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KETCHUM v. GREEN

IN THE UNITED STATES DISTRICT COURT FOR THE WESTERN DISTRICT OF PENNSYLVANIA


July 14, 1976

Chandler G. KETCHUM and Harold S. Bigler, Plaintiffs,
v.
Edward J. Green, HARRY B. HILTZ, JOHN C. MCCUTCHEN, DAVID G. ROOF, WILLIAM M. WAUGH, JR., RONALD B. LIVINGSTON, WILLIAM M. STEELE and BABB, INC., Defendants

The opinion of the court was delivered by: TEITELBAUM

This is an action for injunctive relief arising out of an internal struggle for control of Babb, Inc., a Pennsylvania corporation engaged primarily in the insurance brokerage business in Pittsburgh, Cleveland and Philadelphia.

 Such a contest is rarely an amiable affair -- indeed, especially in the arena of the small, private corporation, a struggle for power is often intense and bitter, generated by a basic clash of strong personalities and conflicting business policy judgments. For the loser, the consequences can be both swift and severe, and it is therefore not surprising that the courts are frequently called upon to determine the legality of the mode of intra-corporate combat and the legitimacy of its outcome. But it is obviously not every corporate conflict that sparks a cognizable legal claim. Especially in the federal forum, where the prevailing principle of limited jurisdiction protects no less than the right and power of the state to adjudicate controversies governed by its laws, the Court must not permit empathy for the plight of the vanquished to impel an overreaching of subject matter jurisdiction in circumstances that do not clearly reveal a basis for a federal cause of action.

 So it is with the difficult case sub judice, an action in equity founded for federal jurisdictional purposes upon an alleged violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, promulgated thereunder. Plaintiffs Ketchum and Bigler are, respectively, the recently-ousted chairman of the board and the recently-ousted president of Babb, Inc. (Babb). Their combined service with Babb and its organizational predecessors totals some 55 years, and, since 1967, they (along with certain of the defendants herein) have actively managed the corporation. During the period of their stewardship, Babb has grown from 30 to 140 employees, and its annual revenues have increased from $600,000 to more than $4,000,000.

 Nonetheless, in late 1975, several of the individual defendants in this case, all seven of whom were and are directors of the corporation, began discussing among themselves the possibility of either severing their associations with Babb or, alternatively, removing plaintiffs from top management positions at the time of the 1976 elections. Babb had not shown a profit for at least three preceding years, and, in view of the defendant-directors, this decline was the direct result of what they deemed to be plaintiffs' "wasteful and counter-productive" diversion of corporate resources into "unrelated, losing ventures," and "repeated disregard" of the board of directors in the formulation of important corporate decisions. In early 1976, certain of the defendants, subsequently joined by the others, determined that they would oppose plaintiffs' reelection as officers of the company.

 On April 23, 1976, the date of the annual shareholders meeting and the critical juncture in the chain of events here in question, the eleven individuals who had comprised the membership of Babb's board of directors throughout the prior year -- the two plaintiffs, seven defendants and two other persons not parties to this lawsuit -- again were nominated by a committee of the board to serve as directors for the following year. By unanimous voice vote, the assembled shareholders reelected the same eleven individuals as directors. *fn1"

 Immediately following the shareholders meeting, the newly-reelected board met in accordance with corporate by-laws to elect officers for the upcoming year. The nominating committee proposed the election of a slate of officers including plaintiff Ketchum as chairman and plaintiff Bigler as president. An opposing slate was nominated, including neither plaintiff, but naming defendant Waugh as chairman and defendant Livingston as president. In the ensuing ballot, Ketchum and Bigler were defeated by a vote of 7 to 4 (the seven defendants against the two plaintiffs and the two additional directors). Waugh was elected chairman and Livingston was elected president.

 Following the election of officers, a resolution to terminate Babb's employment of plaintiffs Ketchum and Bigler -- neither of whom had employment contracts with the company or its subsidiaries -- was adopted by a similar 7 to 4 vote. Plaintiffs were discharged immediately, with one week's salary.

 Upon termination of their employment, plaintiffs were required by the terms of previously-executed stock retirement agreements to resell their shares of Babb stock to the company. *fn2" All shares of Babb stock are held by employees pursuant to such stock retirement agreements, and all such agreements provide for the compulsory sale to and repurchase by Babb of all outstanding shares held by a shareholder "on his termination of employment for any reason or on his death." Babb has consistently enforced this stock retirement agreement -- the provisions of which apparently were drafted at the instruction, and with the participation, of plaintiffs Ketchum and Bigler -- against every employee terminated by the corporation. Accordingly, at the conclusion of the April 23 organization meeting, pursuant to the terms of the repurchase agreements executed by plaintiffs, Babb tendered checks and notes to Ketchum and Bigler in the contractually-obligated aggregate amount of $544,410, or $2.63 per share for 207,000 shares of company stock. *fn3"

 Plaintiffs returned the checks and notes to defendants and subsequently filed the instant action, alleging, inter alia, federal securities fraud. They request, inter alia, that the Court enjoin defendants Waugh and Livingston from occupying the offices to which they were elected on April 23, return plaintiffs to their former positions and restrain defendants (a majority of the board of directors) "from taking any other action to change or disturb the arrangements for the management and operation of defendant Babb, Inc. . . ."

 We emphasize at the outset that what has been set forth above is no more than a factual skeleton constructed for dispositional purposes, and does not purport to be a complete summary of the facts which give rise to the instant litigation. The circumstances surrounding the termination of plaintiffs' employment are both intricate and complex, and, in another forum, might well merit closer scrutiny. But such scrutiny is not automatically warranted here, where entitlement to any remedy is, initially, entirely dependent upon the Court's acceptance of the proposition that plaintiffs have alleged a cause of action under the federal securities law embodied in Rule 10b-5. If that proposition is rejected, our inquiry is properly at an end, for, regardless of the legality vel non of defendants' conduct in ousting and discharging plaintiffs under state corporation law, this Court would lack jurisdiction to determine plaintiffs' pendent state claims. After a full hearing in this matter, and careful consideration of the various briefs and memoranda of the parties, I am persuaded that plaintiffs have failed to state a cognizable federal claim, and that the Court is therefore deprived of subject matter jurisdiction in this case.

 The essence of Rule 10b-5 is its proscription of "fraud in connection with the purchase or sale of any security." *fn4" Plaintiffs endeavor to bring their action within the bounds of the Rule's proscription via the allegation that, prior to April 23, 1976, defendants failed to disclose and tacitly misrepresented to fellow shareholders their intention to vote against the reelection of plaintiffs as officers and to terminate their employment with Babb at the organization meeting following defendants' own reelection to the board by the shareholders. Plaintiffs contend that this "active nondisclosure" amounted to fraud which directly infected the shareholder vote for directors, 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, *fn5" 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 *fn6" 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. ยง 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. *fn7"

 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.

 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

19760714

© 1992-2004 VersusLaw Inc.



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