4 of the Clayton Act for harm suffered by GSC as the result of alleged violations by Pennco of § 1 of the Sherman Act and § 8 of the Clayton Act.

 The facts alleged in Count I, and accepted for the purposes of a motion to dismiss, are these. In 1964 Pennco acquired 80.12% of the total voting stock of GSC. Shortly after Pennco acquired the GSC stock, defendants Saunders, Bevan and Gerstnecker, all officers and/or directors of Pennco and its parent, were placed on the GSC board of directors, as was defendant Hodge of Glore, who at the same time served as an investment adviser to Pennco and its parent, Penn Central Company. In 1965 Pennco acquired 99% of the total voting stock of Macco, which until then had been a closely held general real estate development company in California. Saunders, Bevan, Gerstnecker and Hodge were then placed on the Macco board, as was defendant Angus Wynne, Jr., who was also a director of GSC. Then in late 1965 or early 1966, Pennco gained control of 51% of the outstanding voting capital stock, as well as an option to purchase more, of Arvida Corporation ("Arvida") of Florida, yet another general real estate development company. Saunders, Bevan, Gerstnecker, Hodge and Angus Wynne, Jr. were then elected to the Arvida board.

 Plaintiffs allege that Pennco, "aided and abetted by" Glore Forgan Staats (which owned the Macco stock not controlled by Pennco), Glore, and the past GSC directors, conspired to allocate markets, territories and customers among GSC, Macco and Arvida in violation of § 1 of the Sherman Act. Two allocations of territories and markets are alleged. The first is that Pennco, after acquiring more than 80% of GSC's stock and 99% of Macco's, forced GSC not to compete with Macco in California by ordering GSC to "deactivate" Great Southwest Pacific Corporation, a wholly-owned subsidiary it had formed to enter the California real estate development market. The second alleged territorial restraint was Pennco's instructions to GSC not to compete with Arvida in Georgia, where Arvida operated and where GSC had begun construction of a thematic amusement park, and in Florida, where GSC is alleged to have "reluctantly" been granted permission by Pennco to continue a previously established mobile-home manufacturing division on the condition that it engage in no other real estate development activities in Florida.

 The question plaintiffs raise is not the normal intra-enterprise conspiracy problem, namely, whether a parent and its subsidiary or subsidiaries, acting jointly and directing their actions against outsiders to the corporate family, constitute the requisite multiplicity of actors necessary to form a conspiracy in restraint of trade and hence whether agreements between members of the corporate family directed against strangers are actionable under the Sherman Act. E. g., Kiefer-Stewart Co. v. Seagram & Sons, Inc., 340 U.S. 211, 95 L. Ed. 219, 71 S. Ct. 259 (1951); Timken Roller Bearing Co. v. United States, 341 U.S. 593, 95 L. Ed. 1199, 71 S. Ct. 971 (1951); see generally Willis and Pitofsky, "Antitrust Consequences of Using Corporate Subsidiaries," 43 N.Y.U.L. Rev. 20 (1969); Handler, "Through the Antitrust Looking Glass -- Twenty-first Annual Antitrust Review," 57 Cal. L. Rev. 182 (1969). Here, no conspiracy directed at outsiders to the corporate family is alleged, either between a parent and its subsidiaries or between subsidiaries of the same parent. The allegations here amount instead to a charge that the parent Pennco, which through majority ownership of the stock of each, (a) instituted policies for its three real estate development subsidiaries which had the effect of restraining GSC from competing with Macco in California and Arvida in Georgia and Florida; and (b) was aided and abetted in this endeavor by the directors it had presumably installed on GSC's board and by Glore Forgan Staats, the owner of the Macco stock not owned by Pennco. The question here is whether Pennco's alleged allocation of territories and markets among its subsidiaries was merely internal management of a single business enterprise or was a conspiracy in restraint of trade in contravention of the Sherman Act. We conclude it was the former.

 Pennco owned 99% of the common stock of Macco, over 80% of GSC's and 51% of Arvida's. Through this majority ownership it was able to elect the directors it desired and through them could put into action policies which would contribute to the corporate health of the whole Pennco enterprise. One of these policies was apparently the decision that it would be in the corporate family's best interest to have Macco operating in California, GSC mainly in Texas, and Arvida chiefly in Florida and Georgia. This decision involves the perfectly legitimate determination that it would not be in the best interests of the Pennco family to have each of its three subsidiaries competing against one another in every market in which any of them had previously operated. According to the allegations of the complaint, the other, vastly smaller, owner of Macco's stock agreed with this policy decision, as did the directors of GSC. We fail to see why this must be viewed as anything other than the normal internal management of a corporation which has chosen to operate through separately incorporated subsidiaries. The fact that this management decision resulted in GSC's not operating in California and carrying on limited activities in Georgia and Florida does not mean that there was a combination in violation of § 1 of the Sherman Act. As another court has said with regard to allegations that a decision between a parent and its wholly-owned subsidiary constituted a refusal to deal in contravention of § 1:

 
"Assuming that there were some discussions between the parent and its subsidiary, which resulted in a refusal to sell to plaintiff, the court cannot conclude that such discussions constitute a combination within the meaning of Section 1 of the Sherman Act or that they represent more than internal dialogue leading to a decision on the part of a single business unit." Beckman v. Walter Kidde & Co., 316 F. Supp. 1321, 1326 (E.D.N.Y. 1970), aff'd, 451 F.2d 593 (C.A. 2, 1971), cert. denied, 408 U.S. 922, 33 L. Ed. 2d 333, 92 S. Ct. 2488 (1972).

 We do not mean to suggest in any way that agreements in restraint of trade between a parent and its subsidiary or between subsidiaries are beyond the purview of the Sherman Act. Various pronouncements of the Supreme Court, Perma-Life Mufflers, Inc. v. International Parts Corp., 392 U.S. 134, 20 L. Ed. 2d 982, 88 S. Ct. 1981 (1968), Timken Roller Bearing, supra, Kiefer-Stewart, supra, make it clear that common ownership or control does not provide separately incorporated companies with immunity from the Sherman Act. But we need not enter the controversy of how extensive the reach of the antitrust laws may be, for that issue is not before us. All that we have here is a decision by a parent as to the conduct of its subsidiaries' businesses, which is not a § 1 violation.

 We are of course mindful that summary procedures must be used sparingly in antitrust cases. Poller v. Columbia Broadcasting System, 368 U.S. 464, 7 L. Ed. 2d 458, 82 S. Ct. 486 (1962). Here, though, the corporate structures and intercorporate relationships are fixed. And it is on the basis of that immutable situation that we hold as a matter of law that no claim under the Sherman Act is stated. Thus, it appears from the face of the complaint that no conceivable set of facts could be alleged which would state a claim for relief under the antitrust laws, and we can see little point to denying the motions to dismiss solely to permit plaintiffs to proceed with what would necessarily be extensive discovery in "the vague hope that something may turn up at trial." Perma Research and Development Co. v. Singer Co., 410 F.2d 572, 578 (C.A. 2, 1969). Such an empty gesture would be particularly injurious to the speedy adjudication of the parties' rights in ...


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