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September 13, 1982

George ROSENBAUM, Renee Shenkin, and Carol Wheeler, on behalf of themselves and all others similarly situated and, derivatively, on behalf of Commonwealth Realty Trust, Plaintiffs,
Julius KLEIN, I. H. Krekstein, Shepard Broad, Edward B. Stokes, Bart J. Axelrod, Michael H. Krekstein, Krekstein, Shapiro, Bressler & Wolfson, Defendants, and Commonwealth Realty Trust, Nominal Defendant

The opinion of the court was delivered by: POLLAK

 This is an action by former and present shareholders of Commonwealth Realty Trust ("CRT") against a group of former and present trustees and officers of CRT. Plaintiffs seek compensatory and punitive damages, costs, and attorneys' fees. The complaint contains both direct and derivative claims which allege violations of the federal securities laws; the complaint also contains pendent state law claims of breach of fiduciary duty, corporate mismanagement, and fraud. Pursuant to Fed.R.Civ.P. 12(b), defendants have moved to dismiss (a) the federal claims for failure to state a cause of action under the federal securities laws, and (b) the pendent claims because the federal claims to which they are attached are insubstantial.


 CRT is a real estate investment trust organized under Pennsylvania law. Its assets (principally commercial real estate) are administered by a board of trustees for the benefit of holders of certificates of beneficial interest ("shares"). CRT shares are traded on the over-the-counter market. The gravamen of the complaint is an alleged conspiracy by defendants to sell their large holdings of CRT shares to a British real estate investment concern, Country & New Town Properties Ltd. ("Properties Ltd.") in November 1980 at a significant above-market profit. Plaintiffs contend that this transaction constitutes a breach of the CRT trustees' fiduciary obligation to CRT shareholders because they sold their controlling interest at a premium without considering the interests of the trust or the other shareholders. Plaintiffs also allege proxy violations under section 14 of the Securities Exchange Act of 1934 ("1934 Act") based on defendants' failure to disclose the nature of their relationship with Properties Ltd. in proxy solicitations issued for the election of trustees.

 In the early 1970s defendants Klein and Krekstein and members of their families held a controlling interest in CRT class A shares. This control enabled them to maintain their positions as members of the five-person board of trustees and as CRT officers and also to appoint their associates Broad and Stokes as additional trustees.

 Through business contacts with Krekstein, Properties Ltd. became interested in investing in CRT. Pursuant to a private placement floated in September 1974, Properties Ltd. and another firm, Brimicon, purchased two newly issued classes of CRT shares, classes B and C. They also obtained certain rights: (1) a right to elect through their holdings two trustees; (2) a right to veto the issuance of more than 100,000 new class A shares in a single year in order to prevent the dilution of their interest; (3) a right to convert class B and C shares into class A shares at their option; and (4) a right of first refusal on the disposition of Klein's and Krekstein's class A shares.

 Properties Ltd. and Brimicon subsequently increased their class B and C holdings by purchases in the market. Then Brimicon, pursuant to a corporate reorganization, assigned its shares to Properties Ltd. By early 1980, Properties Ltd. held approximately 42% of all outstanding CRT shares. The only other major block of shares was the Klein and Krekstein interest in class A shares. Properties Ltd. also began to purchase class A shares in the market as part of its plan to take over CRT.

 During the late 1970s, CRT's financial position had begun to deteriorate and its dividends to shareholders were declining. By early 1980 it seemed clear that Klein's and Krekstein's efforts to obtain new capital without letting Properties Ltd. take over CRT were unlikely to succeed, in part because Properties Ltd. planned to veto any issuance of greater than 100,000 new class A shares and also because the market did not appear willing to absorb such a large CRT offering. According to plaintiffs' allegations, Klein and Krekstein therefore began to reconsider the possibility of selling their controlling interest to Properties Ltd. At this point, Properties Ltd. made a formal offer to buy $4 million worth of new class A shares in order to obtain control. CRT's board of trustees rejected the offer.

 In April of 1980, prior to the May annual shareholders' meeting, a proxy solicitation was distributed to CRT shareholders seeking their votes on the election or reelection of the trustees (including Klein and Krekstein). This solicitation was clearly governed by section 14(a) of the 1934 Act and the Securities Exchange Commission ("SEC") rules promulgated pursuant thereto establishing various disclosure requirements for proxy materials. According to plaintiffs' allegations, these proxy materials failed to disclose fully the nature of Klein's and Krekstein's potentially self-interested dealings with Properties Ltd. and the precise nature of the 1974 private placement and right of first refusal agreement. The self-dealing character of these transactions was, in plaintiffs' view, a material fact that should have been disclosed to shareholders when they were asked to elect these trustees.

 In November 1980, after the election, Klein and Krekstein agreed to sell their class A shares to Properties Ltd. for $12.75 per share. The deal was closed in January 1981. During the spring of 1981, Properties Ltd. used its controlling interest to replace CRT management with its own appointments and to place British trustees on the board.

 Although plaintiffs' complaint is framed in eleven counts, only three principal issues require discussion: plaintiffs' direct and derivative claims under section 14 of the 1934 Act, plaintiffs' direct and derivative claims under section 13(d) of the 1934 Act, and plaintiffs' pendent state law claims.


 Plaintiffs allege that defendants violated section 14(a) by failing to disclose the self-dealing connection between Properties Ltd. and the CRT trustees in the April-May 1980 election proxy solicitation. On the basis of that asserted violation, plaintiffs seek monetary damages for the November 1980 sale of control by Klein and Krekstein to Properties Ltd. Count I charges defendants with material misrepresentations and omissions concerning CRT's financial condition and the Klein-Krekstein interest in Properties Ltd.'s takeover bid which undermined the shareholders' ability to judge the trustees' qualifications for office and therefore improperly skewed the election. Plaintiffs do not, however, seek to set aside the election.

 Defendants have moved to dismiss, contending that plaintiffs' complaint fails to allege a proper basis for seeking monetary damages under section 14(a). In particular, defendants argue that plaintiffs have failed to satisfy the Supreme Court's causation requirement for section 14(a) liability. According to defendants, the April 1980 proxy materials, even assuming they contained misleading information or material omissions, only sought shareholder approval of the May 1980 trustee election; they had nothing to do with the ultimate November 1980 transaction for which plaintiffs seek damages. Thus, plaintiffs may well have stated a proper state law claim for breach of trust in the November 1980 sale of control, but the proxy violation is not causally linked to that transaction and therefore liability for the November transaction may not be predicated on the April 1980 proxy violations. Plaintiffs have responded by contending that the May 1980 election based on the misleading proxies must be seen as a "but for" cause of ...

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