The opinion of the court was delivered by: KNOX
This is an action brought by plaintiff holder of convertible debentures in the Baltimore and Ohio Railroad Company against the company and others involved for alleged violations of Section 10(b) of the Securities and Exchange Act of 1934 (15 USC § 78j):
"It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange --
"(b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors."
and violation of Rule 10(b)(5) of the Commission issued thereunder.
The court has held two days of hearings on an application by plaintiff for a preliminary injunction to restrain the payment of a dividend in kind declared upon the stock of the Baltimore and Ohio Railroad Company declared December 13, 1977. On this date the Board of B&O declared this dividend payable on a share per share basis in stock of Mid-Allegheny Corporation a wholly owned subsidiary of B&O. The dividend was payable to holders of record on that same day December 13, without any notice or warning of any kind to the holders of convertible debentures of B&O.
The evidence shows that plaintiff was the holder of $94,000 of convertible debentures of the B&O out of a total of $13,122,000 outstanding. These debentures are payable on January 1, 2010 and are convertible at any time into shares of B&O at $100 per share of common stock. B&O at the time in question had outstanding 2,535,565 shares which were traded on the New York Stock Exchange, of which 99.63% are owned or controlled by the Chesapeake and Ohio Railway Company, a Virginia corporation which in turn is wholly controlled by Chessie System Inc., another Virginia corporation having its principal place of business in Cleveland, Ohio. Plaintiff in addition to its holdings of convertible debentures has 400 shares of B&O resulting from prior conversions of convertible debentures.
Plaintiff through its president Monroe Gutman had noticed that the cash position of B&O had improved so that a dividend was indicated during the year 1977 and it had made prior inquiries of the defendants as to whether a dividend was considered so that he could take proper steps to determine whether to convert his convertible debentures into common stock and thus share in the dividend. Correspondence received from the officers indicated that they would send Gutman a press release if a dividend was declared. However, it appears that plaintiff was considering a cash dividend and it was to that that the attention of the defendants' officers had been directed.
Plaintiff corporation had no knowledge of pendency of proceedings by B&O to declare the dividend in kind in stock of Mid-Allegheny until after the event when a press release in the Wall Street Journal was noted by plaintiff's president on December 14, 1977. This suit was filed December 28, 1977. It is apparent that plaintiff had no information relative to the proposed declaration of this dividend in kind in Mid-Allegheny shares and no opportunity to convert prior to the record date since the record date was the same as the declaration date, viz: December 13. Plaintiff corporation claims it is customary in corporations to set a record date later than the declaration date although no requirement to this effect has been shown. It was shown on the same date Western Maryland Company an affiliated corporation declared a stock dividend to shareholders of record December 31, 1977, which would have given the holders of convertible debentures a chance to convert.
It appears that the declaration of the dividend in kind in shares of Mid-Allegheny Corporation upon the stock of B&O was part of Chessie's reorganization strategy, one purpose being to avoid ICC restrictions on financing and another to place the non-rail real estate in a corporation managed by experts to produce the highest return. Since the Chessie System holds 99.639% of B&O stock it is apparent that nearly all the shares of Mid-Allegheny included in this dividend will go to Chessie Systems via its subsidiary C&O Railway Company and it is stated that it is its intention to donate these shares to Chessie Resources Corporation a wholly owned real estate subsidiary of the Chessie System.
The tax effect of the declaration of this dividend in kind in Mid-Allegheny stock on the B&O stockholder recipients is not clear. The defendant claims it is not taxable either to the minority shares in B&O Railway Company or to the Chessie System although no one can say with confidence what position the Internal Revenue Service might take in this complex tax area involving partial liquidating dividends, dividends in the course of reorganization. The court declines an invitation to speculate on this inasmuch as we have sufficient on our hands to decide the instant controversy.
It is claimed that the issuance of this dividend in kind is in addition to being violative of 10(b)(5), a violation of Article V, Section 12 of the indenture pursuant to which the convertible debentures were issued which is attached as exhibit A to the ...