ON APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE WESTERN DISTRICT OF PENNSYLVANIA Civil No. 76-571.
Aldisert and Adams, Circuit Judges, and Markey, Chief Judge, United States Court of Customs and Patent Appeals.*fn*
The issue in this appeal is whether the district court erred when it dismissed the complaint in a dispute arising out of an intra-corporate contest for control of a close corporation. Specifically, we must ascertain whether the factual matrix here satisfies the "in connection with" clause of § 10(b) of the Securities Exchange Act of 1934 and its administrative derivative, Rule 10b-5 - a clause which requires for a cause of action that a misrepresentation be rendered in connection with a sale or purchase of a security.
Although the background for the litigation is somewhat complex, for purposes of this appeal we need only outline those facts pertinent to our decision.
Plaintiffs Ketchum and Bigler are the former Chairman of the Board and President, respectively, of Babb, Inc., a close corporation engaged in the insurance business. In addition to serving as directors of the company, both men were holders of substantial portions of the outstanding Babb stock, owning between them roughly forty-five per cent of such shares. The seven individual defendants constituted other directors and officers of Babb, with five of them holding approximately forty-eight per cent of the outstanding stock.
Under terms contained in a stock retirement agreement, dated November 18, 1968, all Babb shareholders are required to be employees of the corporation. Upon death, retirement or disability, a shareholder or his representative must surrender his stock, and the company is required to redeem such securities at a price determined by a formula relating to corporate income. In the event of a termination of employment for any other reason, only one-third of such formula price would be paid.*fn1
Late in 1975, several of the defendants began discussions among themselves as to the possibility of removing Ketchum and Bigler as officers and employees of Babb. During the ensuing months, the same coterie of defendants continued to discuss the ouster of Ketchum and Bigler, enlisted the support of the remaining defendants, but concealed their scheme from the plaintiffs.*fn2
In March of 1976, the entire board of directors, including the plaintiffs as well as the defendants, proceeded to appoint a committee to select nominees for the board and officer elections that were scheduled for the month of April. The committee, consisting of one of the plaintiffs, one of the defendants and another director of the company, decided to nominate the incumbent board members and officers, among them the two plaintiffs.
On April 23, 1976, the nominating committee submitted its slate of candidates for the board and officerships. The list was received, without any signs of dissension, at a directors' meeting that preceded the annual meeting of shareholders. By this juncture, the defendants had agreed among themselves to dislodge the plaintiffs as officers. Nevertheless, the defendants did not reveal their intention to oppose the reelection of the plaintiffs as officers, making no disclosure of their plan to depart from the usual practice of supporting candidates selected by the nominating committee.
During the April 23 shareholders' meeting, the defendants continued to conceal their plans regarding the election of officers. There is some indication that they did so out of necessity. Although the defendants constituted a majority of the board of directors, they held slightly less than fifty per cent of the outstanding Babb stock. Indeed, at the time of the shareholders' meeting, it was Ketchum and Bigler who possessed the controlling bloc of stock, given their own holdings together with proxies that they had obtained. Nevertheless, the plaintiffs, assuming that the defendants would support all of the candidates designated by the nominating committee, and having no reason to believe otherwise, joined with the defendants and other shareholders to reelect unanimously the incumbent directors. The result of the election was to return the defendants to their dominant position on the directorate.
Immediately following the meeting of the shareholders, the board of directors convened to elect company officers. The slate formulated by the nominating committee then was proposed. At that moment, the defendants made known, for the first time, their intention to expel Ketchum and Bigler as corporate officers. Rejecting the nominations of the plaintiffs, the defendants instead produced their own candidates for the positions of chairman of the board and president. The nominees of the defendants then were elected, thereby removing Ketchum and Bigler as officers.
Once the purge of the plaintiffs as officers was accomplished, the defendants, comprising a majority of the board, proceeded summarily to terminate Bigler and Ketchum as Babb employees as well. Thereafter, the board adopted a resolution to purchase plaintiffs' shares, as authorized by the stock retirement plan, and then tendered payment for the purchase price. But Ketchum and Bigler have declined to surrender their stock certificates or to accept any payment for such shares.
Subsequent to these events, plaintiffs initiated the present lawsuit, seeking, inter alia, to enjoin their ouster as officers and shareholders of Babb and to secure damages. Basically, Bigler and Ketchum claim that the defendants, in violation of § 10(b) and Rule 10b-5, had fraudulently induced them to vote for their own demise. By masking and supposedly misrepresenting their intentions with respect to the officership election, the defendants, it is asserted, were able to retain their majority bloc on the board of directors, despite their minority position among the company stockholders. According to Ketchum and Bigler, such alleged improprieties in turn tainted the subsequent vote by the directors to depose and discharge the plaintiffs as officers, which then facilitated the removal of plaintiffs as employees, and which ultimately activated the stock retirement agreement compelling the sale and corporate repurchase of plaintiffs' stock.
After the entry of a stipulation of facts and a hearing concerning the plaintiffs' demand for injunctive relief, the district court dismissed the action for failure to state a claim ...