which in turn tainted the subsequent board votes to depose and discharge plaintiffs, which in turn triggered the operation of the stock retirement agreements compelling the sale and corporate repurchase of plaintiffs' Babb stock. Ergo, plaintiffs submit, a claim for fraud "in connection with the purchase or sale" of a security has been stated in this case.
The Court does not agree. It is not necessary to engage in lengthy discourse on each of the requisite elements of a cause of action under Rule 10b-5,
or to address each of the parties' multiple and rather sophisticated arguments regarding the existence vel non of such elements in these circumstances. It is sufficient to note that the "in connection with" language of Rule 10b-5 requires a showing of causation between the alleged fraud and a plaintiff's sale (or purchase) of a security, see Affiliated Ute Citizens v. U.S., 406 U.S. 128, 154, 31 L. Ed. 2d 741, 92 S. Ct. 1456 (1972), and to express the Court's basic view that the instant plaintiffs cannot be deemed to have satisfied this causation requirement where the sale of their Babb stock occurred solely as a matter of contractual obligation, by operation of long-standing stockholders retirement agreements between plaintiffs and the company, and not as the result of the allegedly tainted stockholders' vote for directors. Indeed, it is difficult to discern any merit in the contention that defendants' assertedly fraudulent conduct caused the instant securities transaction when it is clear that it was plaintiffs' termination, and not their ouster as officers, that triggered the forced sale and repurchase of their stock. Inasmuch as defendants constituted a majority of Babb's board of directors prior to the 1976 shareholders meeting and therefore could have caused Babb to terminate plaintiffs at any time prior thereto, the sale of plaintiffs' stock was not caused by any fraud that might have affected the results of the annual meeting. Accordingly, the Court would be compelled to find an absence of causation in this case even if it were to accept the rather dubious propositions that the alleged non-disclosures amounted to actionable fraud
and that such fraud caused plaintiffs' ouster as officers of the company.
The above result necessarily follows from an orthodox causation analysis. The causation element of Rule 10b-5 may be evaluated through the application of materiality and reliance tests. See Harnett v. Ryan Homes, Inc., 496 F.2d 832 (3d Cir. 1974). The former is measured by the standard of "whether 'a reasonable man would attach importance [to the undisclosed or misrepresented facts] in determining his choice of action in the transaction in question. '" Rochez Bros. v. Rhoades, supra at 408 (citations omitted). The latter is judged by whether the plaintiff would have acted differently had he known the undisclosed or misrepresented information. Id. at 410-411. Obviously, neither objective materiality nor subjective reliance is present here. Plaintiffs were contractually bound to sell their shares to Babb upon termination of their employment. They had no choice in this matter at the time of the operative events in this case. Clearly, the alleged fraud could not have influenced a reasonable man's decision to sell his stock to Babb after termination when that man had previously committed himself to such a sale; nor could plaintiffs themselves have relied on allegedly fraudulent acts occurring long after plaintiffs had contracted to make the sale in question. Thus, as a matter of traditional analysis, as well as pursuant to a conviction that the relationship between the nondisclosures and the forced sale of plaintiffs' shares is simply too attenuated to present a viable Rule 10b-5 claim, the Court must conclude that the requisite causation is absent in this case.
It is important to recognize in this regard that there has been no allegation of fraud or deceit surrounding plaintiffs' signing of the original stockholders retirement agreements in 1962 or the various amendments thereto since that time. Moreover, the agreements in question clearly appear to be facially valid, and, as a species of contract, are in no way inherently suspect: similar provisions have been upheld by the courts, see, e.g., Clayton v. Clow & Sons, 327 F.2d 382 (7th Cir. 1964), and would appear to be authorized by statute in this Commonwealth (15 Pa. Stat. Annot. § 1613.1C). In sum, the record is utterly devoid of anything to indicate that the stock retirement agreements between plaintiffs and Babb are themselves tainted by fraud or invalid in any respect.
In these circumstances, only the most boundlessly expansive reading of Rule 10b-5 would permit the Court to discern the existence of a cause of action for federal securities fraud. In this vein, I am mindful of the Supreme Court's admonition that Rule 10b-5 must be read "flexibly." Superintendent of Insurance v. Bankers Life & Casualty Co., 404 U.S. 6, 12, 30 L. Ed. 2d 128, 92 S. Ct. 165 (1971). But the very word implies contraction and expansion in light of the circumstances, and clearly does not impart an unlimited scope to the Rule. Id. at 12. Moreover, in evaluating plaintiffs' apparent contention that 10b-5 reaches every securities transaction remotely related in any way to activities alleged to be fraudulent, it is important to consider that the broad exercise of federal jurisdiction, though sometimes clearly necessary or appropriate, amounts to nothing less than the broad assertion of federal power and, as such, never reverberates in a vacuum or impacts merely on an isolated lawsuit. Rather, each such exercise of jurisdiction works a diminution -- both in an immediate, specific sense and as a matter of precedent -- of the state's power to determine controversies arising under its laws, and, in my view, such undertakings should therefore be confined to cases that pose questions of true federal significance. I do not believe that this is such a case.
In Blackett v. Clinton E. Frank, Inc., 379 F. Supp. 941 (N.D. Ill. 1974), the court dismissed a Rule 10b-5 claim on facts strikingly similar to those which obtain herein, stating as follows:
"This is an example of a trend of cases in which the invocation of federal securities laws is wholly inappropriate and wide of the Congressional mark. . . . The vice of the instant complaint is that the plaintiff has engrafted upon a state cause of action a misplaced federal securities law claim which, but for that inappropriate federal gloss, would have been litigated in a local state court." Id. at 944 (citations omitted).
In my view, that language is entirely apposite in the context of the instant case. By any realistic standard of appraisal, plaintiffs' complaint goes to the propriety of their ouster and discharge, and not to the sale or purchase of their Babb stock. They have engrafted a remote wisp of a Rule 10b-5 claim upon a cause of action controlled entirely by state law governing the actions of the board of directors of a Pennsylvania corporation. The "federal gloss" on their lawsuit is simply too thin to invoke the Court's jurisdiction in this matter. Accordingly, the instant action will be dismissed by appropriate Order.
AND NOW, to-wit, this 14th day of July, 1976, in consideration of the foregoing opinion in the above-captioned case, IT IS ORDERED that the complaint filed by plaintiffs at the above civil action number be and the same is hereby dismissed.
Upon consideration of plaintiffs' motion to reopen and for leave to engage in additional discovery, it appearing to the Court that defendant Roof's resignation from Babb, Inc. occurred after trial of this case and could have no bearing on any of the issues before the Court, and, further, that nothing in defendant Roof's letter of resignation indicates that the pretrial issuance to him of 7,500 shares of Babb, Inc. stock occurred in violation of the federal securities laws, IT IS FURTHER ORDERED that said motion to reopen be and the same is hereby denied.
Hubert I. Teitelbaum / United States District Judge
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