WEINFELD, District Judge.
This essentially is a stockholders' derivative action brought on behalf of Central American Mining & Oil, Inc., a Panamanian corporation, hereinafter called CAMO, charging the defendants, who are its principal officers, sole directors and majority stockholders, with fraud, waste, mismanagement and diversion of a corporate opportunity.
The second amended complaint, the subject of the defendants' motion to dismiss, contains three separate counts which are based substantially upon the following allegations:
That plaintiffs, John J. and Joseph J. Kane, are the owners of 58,000 of the more than 7,000,000 shares of common stock issued by CAMO, which was incorporated under the laws of the Republic of Panama; that in 1961, shortly after its incorporation, CAMO acquired, indirectly through a corporate shell controlled by the defendants, a large mineral concession in the Republic of Honduras for a consideration of $40,900 in cash and 1,005,000 shares of its common stock; that by this transaction the defendants improperly arrogated CAMO's corporate opportunity unto themselves; further, that at or about the time the concession was acquired, CAMO issued 2,000,000 shares of common stock to one O. R. Seagraves and 2,000,000 shares to the defendant, Robert Guadano, for which the latter paid no or an inadequate consideration; that thereafter Guadano, to gain control of the corporation and to oust O. R. Seagraves, caused another 2,000,000 shares to be issued to his brother, Bernard Guadano, also a defendant, for which no or an inadequate consideration was paid; that in July 1961 CAMO assigned part of its Honduran concession to Pure Oil Company in return for $450,000 cash ($50,000 of which was held in escrow) and for a share of Pure Oil's profits; that the defendants misappropriated a substantial portion of the $400,000
The three separate counts are as follows: The first, predicated upon diversity of citizenship, charges violations of the Articles of Incorporation and of Panamanian law. It alleges that the plaintiffs are citizens of the State of Texas, that the individual defendants are citizens of the State of New York, and that the corporation is doing business in that State and has conducted meetings there. The second count alleges liability under Section 10(b) of the Securities Exchange Act of 1934
Plaintiffs seek the return to the corporation of the 4,000,000 shares issued to the defendants, Robert and Bernard Guadano, the removal of the three individual defendants from their corporate posts, and an accounting with respect to the sums received in connection with the Pure Oil Company transaction.
The defendants move under Rule 12(b) of the Federal Rules of Civil Procedure for dismissal of the complaint on the following grounds:
In the event of denial of their motion, they further move that plaintiffs post security for expenses and damages pursuant to the New York Business Corporation Law
The parties have submitted affidavits in support of and in opposition to the motion and that branch which seeks dismissal of the complaint for failure to state a claim is treated as one for summary judgment.
The extensive contentions of the parties, which in some respects overlap, make it desirable initially to consider the second count, the nondiversity and federally based claim, since if it withstands dismissal the disposition of the two remaining counts falls in place.
The principal thrust of the defendants' position, broadly stated, is that CAMO is a Panamanian corporation; that it is not found, present, nor doing business in this State; that even if, contrary to their contention, diversity jurisdiction exists, the basic claim asserted by the plaintiffs involves the internal affairs of a foreign corporation, as to which the New York courts would decline jurisdiction
The plaintiffs, on the other hand, while challenging these contentions, which involve sharply disputed fact issues, contend that in any event the second count states a claim upon which relief may be granted and satisfies subject matter jurisdiction, venue and process requirements.
I. THE FEDERAL CLAIM
The nub of this claim is that the defendants, in causing CAMO to issue to the Guadanos 4,000,000 shares for no or an inadequate consideration, "employed a device, scheme and artifice to defraud, and engaged in acts which operated and would operate as a fraud and deceit upon the defendant corporation and its stockholders"; that in so doing, the defendants used "means and instrumentalities of interstate commerce and the mails" in violation of Section 10(b) of the 1934 Act.
The defendants' position is that, even though cloaked in the garb of 10(b) violations, the asserted claim is nothing more or less than one involving the internal affairs and management of a Panamanian corporation and the determination of whether the stock issued to the Guadanos was for a proper consideration. Accordingly, they contend that Count II fails to state a claim upon which relief may be granted, their theory being that Section 10(b) and Rule 10b-5 are restricted to fraud in connection with national securities exchanges or with public distributions of stock and were not intended to reach private securities transactions
This position, and corollary ones, repeatedly urged from the inception of the 1934 Act, have not gained acceptance. It is no longer open to question that a corporation which is fraudulently induced to issue stock for no or inadequate consideration is a defrauded "seller" under the statute;
Accordingly, the Court holds that the statute is properly invoked and that Count II states a claim thereunder. Section 27 of the 1934 Act
The challenge to venue rests in large measure upon the general venue provision, Section 1391 of Title 28, and the defendants' disputed contention that the corporation was not doing business in this district. However, it is not necessary
Pursuant to the Congressional purpose of providing an accessible forum for imposing the Act's standards upon multistate transactions in securities, telephone calls from the forum district,
SERVICE OF PROCESS
(a) The individual defendants.
Section 27 of the Act contains a further provision which permits extraterritorial service of process "wherever the defendant may be found." As to the individual defendants, there is no basis for quashing service since one defendant was served at his residence in the Eastern District of New York, and the other two were "found" and served in the State of Texas. They contend, however, that service upon them outside the forum district is invalid because the original complaint contained a single count in which jurisdiction was based upon diverse citizenship, and it was only after service of process that the complaint was amended to include the second count based upon Federal subject matter jurisdiction. Their contention must be rejected. Since
(b) The corporation.
Service of the summons and complaint upon the defendant corporation made upon its secretary-director, Bernard Guadano, at his residence in the Eastern District of New York, presents a different and more troublesome question. The essence of the attack here is that the corporation was not "doing business" in that, this, or in any other district of the United States. It may be acknowledged that in the strict literal sense this is so, and were the sufficiency of service of process to be gauged by whether CAMO was "doing business" in the Eastern District in the Tauza sense,
This Court is of the view that the service of process provision of Section 27 is at least as broad as the closely parallel Section 12 of the Clayton Act,
Section 27 here under consideration has an even broader venue provision than that contained in Section 12 of the Clayton Act in that it also supports venue in the district where the violation occurred. Considering the broad remedial objective of the 1934 Act, it would be an anomaly to expand the venue provision and at the same time to contract service of process
The defendant is incorporated in Panama and its mining concessions are located in Honduras. However, upon the record here presented there is a paucity of information as to what precisely its corporate activities are outside the Southern and Eastern Districts of New York. It appears that up to the commencement of this action its principal function has been getting off the ground in preparation for the exploitation of its mining and oil concessions, including the raising of necessary capital for that purpose. There is no suggestion that the corporation has sold or promoted the sale of any commodity derived from its mining concessions here, or for that matter, anywhere in the world. When suit was commenced the corporation had been in existence less than three years. The three defendants constituted its entire Board of Directors, were its principal officers and were residents of the Eastern District of New York. They carried on corporate activities in the Eastern District, as well as in this Southern District. One of the three individual defendants is an attorney who rendered legal services in advancing the defendants' interests either in the Eastern or the Southern District, or both. During this three-year period a special meeting of stockholders and a special meeting of directors were held at Robert Guadano's home in the Eastern District, the purpose of which related in part to the subject matter of the complaint; six months later another special meeting of stockholders, and, within ten days, the annual meeting of stockholders were held at 120 Broadway, New York City, in this district. The notices for these meetings were prepared and mailed from either the Eastern or Southern District of New York. Letters from the officers and directors to stockholders, purporting to keep them informed as to corporate activities, were mailed from the Eastern District and bore a return address there.
During this initial period of the corporation's existence, manifold and important activities were carried on in this and the Eastern District by the defendants' officers and directors in association with accountants, lawyers and others in the preparation of the registration statement, which was filed with the SEC, the purpose of which was to raise capital funds.
The Court concludes that a sufficient showing has been made to establish that the officers and directors of this corporation directed and carried on its affairs in such substantial measure in the Eastern and Southern Districts of New York so that for the purposes of service of process it was found in the Eastern District, and that service upon Bernard Guadano, its secretary, was valid.
II. THE NONFEDERAL CLAIMS
Since the Federal claims alleged in Count II have survived the defendants' motion to dismiss, plaintiffs' nonfederal claims set forth in Counts I and III
Defendants argue, however, that extraterritorial service of process under the Federal claim does not suffice to give personal jurisdiction with respect to the pendant claims. Some district courts, it is true, have taken that position.
III. RES JUDICATA
Next, the defendants urge the dismissal of the entire action upon a plea of res judicata or, more properly, of collateral estoppel. This contention, made after argument of the motion and submission of briefs, is based upon a judgment of the Second Circuit Court of Panama in an action brought by CAMO against Marathon International Oil Company. Marathon, citing this litigation, raised the defense that the officers of CAMO were without authority to enter into the agreement. However, the plaintiffs were neither parties nor privies of parties to that litigation and are not bound by that result.
IV. INDISPENSABLE PARTY
The defendants contend that the complaint should be dismissed since Seagraves, to whom 2,000,000 shares of stock were also issued, is an indispensable party and has not been named as a defendant. While the complaint charges that stock was issued to the Guadanos for no or an inadequate consideration, no such claim is made as to Seagraves or that he despoiled the corporation in any manner. Plaintiffs are entitled to assert their own claims and may not be compelled to bring in a party as to whom no
V. SECURITY FOR EXPENSES AND SECURITY FOR COSTS
There remains for final consideration CAMO's motion for security for expenses under Section 627 of the New York Business Corporation Law since it appears the plaintiffs do not hold the amount of stock specified therein. Plaintiffs urge, however, that since, with respect to the Federal claims, state law requirements for security are inapplicable
Accordingly, further proceedings on the nonfederal claims in the second amended complaint are hereby stayed pending plaintiffs' posting security in the amount of $10,000 for defendant corporation's reasonable expenses in the defense thereof. In addition, plaintiffs, as nonresidents, are required to post security for costs in the amount of $250.
Submit proposed order in accordance with the foregoing.
"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—
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"(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." 15 U.S.C. § 78j.
Rule 10b-5, implementing the section, reads:
"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,
"(1) to employ any device, scheme, or artifice to defraud,
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"(3) 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." 17 C.F.R. § 240.10b-5.