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Rothberg v. Rosenbloom

September 9, 1985



Author: Gibbons

Before: GIBBONS and HIGGINBOTHAM, Circuit Judges and SAROKIN, District Judge*fn*


GIBBONS, Circuit Judge :

Benjamin Rothberg, the payee of two demand promissory notes, appeals from a judgment in favor of the makers and guarantor. One note, for $441,050, is made by Sanford Rosenbloom and is unconditionally guaranteed by his brother, David Rosenbloom. The other, for $135,000, is made by David Rosenbloom. After a bench trial the district court held that both notes were subject to the defense of in pari delicto, because they grew out of transactions involving trading on insider information in violation of the federal securities laws. Rothberg contends that the court erred (1) in finding insider trading violations, and (2) in admitting evidence of other insider trading activities. he also contends that, as a matter of law, the notes in issue were not subject to the in pari delicto defense. We affirm in part and remand in part.


Insider Trading

Rothberg is a wealthy investor who, with his father, founded Montrose Chemical Company, a successful business, and who also served as a director of another publicly held company, Mallory Randall Corporation. David Rosenbloom is a self-employed investor who, with others, from 1967 through 1976, acquired control of various publicly held corporations, most notably Nytronics, Inc., where Rosenbloom served as chairman of the executive committee and as director from 1967 through 1973, and Mallory Randall Corporation, where Rosenbloom was a member of the control group, a salaried executive, and a director from 1968 through 1976. Sanford Rosenbloom is a member of the bar who specializes in real estate law. Benson Selzer, a registered representative for a securities broker, served beginning in 1967 as a vice president and director of Nytronics, Inc., and beginning in 1968 as a vice president and director of Mallory Randall Corporation.

Sic joint ventures were entered in to between February of 1968 and May of 1969 for the acquisition of securities in various corporations. In five of these, David and Sanford Rosenbloom were designated as co-venturers. The arrangement involved advances by Rothberg totalling in excess of $1,365,000. Sanford Rosenbloom guaranteed Rothberg against loss, and David Rosenbloom separately guaranteed Sanford's guarantee. Under the terms of the joint venture agreement, the Rosenbloom share of profits was to be shared equally with Benson Selzer, or his father Harry, and the Selzer named in the specific agreement was to share equally with the Rosenblooms the undertaking to indemnify Rothberg against loss.

Three of the first four joint ventures were profitable. The fourth resulted in a loss, for which David Rosenbloom indemnified Rothberg. The last two joint ventures, which give rise to this litigation, also produced losses. These two ventures involved investments in Mallory Randall Corporation and in Gulton Industries.

A. The Mallory Randall Joint Venture

Rothberg had been a member of a group of investors led by David Rosenbloom and Benson Selzer which acquired working control of Mallory Randall in 1968. David Rosenbloom became chairman of Mallory Randall's executive committee, a vice president, treasurer and director. Benson Selzer became a vice president and director. Rothberg became a director. On April 18, 1969 Rothberg and Sanford Rosenbloom, trustee, entered into a joint venture agreement involving Rothberg's purchase of 10,800 shares of Mallory Randall stock for approximately $10 a share. Sanford Rosenbloom agreed to indemnify Rothberg and David Rosenbloom guaranteed Sanford Rosenbloom's indemnity obligation. Henry Selzer, Benson Selzer's father, agreed to indemnify the Rosenblooms for any losses which they might have to pay to Rothberg, in exchange of 50% of the Rosenblooms share of any joint venture profit.

About the time of the April 18, 1969 joint venture, Mallory Randall stock, which in December of 1968 had been selling at 15-5/8, had declined to a range of 9-5/8 to 10-1/2. In December, 1968, Mallory Randall had contracted to purchase a toy manufacturer, Carolina Toy, for a price of 10 times Carolina's 1968 earnings plus additional cash contingent on Carolina's net earnings up to a maximum purchase price of $21,500,000. When Carolina's net earnings for 1968 were reported, they were more than double what had been projected, and it became necessary for Mallory Randall to raise $4.2 million additional dollars by a private placement. Mallory Randall made a public announcement of Carolina Toy's 1968 earnings and of the terms of its private placement of bonds, some of which were convertible into common stock.

One week before the April 18, 1969 joint venture agreement, David Rosenbloom and Benson Selzer learned from the Vice President of Sales of Carolina Toy that orders for the current year, 1969, substantially exceeded those for the prior year, and that this as particularly so with respect to Carolina's largest retail customers. David Rosenbloom confirmed same by looking at certain orders on the books at Carolina Toy and by conversing with Carolina sales people and with certain Carolina customers. No public announcement was made of the anticipated increase in Carolina's 1969 revenues prior to the time the joint venturers bought the 10,800 shares of Mallory Randall stock. During 1969, Mallory Randall's net income increased from $17,787 to $1,620,718; this increase was attributable almost entirely to the earnings of Carolina Toy.

By the end of May, 1969, the Mallory Randall stock price rose to 12-3/8. Thereafter, however, because Mallory Randall management was involved with Nytronics, Inc., which experienced a series of reversals after June of 1969, the price declined. As a result of this decline the joint venture lost $107,836.

Rothberg contends that purchase of the 10,800 shares by the April 18, 1969 joint venturers did not involve insider trading in violation of the federal securities laws. His theory is that although David Rosenbloom was an insider, the information which he acquired prior to April 18, 1969 about orders on the books at Carolina Toy was immaterial as a matter of law. The trial court found:

The other tip was that a toy company would have banner earnings for a particular year. That tip was based on inside information which David had a duty not to reveal to the plaintiff. The information was based on his factual inside knowledge of the toy company's activities during the year in question. It was not based upon merely a guess or a prediction.

A reasonable investor in Mallory Randall would consider the information about the 1969 earnings on its Carolina toy subsidiary to be objective, valuable, material knowledge of how much Mallory Randall would earn in the year in question. The only reason the joint venture purchased the Mallory Randall stock was because ...

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