-
USCA1 Opinion
UNITED STATES COURT OF APPEALS
FOR THE FIRST CIRCUIT
____________________
No. 94-1405
ESTATE OF JAIME SOLER,
Plaintiffs, Appellants,
v.
JOAQUIN RODRIGUEZ, ET AL.,
Defendants, Appellees.
____________________
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF PUERTO RICO
[Hon. Jose Antonio Fuste, U.S. District Judge] ___________________
____________________
Before
Boudin, Circuit Judge, _____________
Campbell, Senior Circuit Judge, ____________________
and Boyle,1 Senior District Judge. _____________________
____________________
Pedro A. Jimenez, with whom Katarina Stipec Rubio and _________________ _______________________
Gonz lez Oliver, Correa Calzada, Collazo Salazar, Herrero & _________________________________________________________________
Jim nez were on brief for appellants. _______
Jorge E. P rez D az, with whom Jorge I. Peirats and ______________________ __________________
Pietrantoni Mendez & Alvarez were on brief for appellee Centro _____________________________
Medico Del Turabo, Inc.
Eli B. Arroyo for appellee Universidad de Ciencias Medicas _____________
San Juan Bautista, Inc.
____________________
August 15, 1995
____________________
____________________
1Of the District of Rhode Island, sitting by designation.
CAMPBELL, Senior Circuit Judge. In this ________________________
shareholder's derivative suit brought on behalf of Centro
M dico del Turabo, Inc. ("CMT"), Plaintiffs-Appellants Ivette
Perez Vda. de Soler, Marie Ivette Soler Perez, Jaime A. Soler
Perez, and Antonio Soler Perez (as representatives of the
Estate of Dr. Jaime Soler, or the "Soler Estate") and Dr.
Jose A. Badillo appeal from the district court's Opinion and
Order and Order on Reconsideration dismissing their verified
complaint under Fed. R. Civ. P. 12(b)(6) for failure to state
a claim upon which relief may be granted.1 Estate of Soler ________________
ex rel. Soler v. Rodriguez, 847 F. Supp. 236 (D.P.R. 1994). _____________ _________
____________________
1. In its Opinion and Order and Order on Reconsideration,
the district court said it was dismissing the complaint for
failure to state a claim under Rule 12(b)(6), but stated in
the judgment that the complaint was dismissed for lack of
subject matter jurisdiction. Where both federal jurisdiction
and the existence of a federal claim turn upon whether the
complaint states a federal question, the preferable practice
is to assume that jurisdiction exists and proceed to
determine whether the claim passes muster under Rule
12(b)(6). See Bell v. Hood, 327 U.S. 678, 682-83 (1946) ___ ____ ____
(where the merits of the action are intertwined with the
issue of jurisdiction, the federal claim should be dismissed
for lack of subject matter jurisdiction only if the claim is
immaterial and made solely for the purpose of obtaining
jurisdiction or if the claim is clearly frivolous or wholly
insubstantial); Arroyo-Torres v. Ponce Fed. Bank, F.B.S., 918 _____________ _______________________
F.2d 276, 280 (1st Cir. 1990) (since plaintiff's assertion
that federal law implied a private right of action was not
frivolous, the district court had subject matter jurisdiction
to determine whether or not a claim existed; therefore, the
dismissal entered by the district court, ostensibly for lack
of jurisdiction, should have been premised upon Rule
12(b)(6)); see also 2A James W. Moore et al., Moore's Federal ________ _______________
Practice 12.07[2.-1] (2nd ed. 1993). However, "we are not ________
bound by the label employed below," Carr v. Learner, 547 F.2d ____ _______
135, 137 (1st Cir. 1976), and will treat the dismissal as one
made pursuant to Rule 12(b)(6).
-2- 2
The district court held that appellants failed to plead the
"in connection with" requirement of a cause of action under
Section 10(b)2 and Rule 10b-5,3 but rather alleged only a
____________________
2. Section 10(b) of the Securities Exchange Act of 1934, 15
U.S.C. 78j(b), states:
It shall be unlawful for any person,
directly or indirectly, by the use of any
means or instrumentality of interstate
commerce or of the mails, or of any
facility of any national securities
exchange . . .
(b) To use or employ, in connection with
the purchase or sale of any security
registered on a national securities
exchange or any security not so
registered, any manipulative or deceptive
device or contrivance in contravention of
such rules and regulations as the
Commission may prescribe as necessary or
appropriate in the public interest or for
the protection of investors.
3. Rule 10b-5, 17 C.F.R. 240.10b-5 states:
It shall be unlawful for any person,
directly or indirectly, by the use of any
means or instrumentality of interstate
commerce, or of the mails or of any
facility of any national securities
exchange,
(a) To employ any device, scheme, or
artifice to defraud,
(b) To make any untrue statement of a
material fact or to omit to state a
material fact necessary in order to make
the statements made, in the light of the
circumstances under which they were made,
not misleading, or
(c) To engage in any act, practice, or
course of business which operates or
would operate as a fraud or deceit upon
any person,
in connection with the purchase or sale
of any security.
-3- 3
case of breach of fiduciary duty and corporate mismanagement
under Puerto Rico law. We reverse.
I. FACTS. _____
The facts alleged in the complaint extending
every reasonable inference in plaintiffs' favor, see Coyne v. ___ _____
City of Somerville, 972 F.2d 440, 443 (1st Cir. 1992) are __________________
as follows. CMT is a private, for-profit Puerto Rico
corporation organized in 1978 to offer medical services in
the eastern central region of Puerto Rico. Through its
subsidiary, Turabo Medical Center Partnership,4 CMT owns and
operates the Hospital Interamericano de Medicina Avanzada
("HIMA"), a hospital located in Caguas, Puerto Rico.
The individual plaintiffs are the widow and
children of Dr. Jaime Soler, one of CMT's founders, and Dr.
Jos Badillo, the other founder of CMT. Prior to the
disputed sale of securities described below, Dr. Badillo
owned 217,500 shares of common voting stock of CMT, which
constituted 16.81% of the total 1,293,942 shares of common
voting stock of the company then issued and outstanding. In
1990, Dr. Soler passed away, leaving his 435,000 shares,
which constituted 33.62% of CMT's common voting stock, to the
Soler Estate. Appellants thus collectively owned 50.43% of
CMT's common voting stock.
____________________
4. Not a party to this suit.
-4- 4
Appellee Joaqu n Rodr guez was originally hired by
Drs. Soler and Badillo to manage CMT and eventually became a
minority shareholder as well as the chairman of its board of
directors. The founders gave Rodr guez full administrative,
financial, and operational control over all of the affairs of
CMT. On November 14, 1991, Mrs. Soler replaced her deceased
husband on the board. The other directors during the
relevant periods were appellant Dr. Badillo and appellees
Juan Chaves, Carlos M. Pi eiro, and Dr. Jos J. Vargas-
Cordero. Rodr guez was CMT's president; Dr. Badillo its
vice-president; Chaves its secretary; and Pi eiro its
treasurer. Appellee Fernando E. Agrait was an attorney hired
by Rodr guez to handle the in-house legal affairs of CMT.
Appellee Luis Garc a Passalacqua was owner of Miramar
Construction, Inc., which had a pending business deal with
CMT.
Appellees Chaves and Vargas-Cordero were also
respectively the owner and dean of appellee Universidad de
Ciencias M dicas San Juan Bautista, Inc. ("UCMSJB"), a non-
profit company operating an independent school of medicine at
HIMA. Appellees Rodr guez and Pi eiro were trustees of
UCMSJB. UCMSJB operated its medical school from a space
rented from CMT for $1.00 per year. Prior to the disputed
sale, UCMSJB also owned 10,000 shares, or 0.77%, of CMT's
common voting stock.
-5- 5
In 1987, CMT's shareholders authorized the issuance
of 300,000 common voting shares of CMT and the placement of
those shares in a public sale at $10 per share, subject to
registration under the Blue Sky laws of Puerto Rico, and for
distribution solely to residents of Puerto Rico. This sale
was not successful; very few of the shares were sold.
Sometime between 1991 and the fall of 1993, Rodr guez told
Dr. Ramon Carlos, a physician with privileges at HIMA who had
approached him to purchase shares in CMT, that the public
sale had been closed and that CMT's shares were no longer for
sale.
During all of 1992 and until October 1993,
shareholders meetings of CMT were not held, because,
according to Rodr guez, the audited financial statements of
the company were not ready. In 1993, Mrs. Soler and Dr.
Badillo [the "plaintiff directors"] decided that outside
experts should be hired to analyze CMT's future plans, and
felt that no corporate assets should be conveyed or
encumbered until this was done and the board was fully
informed.
Notwithstanding this decision, Rodriguez insisted
upon the sale of surface rights over HIMA's parking facility
to Miramar Construction for the development of a doctor's
office building. Mrs. Soler opposed this sale at a meeting
of CMT's board of directors held on September 9, 1993. At
-6- 6
this same meeting, Rodriguez reiterated a prior request for
approval of a three-year lease to UCMSJB of land managed and
partly owned by CMT. Mrs. Soler and Dr. Badillo opposed the
lease because of the nominal yearly rent of $1.00, because no
independent evaluation of the best use of that land had ever
been performed, and because no outside independent advice had
ever been obtained as to the financial benefit to CMT of
having UCMSJB's school of medicine, long unaccredited by the
nationwide accrediting body, affiliated with CMT. The
plaintiff directors also felt that the transaction between
CMT and UCMSJB, which was effectively controlled by Chaves,
Rodr guez, and Dr. Vargas, needed to be independently
analyzed for conflicts of interest.
Unbeknownst to the plaintiff directors, to the
board of CMT, and to CMT as a corporate entity, Rodr guez and
Chaves had designed a scheme to deprive plaintiffs of their
historic majority ownership in the company and gain control
of CMT for themselves. The scheme consisted of the issuance
by Rodr guez and Chaves, on September 16, 1993, without prior
knowledge or approval of the board of directors, of 200,000
shares of CMT stock to UCMSJB at a price of $10 per share,
for a total price of $2,000,000. UCMSJB made a down payment
of $500,000, and agreed to pay CMT the balance through eight
promissory notes in the amount of $100,000 each, payable
consecutively on August 1 and February 1 through February,
-7- 7
1997, at 6% annual interest, and a promissory note in the
amount of $700,000 on the same terms due on August 1, 1997.5
These notes were secured by an assignment of a contract
between the Department of Health of the Commonwealth of
Puerto Rico and UCMSJB by virtue of which UCMSJB was to
receive monthly payments of $249,864.08. This collateral is
alleged to have been "fictitious" because the contract in
question was supposedly non-assignable under Puerto Rico law.
The purposes of the scheme were allegedly to,
a) secure control by Rodr guez and Chaves
and approval of the lease with UCMSJB at
CMT's expense, b) to procure and finance
a substantial block of shares to UCMSJB
at a wholly inadequate price and with
fictitious collateral, c) to entrench
management and validate sweetheart deals
and/or situations of conflicts of
interest, d) to dilute and eliminate
plaintiffs' majority ownership in CMT, e)
to evict plaintiffs from the corporate
board, and f) to prevent the appointment
of independent outside directors to the
company board at the annual shareholders'
meeting.
At the next board meeting on September 29, 1993,
Rodr guez again insisted that the three-year lease be
approved at no charge, ostensibly in order to free up other
space occupied by the medical school in the hospital. The
plaintiff directors decided at this point firmly to oppose
____________________
5. The verified complaint states that the payments were to
be made on a yearly basis for seven years. This is
contradicted by the Agrait letter, infra and included in the _____
complaint. According to the letter, payment was to be as
described above.
-8- 8
the lease until independent analysis could be done. No
mention was made at this meeting of the sale of shares to
UCMSJB.
In early October 1993, the plaintiff directors
noticed that certain statements contained in the minutes of
the September 29th meeting were inaccurate or misleading.
Specifically, the minutes stated that Mrs. Soler had moved
for approval of the minutes of the September 9th meeting,
which she had not done; reflected a motion made by Mrs. Soler
and Dr. Badillo setting forth certain requirements for
consideration of the sale of surface rights to Miramar
Construction, but omitted the principal requirement that such
sale not be approved until it was independently determined
that it was in CMT's best interest; and reflected that Dr.
Badillo had proposed approval of the lease to UCMSJB, when
both he and Mrs. Soler had strongly opposed such lease.
The plaintiff directors decided that the only way
to deal with the increasing conflicts of interest was to
appoint to CMT's board reputable and experienced independent
outside directors at the upcoming shareholders' meeting, to
be held on October 28, 1993, and to do so in such a manner
that these outside directors would hold a determinative vote
in case of an impasse. Dr. Badillo also considered selling
the plaintiff shareholders' majority block as a means of
ending the tense situation, but the Soler Estate decided that
-9- 9
until such time as outside directors were appointed, it would
not consider or decide whether it wished to sell its shares
in CMT.
The plaintiff directors formalized their position
in a letter dated October 7, 1993, a copy of which was hand-
delivered to the directors of CMT at a board meeting held on
that date. The letter stated their formal opposition, both
as directors and as majority shareholders, to the approval of
the lease with UCMSJB, complained of the absence of
information concerning the transaction, and demanded that the
board not approve the lease until such information had been
received and analyzed. The board, controlled by Rodr guez,
nonetheless approved the lease. Again, no mention was made
of the sale of shares to UCMSJB.
Following this meeting, the plaintiff directors
commenced a search for qualified individuals with no
financial ties to CMT who would agree to serve as outside
directors. Between October 10 and October 28, 1993, two such
individuals were located and agreed to serve. The plaintiff
directors intended at the upcoming shareholders' meeting to
vote for the reelection of Rodr guez, Pi eiro, Vargas-
Cordero, and themselves, as well as the two new outside
directors, and to retain Rodr guez as president and chief
operating officer of CMT. It was their intention to inform
Rodr guez of their plans on the night of the shareholders'
-10- 10
meeting, prior to its commencement. However, when the
plaintiff directors arrived at the meeting with their counsel
and the outside directors, Rodr guez informed them that they
no longer had a majority position in the company, by virtue
of the sale of shares to UCMSJB.6
Upon learning of this sale, the plaintiff directors
walked out of the shareholders' meeting. The meeting,
allegedly in the absence of a quorum, then removed Mrs. Soler
and Dr. Badillo as directors, and replaced them with Garc a
Passalacqua. Rodr guez then informed the newly constituted
board of the sale to UCMSJB, and the sale was ratified.
Prior to the shareholders' meeting, Rodr guez had
obtained a letter from CMT's inside counsel, Agrait, dated
October 11, 1993 ("the Agrait letter"), to the effect that
the proposed sale of stock to UCMSJB was legal. Plaintiffs
contend that this letter was deliberately intended to conceal
the illegality of the sale from other shareholders and
directors. The letter first recited the details of the sale,
as recounted above. It then stated that the sale was valid
under the 1987 shareholders' resolution authorizing the
issuance of 300,000 common voting shares of CMT. The letter
concluded that since not all of the 300,000 shares had been
____________________
6. Following the sale to UCMSJB, there were 1,493,942 shares
of CMT common voting stock outstanding. The plaintiffs'
652,500 shares represented 43.68% of the total; UCMSJB's
210,000 represented 14.06%, with the remaining 631,442
shares, or 42.27%, held by other shareholders.
-11- 11
sold, and since the sale to UCMSJB was a private sale to a
single purchaser for part of the balance of the authorized
but unsold shares, the sale had been implicitly authorized by
the shareholders in 1987, and no public disclosure and
registration under the Blue Sky laws were required because
the sale was not part of an offering to more than ten
purchasers.
The complaint also notes that although the Agrait
letter states that the sale was effected on September 16,
1993, Agrait wrote another letter on behalf of CMT to the
Commissioner of Financial Institutions on September 27, 1993,
inquiring whether a private sale of securities to a single
entity was subject to the disclosure and registration
requirements of Puerto Rico Blue Sky laws. The September 27
latter stated that CMT was "going to sell" 200,000 shares to
one of its shareholders.
The complaint also alleges that while $10 per
share was an adequate price in 1987, when CMT was in dire
financial straits and on the verge of bankruptcy, Rodr guez
and Chaves knew that it was no longer an adequate price. In
support of this allegation, the complaint states that
Rodr guez had hired the services of Clark Melvin Securities
and Merrill Lynch to conduct an appraisal in connection with
the refinancing of CMT's debt, which was expected to close
shortly. On the day of the shareholders' meeting, Rodr guez
-12- 12
and Chaves were told by a Mr. Montilla, pursuant to that
appraisal, that the market value of all of CMT's common
voting shares upon approval of the financing would be
approximately $24 million, or at least $18 per share (not
counting the 200,000 shares sold to UCMSJB).
Finally, the complaint states that on November 3,
1993, the plaintiffs sent a formal demand letter to CMT's
management and "the illegally appointed directors," advising
them that any actions taken by the new board after October
28, 1993 were invalid and illegal and demanding various
remedial actions including the convening of an extraordinary
shareholders' meeting. After various negotiated delays, the
defendants responded that under no circumstances would
plaintiffs be reinstated to the board, and offered to buy
plaintiffs' shares at approximately $5 per share. They also
rejected plaintiffs' demand for an extraordinary shareholders
meeting, notwithstanding the requirement in Article IV,
Section 2 of the company by-laws that such meetings "shall be
called by the president" at the request of the holders of
more than 25% of the outstanding voting stock.
II. THIS LAWSUIT. ____________
Plaintiffs' complaint alleged, on behalf of CMT, a
violation of Section 10(b) of the Securities Exchange Act of
1934, 15 U.S.C. 78j(b) and Rule 10b-5 of the Securities
Exchange Commission, 17 C.F.R. 240.10b-5. The complaint
-13- 13
also sought, under the district court's supplemental
jurisdiction, see 28 U.S.C. 1367, rescission of the stock ___
purchase agreement for lack of corporate authority and lack
of proper consideration, annulment of the October 28, 1993
board election, and a new election under Puerto Rico law.
The complaint was filed on November 24, 1993, and included
requests for preliminary and permanent injunctions and for a
temporary restraining order prohibiting any extraordinary
disbursement of corporate funds, sale or encumbrance of
corporate assets, and the holding of board of directors
meetings during the next ten days. The district court issued
the temporary restraining order on the same day the complaint
was filed and set a hearing on the preliminary injunction for
December 3, 1993. At a status conference held on December 2,
1993, the district court consolidated consideration of the
preliminary and permanent injunctions, and set a trial date
of February 7, 1994. The temporary restraining order lapsed
by its own terms on December 3, 1993.
CMT then filed a motion requesting realignment as a
defendant, and for dismissal or summary judgment. UCMSJB
moved to joint CMT's motion for dismissal or summary
judgment. Agrait filed a motion for summary judgment. The
remaining defendants filed a motion to dismiss. The district
court, in an opinion and order filed on February 7, 1994,
decided the motions based on the pleadings only, treating all
-14- 14
motions as motions to dismiss under Fed. R. Civ. P. 12(b)(6).
Finding that the alleged securities fraud did not make out a
claim under 10(b) of the Securities Exchange Act of 1934,
the district court dismissed the federal securities fraud
claim for failure to state a claim under Rule 12(b)(6).7
Because federal jurisdiction was based solely on that claim,
the court declined to retain jurisdiction over the remaining
state law claims, and dismissed them without prejudice.
The plaintiffs filed a motion for reconsideration
on February 21, 1994. The district court denied the motion
in a written order dated March 24, 1994. This appeal
followed.
III. THE DISTRICT COURT'S DECISION. _____________________________
The district court characterized the case as
presenting the question
whether a corporation can be said to have
been deceived in connection with the sale
of its securities within the meaning of
section 10(b) of the Securities Exchange
Act of 1934, when the president and the
secretary authorized the sale of
allegedly previously-issued stock to a
shareholder, without approval of the
board of directors or the other
shareholders.
Estate of Soler, 847 F. Supp. at 238. The court said that _______________
the "in connection with" element requires a showing "that the
wrongful conduct caused the plaintiff to engage in the
____________________
7. See supra n.1. ___ _____
-15- 15
disputed sale or purchase of securities and that the
plaintiff's injuries are directly attributable to the
deception and to the resulting transaction." Id. at 239 ___
(citing Wilson v. Ruffa & Hanover, P.C., 844 F.2d 81, 85 (2d ______ _____________________
Cir. 1988)). If the alleged fraud does not relate to "the
inherent nature, characteristics or value of the security
and, therefore, could not have influenced the plaintiff in a
decision to sell or purchase the security," id. at 240, there ___
is no causal link to the disputed sale.
The court then said that the alleged omission in
this case was
the failure of the defendants to reveal,
in advance, the sale of the stock of CMT
to UCMSJB. Where a corporation is
fraudulently induced into issuing its own
securities for less than their fair value
because of the misappropriation of inside
information regarding the stock, the
corporation itself is injured and a
shareholder derivative action is
appropriate. Frankel v. Slotkin, 984 _______ _______
F.2d 1328, 1334 (2d Cir. 1993). However,
the sale in this case did not take place
because the corporation was uninformed
about the nature of the stock, or because
defendants misappropriated inside
information about the value of the
securities to be sold. We cannot find
that the concealment of the sale itself
from the corporation caused the
corporation to enter into the sale.
Rather than "in connection with" the sale
of a security, the deception here was
"of" the sale of a security.
Id. (footnote omitted). The district court noted the ___
incongruity of suggesting "that disclosure of a sale without
-16- 16
full disclosure of some material aspect of the sale would be
a violation of 10b-5, while failing to disclose the sale at
all is not violation." Id. at 241. However, the court ___
concluded, Rule 10b-5 is not meant to address instances of
corporate mismanagement. "Rather, it was intended to promote
full and fair disclosure to those who buy or sell securities
in order to ensure that investors are able to make the
correct decision as to whether to carry out the purchase or
sale." Id. (citing Santa Fe Indus., Inc. v. Green, 430 U.S. ___ _____________________ _____
462, 477-78 (1977); O'Brien v. Continental Ill. Nat. Bank & _______ _____________________________
Trust Co.,593 F.2d54, 60(7th Cir.1979)). The courtthen noted, _________
While we recognize that the failure to
reveal the sale at all necessarily meant
that information about the nature of the
shares was also concealed, because the
company did not "know" that it was
selling any securities, the corporate
entity cannot be said to have been
deceived as to the characteristics or
value of the securities, or to have made
any decisions based on a lack of
knowledge about the nature of the
securities.
Id. The court then exercised its discretion to dismiss ___
without prejudice the remaining supplemental state law
claims.
On reconsideration, the district court first noted,
in response to the argument that it had applied an incorrect
subjective test of causality, that it had not held that CMT
had not relied on the omitted information, but rather that
the omission was not of the type Rule 10b-5 was meant to
-17- 17
remedy. Id. The court then discussed plaintiffs' argument ___
that it had applied a test of awareness of an investment
decision applicable to transactions between individuals and
entities, not to transactions in which a corporation is
deceived by its own management. The court noted that
Goldberg v. Meridor, 567 F.2d 209 (2d Cir. 1977), cert. ________ _______ _____
denied, 434 U.S. 1069 (1978) and its progeny recognize that ______
even though some controlling directors or
shareholders have complete information,
they can conceal that information and
utilize it to the detriment of the
corporation, thus deceiving the corporate
entity in violation of Rule 10b-5. We
agree that in the case before us, taking
the facts as alleged by plaintiffs, the
corporation was deceived when some
members of the board of directors
conducted a sale of corporate stock
without informing the full board and the
remaining shareholders.
Id. at 242. Nevertheless, the court reiterated its holding ___
that the deception here was not in connection with the sale
of securities as required for liability under Rule 10b-5.
Id. The court distinguished Goldberg, saying, ___ ________
In Goldberg, the minority shareholders ________
knew that the disputed transaction was to
take place, but they were deceived into
forgoing a possible state injunction
because pertinent facts about the
transaction were not revealed by
defendants. Therefore, a decision by the
minority shareholders not to seek a state
injunction was completed without the
benefit of complete information. Here,
because the minority shareholders had no
knowledge that the transaction was taking
place, there was no decision-making
process of either type.
-18- 18
Id. (citation and footnote omitted). ___
The court also addressed plaintiffs' argument that
the transaction found actionable under Rule 10b-5 in
Superintendent of Ins. v. Bankers Life & Casualty Co., 404 _______________________ _____________________________
U.S. 6 (1971), involved a deception unrelated to the inherent
nature, characteristics or value of the security. The court
in effect conceded that this was so, saying that in Bankers _______
Life, ____
[t]he deception related to the nature of
the transaction -- that the plaintiff
would be paying for its own securities --
and not to the existence of the
transactions. We were not intending to
create a hard and fast rule as to what
should be deemed "in connection with" a
securities transaction, but merely to
point to illustrative cases in order to
demonstrate why the instant action falls
outside the purview of Rule 10b-5.
Estate of Soler, 847 F. Supp. at 242 (citation omitted). ________________
Finally, the court compared this case with Ketchum v. Green, _______ _____
557 F.2d 1022 (3d Cir. 1977), cert. denied, 434 U.S. 940 _____________
(1977). In that case, a secret scheme was hatched to oust
certain employees/shareholders, which had the additional
result of forcing them to sell their shares back to the
corporation. The court interpreted the Third Circuit as
holding "that the disputed transaction was not actionable
under Rule 10b-5 because it occurred in connection with a
struggle for control of the corporation, rather than in
connection with the sale of securities." Id. at 243. The ___
-19- 19
court concluded that the present case similarly involved a
dispute over control of CMT, and thus belonged in state
court. Id. ___
IV.
A. The Standard of Appellate Review.8
For purposes of Fed. R. Civ. P. 12(b)(6), a court must
accept all well-pleaded facts as true and draw all reasonable
inferences in favor of the non-movant. Washington Legal _________________
Found. v. Massachusetts Bar Found., 993 F.2d 962, 971 (1st ______ _________________________
Cir. 1993) (citing Coyne, 972 F.2d at 442-43). "A court may _____
dismiss a complaint only if it is clear that no relief could
be granted under any set of facts that could be proved
consistent with the allegations." Hishon v. King & Spalding, ______ _______________
____________________
8. The district court ruled that plaintiffs lacked standing
to maintain a private action in their individual behalves for
securities fraud under Rule 10b-5, because they did not
purchase or sell the securities involved in the disputed
transaction, citing Blue Chip Stamps v. Manor Drug Stores, _________________ __________________
421 U.S. 723 (1975), reh'g denied, 423 U.S. 884 (1975). The ____________
plaintiffs have not appealed from this decision. The
district court held, however, that the plaintiffs had
standing to bring a derivative action on behalf of CMT.
Appellees challenge this ruling on the ground that an "action
that is not for the benefit of the corporation, but merely
seeks to enforce the rights of one or more shareholders is
not a derivative action." But as we discuss, infra, the _____
verified complaint adequately alleges injury to the
corporation, stating that certain of its board members caused
it to sell its own stock, without disclosure of the
transaction to other, disinterested board members, hence
without disclosure to all those charged by law to act on
behalf of the corporation, at a price far below the stock's
actual value, with partial payment secured by fictitious
collateral. That the plaintiffs may also have been injured
in a personal capacity is irrelevant to the question of their
standing to bring a derivative suit for the corporation.
-20- 20
467 U.S. 69, 73 (1984) (citing Conley v. Gibson, 355 U.S. 41, ______ ______
45-46 (1957)). An appellate court is not limited to the
legal grounds relied upon by the district court, but may
affirm on any independently sufficient grounds. Willhauck v. _________
Halpin, 953 F.2d 689, 704 (1st Cir. 1991). ______
B. Fraud Upon a Corporation by its Directors.
"To prevail under Rule 10b-5, 'a plaintiff must
prove, in connection with the purchase or sale of a security,
that the defendant, with scienter, falsely represented or __
omitted to disclose a material fact upon which the plaintiff ____________________
justifiably relied.'" Willco Kuwait (Trading) S.A.K. v. ________________________________
deSavary, 843 F.2d 618, 623 (1st Cir. 1988) (quoting Kennedy ________ _______
v. Josephthal & Co., Inc., 814 F.2d 798, 804 (1st Cir. 1987)) ______________________
(emphasis supplied). "The Act protects corporations as well
as individuals who are sellers of a security." Bankers Life, ____________
404 U.S. at 10. We hold that the district court erred in
ruling that the verified complaint did not state a claim for
CMT under 10(b) and Rule 10b-5.
Briefly recounted, the scheme described in the
complaint was allegedly hatched by CMT's president and by its
secretary, both of whom were also its directors. The scheme
was to cause CMT to issue and sell 200,000 shares of earlier
authorized common voting stock9 to UCMSJB a medical
____________________
9. The issuance of 300,000 shares of new stock had been
authorized by the shareholders in 1987, six years earlier, at
a price of $10 a share, when CMT was allegedly close to
-21- 21
school of which CMT's president was a trustee, and of which
CMT's secretary was the owner for the price of $10 a
share. The issuance and sale of stock was allegedly
accomplished without the knowledge or approval of the
plaintiff directors, of the board of directors, and of the
corporate entity itself. UCMSJB paid CMT for the stock
largely in notes secured by an assignment of a contract
between the Department of Health of Puerto Rico and UCMSJB.
Two of CMT's other directors were at the time closely
affiliated with UCMSJB, while the two plaintiff directors
who between them controlled a bare majority of CMT's stock
were unhappy with CMT's developing relationship with UCMSJB.
As a result of the deliberately concealed sale, the
proportion of CMT stock controlled by the plaintiff directors
fell below 50%, leaving UCMSJB and those associated with it
in practical control of CMT. The complaint alleged that an
objective of selling the 200,000 shares of CMT stock to
UCMSJB was to enable the latter to obtain a substantial block
of CMT shares at a wholly inadequate price and to finance the
stock purchase with fictitious collateral. According to the
complaint, the appraised market value of CMT's stock when
sold to UCMSJB in 1993 was $18, not $10, a share; and the
government contract constituting collateral for the notes was
____________________
bankruptcy. Efforts to sell the shares at that time were
unavailing and, it might be inferred, were abandoned.
-22- 22
non-assignable, rendering the collateral fictitious. The
complaint further alleged that, although the stock was issued
to UCMSJB on September 16, 1993, no mention was made of the
fact at the two board of director meetings held in September
one held before and one after the 16th. By the time of
the October shareholders' meeting, defendants now firmly
in control revealed the stock transaction for the first
time to the plaintiff directors and former majority
shareholders. Plaintiffs were then ousted as directors.
It is by now well established that a corporation
has a claim under 10(b) if the corporation was defrauded in
respect to the sale of its own securities by some or even all
of its directors. See, e.g., Goldberg, 567 F.2d at 215. In _________ ________
Ruckle v. Roto Am. Corp., 339 F.2d 24 (2d Cir. 1964), a case ______ _______________
factually close to the present, a director who represented
more than half the stock entitled to vote at the 1964 annual
meeting of the defendant corporation successfully brought a
derivative action against his six fellow directors, who also
constituted the corporation's officers. The complaint
alleged that the officers had sought to perpetuate their
control by, among other ways, having the board approve the
issuance of some 75,000 treasury shares that were to be
resold to the president or voted as he directed. The
plaintiff alleged that the defendants had withheld the latest
financial statements from the board, had arbitrarily ascribed
-23- 23
a $3 value to the shares, and had approved several
transactions involving the stock without disclosing pertinent
facts to the entire board. Id. at 26. Reversing a ___
dismissal, the Second Circuit held that it was possible under
Rule 10b-5 for a corporation to be defrauded by a majority of
its directors "or even the entire board." Id. at 29. The ___
court went on to say,
If, in this case, the board defrauded the
corporation into issuing shares either to
its members or others, we can think of no
reason to say that redress under Rule
10B-5 [sic] is precluded, though it would
have been available had anyone else
committed the fraud. There can be no
more effective way to emasculate the
policies of the federal securities law
than to deny relief solely because a
fraud was committed by a director rather
than an outsider. Denial of relief on
this basis would surely undercut the
congressional determination to prevent
the public distribution of worthless
securities.
Id. ___
While Ruckle predated the Supreme Court's decision ______
in Santa Fe, nothing in Santa Fe and its progeny invalidate ________ ________
Ruckle's relevant holding. See, e.g., Frankel, 984 F.2d at ______ __________ _______
1334 (citing Ruckle with approval); see also O'Neill v. ______ _________ _______
Maytag, 339 F.2d 764 (2d Cir. 1964); Schoenbaum v. ______ __________
Firstbrook, 405 F.2d 215 (2d Cir. 1968) (en banc), cert. __________ _____
denied sub nom. Manley v. Schoenbaum, 395 U.S. 906 (1969); ________________ ______ __________
Santa Fe, 430 U.S. at 462; Goldberg, 567 F.2d at 209; see ________ ________ ___
-24- 24
also 7 Louis Loss & Joel Seligman, Securities Regulation ____ ______________________
3530-41 (3rd ed. 1991) (discussing this line of cases).
As in Bankers Life, it is here alleged that the _____________
corporation on behalf of which suit has been brought was
"injured as an investor through a deceptive device which
deprived it of [adequate] compensation for the sale of its
valuable block of securities." 404 U.S. at 10. The
deceptive device was that interested directors of CMT and
other parties deliberately omitted to inform CMT's
disinterested directors and shareholders, at a time when they
might still have acted to protect CMT, of an impending,
allegedly deleterious, sale of stock to UCMSJB. CMT "relied
upon" this omission to its detriment, in that its managers
issued and sold its stock at an allegedly inadequate price
and without adequate security, CMT having been fraudulently
deprived of the judgment of its full board of directors on
the matter and, in particular, of the judgment of those
directors and stockholders who were disinterested and not
personally connected with UCMSJB. Such facts plainly make
out a claim of defendants' knowing deception of and injury to
CMT in connection with the sale of its stock.
The district court recognized that, "in the case
before us, taking the facts as alleged by plaintiffs, the
corporation was deceived when some members of the board of
directors conducted a sale of corporate stock without
-25- 25
informing the full board and the remaining shareholders."
Estate of Soler, 847 F. Supp. at 242. The court even _________________
acknowledged that a 10(b) violation would have occurred had
the directors been told of the proposed sale of stock but
deceived as to related material facts. The court believed,
however, that no violation occurred here, because the sale
itself was concealed, resulting, it said, in no decision-
making process at all. We do not see the distinction. The
calculated concealment of the sale itself, thus depriving
CMT's disinterested directors of the opportunity to take
steps to prevent it before it occurred, was an omission to
provide essential material information to the company
regarding the stock sale. Indeed, accepting the allegations
of the complaint as true, it is a reasonable inference that
concealment of the proposed sale from CMT's board of
directors was essential to the success of the fraud, since
the plaintiff directors controlled a majority of CMT's
outstanding shares and would doubtless have acted to block
the sale had they known.
We see no merit in the district court's analogy
between this case and Santa Fe. In Santa Fe, acting without ________ ________
fraud or concealment, a controlling company utilized
Delaware's "short form merger" statute to force minority
stockholders in a subsidiary to sell back their shares. The
latter sued under 10(b) asserting a breach of fiduciary
-26- 26
duty. Noting the absence of a "manipulative or deceptive
device," the Supreme Court held that 10(b) is not meant to
remedy corporate mismanagement, but rather to promote full
disclosure to those who buy or sell securities. The Court in
Santa Fe nowhere suggested that a deliberate stock fraud, ________
involving the calculated omission by personally interested
directors to tell other directors that the company was
selling its treasury stock at a below market price and
without adequate security, was beyond the reach of 10(b).
The allegations here are precisely of a lack of
full disclosure to CMT, the seller of the securities. They
go beyond mismanagement to the calculated and deliberate
concealment, by interested directors, of information that a
substantial block of the company's stock was being sold at an
improperly low price to another company with whom the
interested directors were linked. The sale of CMT's
securities, and the price and terms of the sale, were
deliberately withheld to prevent the disinterested members of
CMT's board of directors, who were also its controlling
shareholders, from taking action prior to the completed sale.
Hence those sharing in the legal responsibility to manage
CMT's affairs were kept in the dark until the time had passed
when they might still have acted to safeguard CMT's
interests. As there was no "full and fair disclosure" to
those legally empowered to act for the corporation, there was
-27- 27
no full and fair disclosure to CMT itself. Unlike the
situation in Santa Fe, the facts alleged go well beyond mere ________
corporate mismanagement "in which the essence of the
complaint is that shareholders were treated unfairly by a
fiduciary." 430 U.S. at 477.
Appellees contend that the verified complaint
alleges no more than violations of state law, such as breach
of fiduciary duty, and that therefore this case falls into
the "exception" to 10(b) liability created by Bankers Life. ____________
We do not agree. That state causes of action are also
available to the plaintiff does not mean that a right of
action will not lie under 10(b). "Section 10(b) must be
read flexibly, not technically and restrictively. Since
there was a 'sale' of a security and since fraud was used 'in
connection with' it, there is redress under 10(b), whatever
might be available as a remedy under state law." Bankers _______
Life, 404 U.S. at 12. The statement in that case that ____
"[C]ongress by 10(b) did not seek to regulate transactions
which constitute no more than internal corporate _________________
mismanagement," id. (emphasis added), means only that a ___
breach of fiduciary duty, "without any deception,
misrepresentation, or nondisclosure," Santa Fe, 430 U.S. at ________
476, does not violate 10(b). Where corporate fiduciaries
deceive other board members and stockholders by withholding
key information pertinent to the corporation's sale of its
-28- 28
own securities, the corporation may have redress through
10(b).
In dismissing the corporation's 10(b) claim, the
district court also held that the defendants' alleged
deception here was not sufficiently linked causally to a sale
of securities. The court cited to cases where the
misrepresentations or omissions "did not relate to the
inherent nature, characteristics or value of the security."
See, e.g., Chemical Bank v. Arthur Anderson & Co., 726 F.2d _________ ______________ ______________________
930 (2d Cir.), cert. denied, 469 U.S. 884 (1984). From ____________
these, the court reasoned that simply omitting to tell CMT's
directors and majority shareholders of the fact of the sale
of CMT's authorized stock was different from feeding them
false information about the specifics of the sale. In so
reasoning, the court sought to distinguish cases such as
Bankers Life, 404 U.S. at 6, Goldberg, 567 F.2d at 209, 219- ____________ ________
20, and Frankel v. Slotkin, 984 F.2d 1328 (2d Cir. 1993). _______ _______
The short answer, we think, is that these cases cannot be
distinguished. The district court asserts that "the sale in
this case did not take place because the corporation was
uninformed about the nature of the stock." Estate of Soler, _______________
847 F. Supp. at 240. Yet the complaint alleges that an
appraisal of the stock indicated that it was worth $18, not
$10, a share. Had the board of directors been so advised,
and had it been told of other aspects of the sale (such as
-29- 29
the alleged fictitious security), it might not have agreed to
the sale, and, in any case, the minority directors (who were
majority shareholders) might have been able to take action to
block the sale.
Nor do we agree that this case is controlled by
Ketchum v. Green, 557 F.2d 1022 (3d Cir. 1977). In that _______ _____
case, the Third Circuit wrote:
Upon review of the stipulation of facts
and the record of the proceedings before
the district court, it becomes clear that
the case at hand involved little more
than allegations pertaining to an
internal corporate conflict. Although
the complaint seemingly stresses the
importance of the relinquishment of
plaintiffs' shares under the stock
retirement plan, the factual stipulation
and other segments of the record are
largely silent on this point. For
example, it is only in the concluding
paragraphs of the stipulation that there
is any mention of the forced sale of
securities. It thus is manifest that the
essence of the plaintiffs' claim concerns
their dismissal as officers of Babb, Inc.
557 F.2d at 1027 (footnote omitted).
The alleged fraud in Ketchum was defendants' _______
failure to reveal their intentions to oppose the reelection
of the plaintiffs as officers. While termination of
plaintiffs as corporate employees would trigger a by-law
forcing them to sell their stock, the Third Circuit concluded
that 10(b) did not apply as the essence of the relief
sought was directed against termination of plaintiffs as
officers, not to the sale of securities. In contrast with
-30- 30
Ketchum, the stock sale to UCMSJB is central to the fraud _______
detailed in the complaint here. We see no basis in Ketchum _______
from which to hold that the present scheme was not "in
connection with" the sale of a security, as Rule 10b-5
requires.
We have considered appellees' other arguments,
including those related to the adequacy of the complaint
under Fed. R. Civ. P. 9(b), and find them to be without
merit. We hold that the complaint in this case, viewed in a
light most favorable to the plaintiffs, states a cause of
action under 10(b) and Rule 10b-5. Of course, nothing we
say is meant to relieve appellants of their burden of proof
as to the matters alleged in the complaint, nor to suggest
that we accept those matters as necessarily being complete or
true.10
____________________
10. Appellees Agrait, Pi eiro, and Vargas-Cordero argue that
the verified complaint alleges only that they aided and
abetted the sale of stock to UCMSJB. They cite Central Bank ____________
v. First Interstate Bank, 114 S. Ct. 1439 (1994) (issued ______________________
during the pendency of this appeal), which held that a
private plaintiff could not maintain an aiding and abetting
suit under 10(b) and Rule 10b-5. Appellee UCMSJB argues
that it was under no duty to inform the appellants of its
purchase of CMT's stock, citing Chiarella v. United States, _________ _____________
445 U.S. 222, 234-35 (1980) ("Section 10(b) is aptly
described as a catchall provision, but what it catches must
be fraud. When an allegation of fraud is based upon
nondisclosure, there can be no fraud absent a duty to
speak."), and Taylor v. First Union Corp., 857 F.2d 240 (4th ______ __________________
Cir. 1988). Because we now reverse the district court's
judgment dismissing appellants' complaint, we think these
issues are best left in the first instance to the district
court.
-31- 31
C. Conclusion.
We reverse the district court's judgment dismissing
the complaint in this case for failure to state a claim upon
which relief may be granted, and remand for further
proceedings consistent with this opinion.
Reversed and remanded. _____________________
-32- 32
Document Info
Docket Number： 94-1405
Filed Date： 8/15/1995
Precedential Status： Precedential
Modified Date： 9/21/2015