ON APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE WESTERN DISTRICT OF PENNSYLVANIA
Before Adams, Gibbons and Garth, Circuit Judges.
Opinion ANNOUNCING THE JUDGMENT OF THE COURT
Pittsburgh Terminal Corporation, Monroe Guttmann, Loretta Guttmann, Evelyn Bittner and Janet Rees (the Bondholders), holders, prior to December 13, 1977, of convertible debentures issued by The Baltimore and Ohio Railroad Company (B & O), appeal from a final judgment dismissing their complaint, which charged that a dividend by the B & O on that date of stock of Mid-Allegheny Corporation (MAC) to B & O stockholders of record on that date violated the federal securities laws and the laws of several states. The defendants are B & O, a Maryland corporation, The Chesapeake & Ohio Railway Company (C & O), a Virginia corporation which on December 13, 1977, owned more than 99% of B & O's common stock, Chessie System, Inc. (Chessie), a Virginia corporation which is a holding company for C & O and its subsidiaries, and fourteen present or former directors of B & O. The convertible debentures owned by the Bondholders are B & O Series A, dated January 1, 1956 and maturing January 1, 2010, paying interest at 4.5%, and convertible at any time before maturity into 10 shares of B & O common stock for each $1000 of face value. The action of which the Bondholders complain is the action of the defendants in fixing December 13, 1977, as both the date of declaration of, and the record date for participation in, the in kind dividend of MAC stock to B & O common stockholders. That action deprived debenture holders of the opportunity to convert before the record date and thereby participate in the dividend. The District Court held that it violated no legally protected rights of the debenture holders.*fn1 We reverse.
B & O owns and operates a railroad regulated by the Interstate Commerce Commission (ICC). Prior to the transactions giving rise to this lawsuit, B & O also owned substantial non-rail assets such as real estate, timber and mineral reserves. At one time both its common stock and its debentures were traded on the New York Stock Exchange (NYSE). When C & O acquired 99.63% of B & O's common stock, trading in that security ceased and it was delisted, although 13 individuals still held some shares. The NYSE listing of B & O's convertible debentures continued. No dividends were paid on the B & O common stock after 1961. Thus the holders of convertible debentures had no particular incentive to exercise the conversion privilege unless the no dividend policy were to change.
Because the regulations of the ICC prohibited a railroad corporation from engaging in non-rail business, B & O's and C & O's assets not used in rail transportation remained undeveloped. Beginning in 1973 when Chessie was formed, C & O began segregating its non-rail assets in a separate corporation, Chessie Resources, Inc., so that they could be developed free of constraints imposed by the ICC. The Chessie management desired to accomplish the same result with respect to B & O's non-rail assets. To that end, in January of 1977, the Chessie Corporation Restructuring Committee settled on a plan whereby the B & O would transfer those assets to MAC, a wholly owned B & O subsidiary, and then distribute the MAC stock as a dividend to B & O's fourteen common stockholders.
If, prior to the dividend in MAC stock, the number of B & O common stockholders were to increase substantially, B & O might have had to file a registration statement for MAC with the Securities and Exchange Commission (SEC). 15 U.S.C. § 77f (1976). There were practical difficulties with the preparation of a registration statement, especially that of placing a value on B & O's non-rail assets. But if notice of the MAC transaction had been given to the convertible debenture holders prior to the record date of the in kind dividend, many of them might have elected to convert. Thus the Restructuring Committee concluded that the MAC transaction should be structured in such a way that the convertible debenture holders would not have such notice until after the record date. This, it was thought, would permit counsel for B & O to obtain from the SEC a no-action letter with respect to registration of the MAC stock.
At the time the MAC transaction was under consideration, B & O had outstanding bond obligations under three trust indentures. One of these, a Convertible Income Bond Debenture, contained a provision requiring B & O to pay into a surplus income sinking fund an amount equal to any dividend. A second, the Refunding and General Mortgage Indenture, required that arrearages in the sinking funds had to be made up before a dividend could be paid. It was these provisions which had prevented B & O from paying dividends since 1961. The third Indenture was that governing the convertible debentures held by the Bondholders. In order to facilitate the dividend in MAC stock, B & O called for redemption the Convertible Income Bonds, and discharged the sinking fund arrearages on the Refunding and General Mortgage Indenture by paying the sinking funds approximately $7,000,000. These steps were accomplished by the summer of 1977. The Restructuring Committee then turned to the Indenture for the convertible debentures.
The convertible debentures also contained a redemption feature which in 1977 called for payment of a premium of 2.5% of their face amount. (344a). B & O did not elect to redeem. Conversion privilege features of the indenture oblige B & O to reserve sufficient common stock and to adjust for changes in par value. (350a). Conversion rights to the bondholders are protected in the event of merger or sale. (354a). Article V, Section 12 of the Indenture provides:
SECTION 12. The Company covenants and agrees that it will not declare and/or pay any dividend on its common stock payable in stock or create any rights to subscribe for stock or securities convertible into stock unless in any such case notice of the taking of a record date for the determination of the stockholders entitled to receive such dividend, distribution or right is given at least ten days prior thereto by at least one publication in an Authorized Newspaper. A copy of each such published notice shall promptly after such publication be filed with the Trustee.
(357a). When the convertible debentures were issued in 1956, B & O entered into a listing agreement with the NYSE relating to them, which incorporated by reference B & O's earlier listing agreements. Listing Agreement A-12653 for an earlier bond issue, incorporated by reference in that for the 1956 convertible debenture issue, provides:
4. The Corporation will give the Exchange at least ten days' notice in advance of the closing of the transfer books, or of the taking of a record of its stockholders for any purpose.
5. The Corporation will publish promptly to the holders of any of its securities listed on the Exchange any action taken by the Corporation with respect to dividends or to the allotment of rights to subscribe or to any rights or benefits pertaining to the ownership of its securities listed on the Exchange; and shall give prompt notice to the Exchange of any such action; and shall afford the holders of its securities listed on the Exchange a proper period within which to record their interests and to exercise their rights; and shall issue all such rights in form approved by the Exchange and will make the same transferable, payable and deliverable in the Borough of Manhattan, in the City of New York.
(455a). In addition to the Listing Agreements, the B & O is bound by the Rules of the NYSE. Section A-2 of its Manual, "Timely Disclosure," provides:
A corporation whose securities are listed on the New York Stock Exchange, Inc., is expected to release to the public any news or information which might reasonably be expected to materially affect the market for those securities. This is one of the most important and fundamental purposes of the listing agreement which each corporation enters into with the exchange.
In November of 1977, by which time impediments to the payment of dividends on B & O stock in the Convertible Income Bond Debenture and the Refunding and General Mortgage Indenture had been removed, plaintiff Monroe Guttmann wrote to the Secretary of B & O:
As one of the very few public owners of B & O common stock, we are concerned that we may not be made aware of any dividend the directors declare on the common stock in sufficient time to convert any of our convertible debentures.
Although it may not be customary to do so in view of the fact that declaration of a dividend may not be widely publicized, if publicized at all, we ask that you notify us promptly of any such dividend declaration so that we will have an opportunity to convert debentures in time to receive such dividend if we choose to do so.
Will you please let me know what provisions there are in the by-laws of the company that govern the time which must elapse between the declaration of a dividend, the record date and the payable date.
(311a). To this pointed inquiry the Secretary, on November 17, 1977, replied:
Thank you for your letter of November 11. We appreciate your concern as a holder of B&O Convertible Debentures as to whether B&O would fail to disclose the declaration of a dividend in its common stock.
You may be assured that if B&O should have any information to announce regarding dividend action on B&O stock, such information will be disseminated promptly to the public at large. Because we cannot prefer you over the public at large advance advice cannot be sent to you, but I will make sure that you get a copy of such press release. We are not in a position to help you with respect to your decision whether or not to convert.
There is no by-law provision relating to the timing of the declaration, record, and payment dates.
(312a). By the time of Guttmann's inquiry and the Secretary's reply, the Restructuring Committee's plan to structure the MAC transaction so as to avoid timely notice to the convertible bondholders was well advanced.
Four in-house attorneys employed by B & O or C & O, one of whom was Chairman of the Restructuring Committee, examined the 1956 indenture and the New York Stock Exchange listing agreements. They concluded that the indenture required notice of stock dividends in B & O stock, but not of distributions of stock of subsidiaries. They concluded that that provision in the New York Stock Exchange listing agreement was inapplicable because it requires 10 days notice only with regard to dividends declared on listed stocks, and B & O common stock had been delisted. They concluded that under Maryland law, absent any action by the directors, the payment date of a dividend could be the same as the declaration date. The Restructuring Committee determined, therefore, to avoid giving notice to the convertible debenture holders. Their purpose in doing so was to prevent conversions which might require filing a registration statement for MAC stock.
The General Counsel of B & O retained the law firm of Hunton & Williams of Richmond, Virginia, to submit to the SEC a request for a no-action letter with respect to B & O's distribution of MAC shares. Prior to the time Hunton & Williams wrote to the SEC, the B & O Board of Directors met and adopted two resolutions. In the first resolution the Board authorized B & O's officers to convey a list of non-rail assets to MAC as a contribution to its capital. (409a). In the second, the Board resolved to distribute the MAC stock as a dividend to B & O shareholders. That resolution provides in part:
RESOLVED, that the dividend on the Common Stock as specified in the next preceding resolution be payable on this date to shareholders of record at the close of business on this date; provided, however, that such payment shall be made by depositing such stock of Mid Allegheny Corporation with Mercantile Safe Deposit and Trust Company of Baltimore, Maryland, in trust, to be delivered to such shareholders of this Company on the earlier of the following dates, viz.: two days following the receipt of a letter from the Securities and Exchange Commission that it will take no action if the stock of Mid Allegheny Corporation is distributed to this Company's shareholders without registration under the provisions of the Securities Act of 1933; or two days following the date of an effective registration statement with respect to the stock of Mid Allegheny Corporation.
(417a). Thus actual delivery of the MAC stock certificates to shareholders was made contingent upon the obtaining of a no-action letter or the filing of a registration statement. It seems clear from the wording of the resolution that B & O intended to file a registration statement if it could not obtain a no-action letter, for the dividend declaration is unconditional.
Three days after B & O's dividend action, Hunton & Williams sent a request for a no-action letter to the SEC. (908a). That firm's December 16 letter to the Commission requested a no-action letter only with respect to a distribution of MAC stock to C & O and 13 individual B & O stockholders. It made no mention of the rights of convertible debenture holders. In its request Hunton & Williams opined that the distribution of MAC shares by B & O was not a sale within the meaning of Section 2(3) of the Securities Act of 1933, 15 U.S.C. § 77b(3). Alternatively the firm suggested that if a sale were involved, the transaction was exempt under 17 C.F.R. § 230.240 (1981). That SEC rule, issued pursuant to Section 3(b), 15 U.S.C. § 77c(b), exempts from registration certain securities of an issuer to fewer than 100 persons, provided that restrictions on transferability are legended on the certificates. The no-action letter was not immediately forthcoming from the SEC, and on January 18, 1978, Hunton & Williams withdrew its reliance on 17 C.F.R. § 230.240. (914a). Another written request was filed on June 29, 1979, relying solely on the contention that the dividend in MAC stock was not a sale. (915a). In September of 1979, long after the commencement of this lawsuit, the SEC issued a no-action letter "provided that MAC shares distributed to persons other than C & O are restricted as to transfer." The SEC letter noted that the District Court had by then entered an order that the defendants must hold at least 940 shares of MAC for tender to the convertible debenture holders if they prevailed. (919a).
The first of these consolidated actions was commenced by Pittsburgh Terminal Corporation on December 28, 1977, and the others soon followed. On March 7, 1978 the District Court issued a preliminary injunction restraining the defendants from proceeding with the dividend in MAC stock.*fn2 Defendants appealed from that order, and when they agreed to hold sufficient shares of B & O and MAC stock to satisfy the claims of the convertible debenture holders, should they prevail, this court reversed that injunction.*fn3 The Bondholders sought class action certification, which was denied as a result of an agreement between B & O and the Trustee under the 1956 indenture that should plaintiffs prevail, all debenture holders similarly situated will be accorded the treatment required by any judgment in plaintiffs' favor.*fn4 Motions for summary judgment in favor of the defendants were denied.*fn5 Thus the consolidated cases went to trial on amended complaints challenging the December 13, 1977 actions of the B & O Board of Directors. The complaints alleged that those actions violated Section 10(b) of the Securities and Exchange Act, 15 U.S.C. § 78j(b), the contractual rights of the convertible debenture holders under the provisions of the Indenture, their rights as third party beneficiaries of the NYSE listing agreements, the obligations of B & O under the rules of the NYSE, and the fiduciary duties of directors and of majority stockholders under Maryland law. The District Court, over defendants' objection, held that the convertible debenture holders had standing to make these claims, but rejected each of them. The court held that there was an insufficient showing of scienter for a Section 10(b) violation; that Section 6 of the Securities and Exchange Act of 1934, 15 U.S.C. § 78f, does not permit private enforcement of the NYSE rules; that the listing agreements confer no rights on any party other than the NYSE; that the indenture does not require notice of a dividend in stock of a subsidiary; and that the December 13, 1977 MAC transactions were entirely legal under Maryland law.*fn6 Without ruling definitively, the court also expressed doubts about what relief would be proper assuming liability had been established.
Section 10(b) prohibits the use of manipulative or deceptive devices or contrivances "in connection with the purchase or sale of any security." The District Court held that a contract to obtain common stock in exchange for the surrender of a convertible debenture is a contract for purchase or sale of a security, and thus that the debenture holders could sue. Defendants challenge that holding. They place principal reliance upon Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 95 S. Ct. 1917, 44 L. Ed. 2d 539 (1975). That case approved the earlier holding in Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2d Cir.), cert. denied, 343 U.S. 956, 72 S. Ct. 1051, 96 L. Ed. 1356 (1952), that only purchasers and sellers of securities could bring a private damage action under Section 10(b). While Blue Chip Stamps v. Manor Drug Stores holds that mere offerees may not sue under Section 10(b), the opinion of the Court carefully distinguishes the case of persons holding actual contractual rights to buy and sell securities. 421 U.S. at 749-50, 95 S. Ct. at 1931-1932. There is no indication that the Court intended to cast any doubt on the settled rule that a contract to buy or sell securities is a purchase or sale within the meaning of Section 10(b), and that a party to such a contract has standing to sue for damages.*fn7 The indication is quite the contrary, for the Court observed:
Unlike respondent, which had no contractual right or duty to purchase Blue Chip's securities, the holders of puts, calls, options and other contractual rights or duties to purchase or sell securities have been recognized as "purchasers" or "sellers" of securities for purposes of Rule 10b-5, not because of a judicial conclusion that they were similarly situated to "purchasers" or ...