impression which inflated the market prices of Bancorp securities throughout the Class Period.
Plaintiffs assert four claims against the defendants in their amended complaint:
violations of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78(b) (1988), Securities and Exchange Commission Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5 (1991) and Section 20(a) of the Securities Exchange Act, 15 U.S.C. § 78t (1988) (count I); violations of Section 14(a) of the Securities Exchange Act, 15 U.S.C. § 78n(a) and Rule 14a-9 promulgated thereunder, 17 C.F.R. 240.14a-9 (count II); a pendent state claim on behalf of Bancorp for breach of fiduciary duty and waste of corporate assets (count III); and a state claim for negligent misrepresentation (count IV).
Defendants move for dismissal of plaintiffs' claims arguing, essentially, that plaintiffs have failed to state federal claims upon which relief can be granted and that their state law claims must be dismissed for lack of federal diversity jurisdiction.
After notice and oral argument held on August 10, 1993, the court hereby grants defendants' motions in part and denies them in part. For the reasons which follow, plaintiffs' federal securities claims are DISMISSED with prejudice, and their state law claims are DISMISSED without prejudice.
In deciding a motion to dismiss for failure to state a cognizable claim, the court must accept as true all of plaintiff's factual allegations and draw from them all reasonable inferences favorable to the plaintiff. D.P. Enterprises, Inc. v. Bucks County Community College, 725 F.2d 943, 944 (3d Cir. 1984). However, the court need not accept as true legal conclusions or unwarranted factual inferences. Gomez v. Toledo, 446 U.S. 635, 636 n.3, 64 L. Ed. 2d 572, 100 S. Ct. 1920 (1980). A case should not be dismissed for failure to state a claim unless it appears certain that no relief can be granted under any set of facts that could be proved consistent with plaintiff's allegations. Hishon v. King & Spalding, 467 U.S. 69, 73, 81 L. Ed. 2d 59, 104 S. Ct. 2229 (1984).
I. Section 10(b) Claim
To plead a Section 10(b) action, plaintiffs must show that the defendants misrepresented or omitted material information in connection with the purchase or sale of securities. See Securities and Exchange Commission Rule 10b-5, 17 C.F.R. § 240.10b-5. Both plaintiffs obtained their shares in Bancorp, the holding company for the Bank, in a merger in which all of their shares in the Bank were exchanged on a share-for-share basis for Bancorp shares.
Generally, when a share exchange accompanies the merger of two separate and distinct corporate entities, such exchange constitutes a "purchase or sale" for purposes of bringing a Rule 10b-5 action. See SEC v. Nat'l Secs., Inc., 393 U.S. 453, 467, 21 L. Ed. 2d 668, 89 S. Ct. 564 (1969) (shareholders "purchased" shares in another company by exchanging shares in a merger where resulting company had different assets and future prospects). However, if the merger or share exchange involves clearly no more than internal corporate reorganization, then the transaction does not fall within the scope of Rule 10b-5. See, e.g., In re Penn Central Securities Litigation, 494 F.2d 528, 538 (3d Cir. 1974); Gelles v. TDA Industries, Inc., 1993 U.S. Dist. LEXIS 9779, 1993 WL 275216 (S.D.N.Y.) citing Int'l Controls Corp. v. Vesco, 490 F.2d 1334, 1343 (2d Cir.), cert. denied, 417 U.S. 932, 41 L. Ed. 2d 236, 94 S. Ct. 2644 (1974).
The court finds, as a matter of law, that plaintiffs were not "purchasers" of Bancorp shares and, therefore, they may not assert a Rule 10b-5 action against the defendants. The merger between Bancorp and the Bank was not one in which two separate and distinct corporations were combining to form an entirely new entity. Here, the Bank's merger was nothing more than a corporation deciding to reorganize and diversify its line of business. In such a merger, "the elements entering into [plaintiffs'] decision were the same as those typically confronting any shareholder voting on the enlargement of the charter purposes of his corporation." See In re Penn Central, supra at 538.
Plaintiffs each owned shares of stock in the Bank for several years prior to its merger with Bancorp. After the merger, their shares in the Bank were simply converted into shares in the holding company for the Bank. While the merger allowed Bancorp to diversify its line of business into areas other than banking, such potential alone is not enough to consider plaintiffs "purchasers" of Bancorp stock. The Bank's stock value was the very same after the merger as it was before the merger. The very same Board of Directors which controlled the Bank before the merger controlled the holding company after the merger.
Additionally, this was not a "forced sale." Plaintiffs assert that at the time of the merger, they were faced with the limited choices of accepting shares in a company that was "materially different" from the one in which they had originally purchased shares, or sell their shares for an amount equal to the "fair value" of their shares. Plaintiffs' Memorandum of Law in Opposition to Defendant's Motion to Dismiss And/Or for Summary Judgment at 21. They argue that this transaction effected "such a significant change in the nature of plaintiffs' investment and investment risks as to amount to a new investment." Id. The court disagrees. Plaintiffs were advised fully of the reasons for the merger, and were given the opportunity to sell their shares in the Bank instead of accepting an equal number of shares in the Bank's holding company. No "forced sale" existed, since plaintiffs retained their interest in the Bank. See Nutis v. Penn Merchandising Corp., 610 F. Supp. 1573, 1578 (E.D.Pa. 1985), aff'd, 791 F.2d 919 (3rd Cir. 1986); Matthey v. KDI Corp., 699 F. Supp. 135, 139-40 (S.D. Ohio 1988).
II. Section 20(a) Claim
Section 20(a) of the Securities Exchange Act of 1934 provides:
Every person who, directly or indirectly, controls any person liable under any provision of this chapter or of any rule or regulation thereunder shall also be liable jointly or severally with and to the same extent as such controlled person to any person to whom such controlled person is liable, unless the controlling person acted in good faith....
15 U.S.C. § 78t(a) (1988).
The third circuit has held that liability under this section can exist only if primary liability has been established as to another controlled defendant. See Shapiro v. UJB Financial Corp., 964 F.2d 272, 279 (3rd Cir. 1992) ("Section 20(a) imposes joint and several liability on any person who 'controls a person liable under any provision of' the Securities Exchange Act of 1934. The text of the statute requires the plaintiff to prove that one person controlled another person, and that the "controlled person" is liable under the Act."). Thus, "once all predicate § 10(b) claims are dismissed, there are no allegations upon which § 20(a) liability can be based." Id. at 279. Here, the dismissal of the Section 10(b) claims against the defendants dictates dismissal of the Section 20(a) claims asserted against them.
III. Section 14a-9 Claim
Under the Federal Securities Exchange Act, it is unlawful for any person to solicit proxies by making false or misleading statements. See J.I. Case Co. v. Borak, 377 U.S. 426, 431, 12 L. Ed. 2d 423, 84 S. Ct. 1555 (1964) (the purpose of Section 14(a) is to prevent management from obtaining authorization for corporate action by means of deceptive or inadequate disclosure in proxy solicitation).
Generally, to prevail on a Section 14a-9 claim, a plaintiff must show (1) that there was a misstatement or omission within the proxy materials and (2) that the misstatement or omission was material and causally related in the accomplishment of the transaction giving rise to the litigation. Mills v. Electric Auto-Lite Co., 396 U.S. 375, 381, 24 L. Ed. 2d 593, 90 S. Ct. 616 (1970).
However, if a proxy omission is material, a plaintiff need not prove that the omission was the direct cause of the harm alleged. Under such circumstances, a plaintiff need only show that the proxy solicitation itself, rather than the particular defect in the solicitation, was "an essential link in the accomplishment of the transaction."
Mills 396 U.S. at 385. See, also, Affiliated UTE Citizens v. United States, 406 U.S. 128, 153-154, 31 L. Ed. 2d 741, 92 S. Ct. 1456 (1972) (the obligation to disclose and the withholding of a material fact establish the requisite element of causation in fact).
"An omitted fact is material if there is a 'substantial likelihood that, under all the circumstances, the omitted fact would have assumed actual significance in the deliberations of the reasonable shareholder.'" Craftmatic Securities Litigation v. Kraftsow, 890 F.2d 628, 639 (3d Cir. 1990) citing TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449, 48 L. Ed. 2d 757, 96 S. Ct. 2126 (1976).
Here, plaintiffs allege that defendants issued false and misleading proxy materials on September 21, 1990, June 14, 1991, and June 3, 1992 for the purpose of electing officers and directors. Specifically, they allege that
"[Defendants] fail to disclose . . . that defendants have mismanaged the Bank and [Bancorp], wasted corporate assets, engaged in self-dealing and have subjected [Bancorp] to liability for its violations of federal securities law . . . In so doing, defendants acted with the knowledge that such claims had been, or in probability would be, asserted against them."