APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE WESTERN DISTRICT OF PENNSYLVANIA
Before: ADAMS, GIBBONS and GARTH, Circuit Judges;
Before: SEITZ, Chief Judge and ALDISERT, ADAMS, GIBBONS, HUNTER, GARTH, SLOVITER and BECKER, Circuit Judges.
Lucile Lowry and Lowry-Zweig Corporation appeal from a summary judgment dismissing their class action complaint against the Baltimore & Ohio Railroad Company (B&O), the Chesapeake & Ohio Railway Company (C&O), and the Chessie System, Inc. The complaint alleged that defendants violated § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b); Rule 10b-5 of the Securities and Exchange Commission promulgated thereunder, 17 C.F.R. § 240.10b-5 (1981); and state common law when, on December 13, 1977, B&O declared a dividend in favor of its common shareholders in the form of the entire stock of the Mid-Allegheny Corporation. This action was taken without giving notice to holders of B&O convertible debentures, thereby precluding their participation in the dividend distribution.In a previous decision, this court allowed persons who held B&O convertible debentures as of December 13, 1977 to maintain an action under § 10(b) and Rule 10b-5. Here, appellants had purchased B&O convertible debentures from persons who held them as of December 13, 1977 from persons who held them as of December 13, 1977 and are attempting to assert their sellers' federal cause of action.*fn1 We conclude that the dismissal of appellants' federal claims was proper and affirm the district court's action as to them. We vacate and remand for further consideration of appellants' state law claims.
The B&O owns both rail and non-rail assets and has issued both common stock and convertible debentures. The C&O controls over 99% of B&O's common stock. There are thirteen other common shareholders and the shares are not publicly traded. The Chessie System is a holding company managing the assets of the C&O. The present controversy arose after B&O sought to restructure its operations in order to avoid federal restrictions that inhibited development of its non-rail assets. To accomplish this it created the subsidiary corporation, Mid-Allegheny, to which it transferred all of its non-rail assets. Then on December 13, 1977, B&O distributed all of the Mid-Allegheny stock to its own common shareholders. A consequence of this arrangement was that B&O convertible debentures, which previously could have been converted into B&O commons tock representing both B&O's rail and non-rail assets, became convertible into B&O common stock representing only B&O's rail assets.
In a separate action, the debenture holders sued under the Securities Exchange Act of 1934 claiming that, as to them, the dividend declaration was fraudulent. They argued that the value of their conversion option, and hence of their convertible debentures, would be reduced unless they were allowed to convert in time to qualify for the Mid-Allegheny dividend. This court agreed, and concluded that B&O had a duty to provide debenture holders with advance notice of such a dividend declaration. Pittsburgh Terminal Corp. v. Baltimore & Ohio R.R., 680 F.2d 933 (3d Cir.), cert. denied, 459 U.S. 1056, 103 S. Ct. 476, 74 L. Ed. 2d 621 (1982).
In the instant suit, appellants purchased B&O convertible debentures from persons who held them on December 13, 1977. Appellants argue that, even though they purchased with full knowledge of the dividend declaration and allege no injury therefrom, the federal cause of action established in Pittsburgh Terminal was automatically assigned to them upon their purchase of the debentures.
A majority of this court, albeit for diverse reasons, agree with the district court and conclude that appellants may not maintain a claim for which relief can be granted based on any violation of federal statutes or regulations. Two judges would overrule Pittsburgh Terminal and are of the opinion that B&O was under no legal obligation to provide holders of the convertible debentures with advance notice of the dividend. According to this view, if the prior holders have no federal cause of action, then a fortiori, neither do their purchasers, and the assignability issue need not be reached. Six members of the court are of the view that the holding in Pittsburgh Terminal should be honored here either because it is correct or binding. Three of the six judges who follow Pittsburgh Terminal conclude that the rights recognized in Pittsburgh Terminal are assignable only if there is an express provision to that effect. Because there was no express assignment here, these judges argue that appellants may not now assert their transferors' rights. The remaining three judges are of the view that the cause of action was automatically assigned to appellants as purchasers. These three members of the court would reverse the dismissal of the federal claims.
As to appellants' state law claims we vacate the judgment of the district court and remand with a direction that the district court consider whether appellants can maintain this part of their class action suit as a diversity action. The district court consider whether appellants can maintain this part of their class action suit as a diversity action. The district court dismissed without explaining whether the jurisdictional requirements of 28 U.S.C. § 1332 were met under Zahn v. International Paper Co., 414 U.S. 291, 38 L. Ed. 2d 511, 94 S. Ct. 505 (1973). The district court may also wish to consider the possibility of state claims under pendent jurisdiction asserted by other litigants.
Accordingly, the judgment of the district court dismissing the federal claims of appellants will be affirmed. As to appellants' state law claims, the district court judgment will be vacated and remanded for further proceedings consistent with this opinion.
Each side to pay its own costs.
GARTH, Circuit Judge, concurring in the judgment, with whom SLOVITER, Circuit Judge, joins:
In Pittsburgh Terminal Corp. v. Baltimore & O. R.R., 680 F.2d 933 (3d Cir.), cert. denied, 459 U.S. 1056, 74 L. Ed. 2d 621, 103 S. Ct. 476 (1982), a panel of this court held that Rule 10b-17, 17 C.F.R. § 240.10b-17 (1982), required notice to holders of convertible debentures of a dividend declared by B & O on December 13, 1977.*fn1 However, the panel was divided in its vote on Lowry, argued and considered by the panel with Pittsburgh, to the extent that no judgment could be entered. This in turn led to a recommendation that the full court sitting in banc entertain Lowry's appeal. The primary issues that divided the Lowry panel were: (1) whether federal law or state law controlled; and (2) if federal law controlled, what was the content of that law. In order to focus the parties' attentions on the concerns of the court, supplemental briefs were sought with respect to the following issues:
1. Upon the sale on the New York Stock Exchange of convertible debentures of the Baltimore and Ohio Railroad Company, does federal or state law govern whether accrued causes of action arising under the federal securities laws are automatically assigned to the subsequent purchasers of those debentures?
2. If federal law applies, what is the content of that law?
3. If state law applies, which state's law governs, and what is the content of that law?
4. What law governs the assignability of any accrued common law or state statutory causes of action pleaded in the complaint?
5. If a different law of assignability applies to causes of action arising under federal and state law, what persons will be covered by the stipulation in Pittsburgh Terminal Corp. v. Baltimore & Ohio R.R. Co., 680 F.2d 933 (3rd Cir. 1982), that convertible debenture holders who are not parties will receive any benefits ultimately decided to be due to the individual plaintiffs in that case?
6. If it is concluded that the plaintiffs have no federal cause of action, what disposition should be made of the remainder of the complaint?
The supplemental briefs filed by both of the parties agreed that federal law controlled. Lowry argued that federal law would recognize automatic assignability, while the B & O argued otherwise. At oral argument before this court, in addition to the arguments found in their briefs, B & O argued for the first time that N.Y. Jud. Law § 489 (McKinney 1968)*fn2 would, in any event, prohibit the Lowry plaintiffs from obtaining an assignment of their transferors' causes of action. B & O raised this section 489 argument ostensibly to counteract the reliance by Lowry on Phelan v. Middle States Oil Corp., 154 F.2d 978 (2d Cir. 1946), and N.Y. Gen. Oblig. Law § 13-107 (McKinney 1978),*fn3 which Lowry claims permits causes of action to be assigned without an express assignment.*fn4
The per curiam opinion, which is entitled "Opinion of the Court," curiously makes no mention of the significance issue which divided the panel: i.e. whether federal or state law dictates the assignability of the Pittsburgh cause of action. Indeed, the per curiam opinion, without reference to whether federal or state law controls, reports that two members of the court do not reach the issue of assignability; that three members of the court would only recognize assignability if there were an express assignment -- which there was not -- and that the remaining three members of the court (two judges were recused) would hold that the Pittsburgh Terminal cause of action was automatically assigned to the Lowry plaintiffs as purchasers. Because I believe the issue of whether federal or state law controls is at the core of the Lowry litigation, and because, according to the tabulation recited in the per curiam opinion, a majority of the court has not expressed itself on the assignability issue, I am forced to write separately.
Lucile Lowry and Lowry-Zweig Corporation appeal from a summary judgment dismissing their class action complaint against the Baltimore and Ohio Railroad Company (B & O), the Chesapeake & Ohio Railway Company, and Chessie System, Inc. The complaint alleges that the defendants violated section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) (1976), Rule 10b-5 thereunder, 17 C.F.R. § 240.10b-5 (1982), and the common law when the B & O declared a dividend in the stock of Mid-Allegheny Corporation (MAC), a B & O subsidiary, on December 13, 1977, without giving notice to holders of B & O convertible debenturees.
Details of the transaction are set forth in our recent opinions in Pittsburgh Terminal Corp. v. Baltimore & Ohio R.R., 680 F.2d 993 (3d Cir.), cert. denied, 459 U.S. 1056, 103 S. Ct. 476, 74 L. Ed. 2d 621 (1982), and will not be repeated here, other than to set forth those facts necessary to focus on the issues which this case presents. Essentially, however, the circumstances in which these actions were as follows.
The B & O had sought to restructure its operations by transferring its non-rail assets to MAC and then distributing MAC stock to the B & O shareholders in the form of a dividend. One consequence of this arrangement was that the B & O convertible debentures, which previously could have been converted into B & O stock representing both B & O's rail and non-rail assets, became convertible into B & O stock which now represented only B & O's rail assets. The Lowry plaintiffs claimed that the value of the conversation option, and hence of the convertible debentures, would thus be reduced, unless the debentureholders could convert in time to qualify for the MAC dividend. The plaintiffs in the Pittsburgh Terminal action alleged that by deliberately not giving the B & O convertible debentureholders advance notice of the MAC dividend, the defendants unlawfully deprived them of the opportunity to convert before the record date, December 13, 1977. This in turn derpived the convertible debentureholders of the right to participate in the dividend. A panel of the court held in Pittsburgh Terminal, supra, the companion case to this action, that the failure to notify convertible debentureholders who held debentures on that date violated Rule 10b-5.
While in Pittsburgh Terminal, the plaintiffs were holders of B & O convertible debentures who acquired those securites prior to December 13, 1977, and held them on that date, the plaintiffs in the instant case acquired their debentures after December 13, 1977, and after the public disclosure that B & O had on that date declared a dividend in MAC stock.*fn5 The district court certified the plaintiffs as representatives of a class of persons who purchased their debentures on or after December 13, 1977, or who have converted or will convert their debentures into B & O stock on or after December 13, 1977. The plaintiffs contend that the class was too narrowly structured by the district court in that it did not include any holders of the convertible debentures who acquired them prior to December 13, 1977 and did not convert. The plaintiffs also assert that summary judgment should not have been entered against them.
In their complaint, the plaintiffs sought to represent a class consisting of "holders of Debentures as of the time that final judgment is rendered, and . . . holders of Debentures who have or will have converted them into stock of B&O on or after December 13, 1977 and before final judgment is rendered." Cplt. P27, App. at 8-9. In granting the plaintiffs' motion for class certification, the district court defined the class to consist of "persons who purchased their debentures on or after December 13, 1977, or who have or will convert their debentures into B & O stock on or after December 13, 1977." App. at 90. By doing so, it excluded debenture holders at the time of judgment who had acquired their debentures before December 13, 1977 and had not converted them. The plaintiffs assert that it was illogical for the district court to include persons in their class who purchased debentures before December 13, 1977 and subsequently converted them, but to exclude persons who purchased debentures before December 13, 1977 and retained them.
As the defendants note, there was no need for the court to include in the class any of the debentureholders who purchased debentures prior to the declaration of the MAC dividend, since the defendants had agreed in the Pittsburgh Terminal action to give such persons any benefits ultimately decided to be due to the individual plaintiffs in that case.*fn6 See Pittsburgh Terminal App. at 493a. Thus, to the extent that any debentureholders were excluded from the Lowry class, they suffered no prejudice. As this court stated in Carter v. Butz, 479 F.2d 1084, 1089 (3d Cir. 1973), "[w]hile we might well have decided otherwise we conclude that the class action determination was within the range of discretion permitted by [Federal] Rule [of Civil Procedure] 23."
I turn now to the question whether the plaintiffs, having acquired their convertible debentures after December 13, 1977, the date when the MAC dividend was declared, are in the same position as the Pittsburgh Terminal plaintiffs insofar as maintaining an action against the defendants for securities fraud under Rule 10b-5. The plaintiffs concede that since they purchased their debentures after the MAC dividend declaration on December 13, 1977, it was not they, but their predecessors in ownership, who were allegedly defrauded. Nevertheless, the plaintiffs maintain that the Rule 10b-5 claims associated with the dividend declaration run with the debentures by operation of law, and that they therefore have standing to sue the defendants even without having obtained any express assignment of the cause of action from the former debenture owners.*fn7
The first consideration to be addressed is whether this court should look to federal or state law in addressing the plaintiffs' contentions. There appears to be little authority on this point, probably because it has generally been assumed that questions of standing under the federal securities laws must be governed by federal law. All the parties to this action at the panel level apparently found this proposition to be self-evident, and thus did not even address this issue. In their in banc briefs, both parties agreed that federal law controlled.
I agree with the parties' original assumption, and their later statements, that questions regarding rights under the federal securities laws must be decided on the basis of federal, and not state, law. Congress enacted the securities laws to vindicate a federal policy of protecting investors. See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 195, 47 L. Ed. 2d 668, 96 S. Ct. 1375 (1976); H.R. Rep. No. 1383, 73d Cong., 2d Sess. 1-5 (1934). It established certain standards of conduct in the securities industry, standards that were to be uniform throughout the nation. In doing so, it supplemented a regulatory regime that had, until then, consisted principally of an assortment of varying state laws. A necessary corollary of this unitary scheme of regulation is that remedies for the breach of duties imposed by the federal laws should be uniform across the nation. I am satisfied, therefore, that we should look to principles of federal law in the furtherance of these federal policies, rather than importing state law principles which vary according to further state goals that may differ from those embodied in the federal acts.*fn8
The vast majority of securities transactions today are conducted on regional and national exchanges, often through the facilities of national brokerage firms. These transactions are entered into against a background of pervasive federal regulation. Under these circumstances, it would undoubtedly come as a surprise to many investors if their right to sue for federal securities fraud were to depend upon the law of a state whose role in the transaction had been completely incidental and never even contemplated.
Even if securityholders' rights under the federal securities acts came to be recognized as depending in part on state law, confusion and uncertainty would still reign because the determination of which state's law governed would turn on the fortuity of where the action was filed and on the choice-of-law principles applied by the forum. The question of assignability conceivably could be governed by the laws of various states, among others: the law of the state where the issuer of the securities was incorporated; the state where the stock exchange on which the securities were trade was located; the state where the purchased security was delivered or paid for; or the state in which the broker who arranged the transaction operated. For example, if a citizen of Ohio sold debentures issued by a Delaware corporation with its principal place of business in Illinois, through a stockbroker in Indiana, who executed the sale on the New York Stock Exchange, to a Kentucky broker on behalf of a purchaser in Tennessee, which state's law would apply? If this Tennessee purchaser brought a class action on behalf of all debenture purchasers, as the plaintiffs in this case have done, would his right to recover differ from other members of the class whose debentures were purchased, for instance, on the Pacific Stock Exchange in Los Angeles?
The Supreme Court has recognized that
the doctrine of [Erie R.R. v. Tompkins, 304 U.S. 64, 82 L. Ed. 1188, 58 S. Ct. 817 (1938)] is inapplicable to those areas of judicial decision within which the policy of the law is so dominated by the sweep of federal statutes that legal relations which they affect must be deemed governed by federal law having its source in those statutes, rather than by local law. . . . When a federal statute condemns an act as unlawful, the extent and nature of the legal consequences of the condemnation, though left by the statute to judicial determination, are nevertheless federal questions, the answers to which are to be derived from the statute and the federal policy which it has adopted. To the federal statute and policy, conflicting state law and policy must yield.
Sola Elec. Co. v. Jefferson Elec. Co., 317 U.S. 173, 176, 63 S. Ct. 172, 87 L. Ed. 165 (1942) (citations omitted). In a case analogous to this one, involving a promissory note given to a bank by one of its directors in violation of the National Bank Act, the Court held that federal law, not state law, governed the validity of defenses to payment of the note. Deitrick v. Greaney, 309 U.S. 190, 200-01, 84 L. Ed. 694, 60 S. Ct. 480 (1940).
In the area of securities regulation, Judge Friendly noted nearly two decades ago that
significant steps toward the development of a federal common law of corporate responsibility have already been taken by implying causes of action from and filling interstices in laws administered by the SEC. . . . When conduct by an "insider" in the sale or purchase of a listed security is challenged under the general language of Section 10(b) of the Securities Exchange Act or Rule X-10b-5 of the SEC, interstitial supplementation is a matter of federal law. Although in these cases the emphasis was on higher standards of conduct, development of federal law can also protect against extreme or unrealistic requirements imposed by a state. . . . [F]or corporations whose business is of national concern, federal law will insure standards that are high but not too high. . . .
Friendly, In Praise of Erie -- And of the New Federal Common Law, 39 N.Y.U.L. Rev. 383, 413-14 (1964).
The authority that does exist with respect to the issue presented in this case holds that federal common law, not state statutes or decisional law, governs whether causes of action under the federal securities laws run with the affected securities and hence are automatically assigned to subsequent purchasers of those securities. 3 L. Loss, Securities Regulation 1817 (2d ed. 1961). See Western Auto Supply Co. v. Gamble-Skogmo, Inc., 348 F.2d 736, 739-41 (8th Cir. 1965) ("federal and general common law" governs question of survivability of § 16(b) action; state statutes provide "added support" for court's interpretation of federal common law), cert. denied, 382 U.S. 987, 15 L. Ed. 2d 475, 86 S. Ct. 556 (1966); Mills v. Sarjem Corp., 133 F. Supp. 753, 761 (D.N.J. 1955) ("In the absence of statutory pronouncement in this regard the federal common law will be applied."); cf. In re Fine Paper Litigation, 632 F.2d 1081, 1090 (3d Cir. 1980) (status of assignments under the antitrust laws is a matter of federal law). But cf. Fund of Funds, Ltd. v. King, [1976-1977] Fed. Sec. L. Rep. (CCH) P95,640 (S.D.N.Y. June 29, 1976) (referring to state law in deciding whether assignment of cause of action was effected).*fn9
Having concluded that federal law governs the question whether federal securities law claims run with convertible debentures upon their sale, the content of that federal law must now be determined because the Securities Exchange Act is silent on this issue. Nor has any other federal statute which addresses this question been called to our attention. I suggest that we must therefore look to the federal common law of securities regulation for the answer.
As the plaintiffs acknowledge, there is only meager support in the cases for their theory that defrauded debentureholders automatically assign their causes of action under federal securities law when they sell their debentures.In my opinion, the better view is that the availability of such Rule 10b-5 actions should be limited to those investors who themselves have been defrauded, or who are express assignees of defrauded parties. Such an approach is necessary to ensure that compensation for fraudulent securities dealings inures to those persons who were injured by the fraud, rather than to corporate bounty hunters.
When the B & O refused to notify its convertible debentureholders of the MAC dividend on December 13, 1977, it was the persons holding convertible debentures on that date -- not subsequent purchasers of those debentures -- who were deprived of the opportunity to obtain the MAC dividend. As a consequence of the dividend declaration, the conversion option of the debentures was diluted, since the debentures, which previously had been convertible into stock representing both rail and non-rail assets, were now convertible into stock representing only rail assets. Thus, in a market in which traders deem the conversion option to be more significant than the income feature of the debentures, it would be expected that after December 13, 1977, the value of the debentures would decline to reflect the dilution of that option. Any sale by the debentureholders under such circumstances could not pass the loss onto a subsequent purchaser as the loss would already have been realized by the original debentureholder when less was received from the sale of the debenture than would have been received in the absence of the MAC dividend declaration. Completing this hypothesis, any subsequent ...