MEMORANDUM AND ORDER
ALDON J. ANDERSON, District Judge.
Defendants moved July 31, 1972, to dismiss the complaint for failure to state a claim upon which relief can be granted. In a Memorandum and Order filed November 2, 1972, this court postponed decision of the motion pending disposition in the United States Court of Appeals for the Tenth Circuit of the case of Vincent v. Moench, 473 F.2d 430 (10th Cir., 1973), which raised related questions of law. That case was decided on the date cited.
Plaintiffs are shareholders of the now defunct National Bank of Coalville, N.A. (hereinafter, the "bank"). Defendants, it is alleged, precipitated the collapse of the bank and resulting worthlessness of plaintiffs' stock through a fraudulent scheme which apparently capitalized on the foibles of a small town bank. In furtherance of the scheme, it is said that defendants caused $1 million to be deposited in the bank in exchange for certificates of deposit and payment of an illegal "finder's fee." It is claimed the relatively large deposit and the finder's fee generated influence sufficient to prompt the bank to make at least $450,000 in bad loans, allegedly to defendants' designees. Apparently it is believed the uncollectable loans impaired the bank's capital and resulted in its collapse.
Under section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b),
Rule 10b-5 requires that actionable fraud be perpetrated "in connection with the purchase or sale of a security. . . ." This requirement has been interpreted to mean that a plaintiff usually cannot recover unless he is the purchaser or seller of a security which is the subject of a fraudulent transaction. E.g., Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2d Cir), cert. denied, 343 U.S. 956, 72 S.Ct. 1051, 96 L. Ed. 1356 (1952); Mount Clemens Industries, Inc. v. Bell, 464 F.2d 339 (9th Cir. 1972) (collecting cases). Plaintiffs do not meet this requirement since they were not involved as purchasers or sellers in the allegedly fraudulent deposit and loan transactions and award of the finder's fee.
The "purchaser-seller" or "Birnbaum" rule apparently began as an effort to limit rule 10b-5 to claims by (1) purchasers and sellers (2) "directed solely at that type of misrepresentation or fraudulent practice usually associated with the sale or purchase of securities (3) rather than at fraudulent mismanagement of corporate affairs. . . ." Birnbaum v. Newport Steel Corp., supra, 193 F.2d at 464; A. R. Bromberg, Securities Law: Fraud—S.E.C. Rule 10b-5 § 4.7(3) (1971) (hereinafter, "Bromberg, Securities Law").
The first and seemingly obvious limitation of the Birnbaum rule, that plaintiffs must in every case be purchasers or sellers, may have resulted from a restrictive reading of rule 10b-5's history. Birnbaum v. Newport Steel Corp., supra 193 F.2d at 463-464; Comment, The Purchaser-Seller Requirement of Rule 10b-5 Reevaluated, 44 U.Colo.L.Rev. 151, 152-53 (1972); Comment, The Birnbaum Doctrine Revisited: Standing to Sue Under Rule 10b-5 Analyzed, 37 Mo. L.Rev. 481, 483, 490-92 (1972); 41 Cinn.L.Rev. 495, 502 (1972). In any event, recent courts generally acknowledge, either by imaginative interpretation of the terms "purchaser" or "seller" or by the creation of outright exceptions, that a proper rule 10b-5 plaintiff need not meet a mechanistic purchaser-seller requirement. E.g., Kahan v. Rosenstiel, 424 F.2d 161, 170-173 (3d Cir.), cert. denied, 398 U.S. 950, 90 S.Ct. 1870, 26 L.Ed.2d 290 (1970), and Mutual Shares Corp. v. Genesco, Inc., 384 F.2d 540, 546-547 (2d Cir. 1967) (shareholders who are neither purchasers nor sellers and who do not sue derivatively have standing under rule 10b-5 to claim injunctive relief); Crane Co. v. Westinghouse Air Brake Co., 419 F.2d 787, 794 (2d Cir. 1969), cert. denied, 400 U.S. 822, 91 S.Ct. 41, 27 L.Ed.2d 50 (1970) and Vine v. Beneficial Finance Co., 374 F.2d 627, 635 (2d Cir.), cert. denied, 389 U.S. 970, 88 S.Ct. 463, 19 L.Ed.2d 460 (1967) (shareholders faced with fraudulently promoted merger have standing under rule 10b-5 because merger would force them to "sell," i.e., obtain cash for, their shares); S.E.C. v. National Securities, Inc., 393 U.S. 453, 466-467, 89 S.Ct. 564, 21 L.Ed.2d 668 (1969), and Knauff v. Utah Construction and Mining Co., 408 F.2d 958 (10 Cir. 1969) (exchange of shares in merger amounts to purchase or sale); Drachman v. Harvey, 453 F.2d 722, 729-730, on rehearing in banc, 453 F.2d 736 (2d Cir. 1972), 47 N.Y.U.L.Rev. 607 (1972), (persons who hold stock in "street name" could sue derivatively under rule 10b-5 upon the authority of their corporation's "purchases").
The second and third Birnbaum limitations, that rule 10b-5 actions must be
As to rule 10b-5's coverage of corporate mismanagement or breach of fiduciary duty, the Court noted, 404 U.S. at 11, 12, 92 S.Ct. at 169, that such offenses are often inextricably tied to securities fraud and while "Congress by § 10(b) did not seek to regulate transactions which constitute no more than internal corporate mismanagement," Congress did intend
404 U.S. at 11-12, 92 S.Ct. at 168 (footnote omitted; emphasis added).
The judicial struggle with the Birnbaum rule results perhaps from an effort systematically to afford the remedial procedural and substantive advantages of rule 10b-5 to worthy plaintiffs while at the same time avoiding an unsalutary federal absorption and expansion of state corporate law principles. At present the struggle appears to be pruning the three, interrelated limitations of the Birnbaum rule down to one, more modest requirement: Actions under rule 10b-5 must be founded in fraud touching a securities transaction and must exhibit a direct and causal relationship between that fraud and the claimed injury. E.g., Heyman v. Heyman, 356 F.Supp. 958 (S.D.N.Y.1973); Tully v. Mott Supermarkets, Inc., 337 F.Supp. 834, 839-842 (D.N.J.1972); see Brief for S.E.C. as Amicus Curiae at 6, Vine v. Beneficial Finance Co., supra, quoted in Bromberg, Securities Law, supra, § 4.7(2) at 88, New Matter n. 73.2. This is the conclusion suggested by this circuit in Vincent v. Moench, supra. Noting the trend "away from strict application of the purchaser-seller rule," the court determined that "in a suit for equitable relief any person showing a `causal connection' between the fraudulent sale of a security and injury to himself may invoke federal jurisdiction." Id. 473 F.2d at 434, 435 citing Crane Co. v. Westinghouse Air Brake Co., supra; Kahan v. Rosenstiel, supra; Tully v. Mott Supermarkets, Inc., supra.
The Vincent court dealt with a suit for equitable relief, but its pronouncement need not be limited to such suits. The purchaser-seller requirement was first disregarded where the plaintiff sought to enjoin a continuing fraud, in effect bringing suit in the position of the S.E.C. rather than as a purchaser or seller of securities. Mutual Shares Corp. v. Genesco, Inc., supra, 384 F.2d at 546-547. However, retrospective injunctive relief of interest principally to individual plaintiffs who are neither purchasers nor sellers appears to be that sought in Vincent and approved in Crane Co. v. Westinghouse Air Brake Co., supra, Kahan v. Rosenstiel, supra, and Tully v. Mott Supermarkets, Inc., supra. There is no reasoned basis for concluding that a plaintiff's stake in the outcome of a suit, i.e. his standing, depends upon whether retrospective injunctive relief rather than damages is necessary to cure his injury. Such a distinction is impractical and would soon be eroded. See, e.g., Heyman v. Heyman, supra; Tully v. Mott Supermarkets, Inc., supra, 337 F.Supp. at 839-841, citing, Crane Co. v. Westinghouse Air Brake Co., supra, and Kahan v. Rosenstiel, supra. While suits in equity do not raise the conceptual difficulties of properly limiting damages claims, these difficulties may generally be reduced to those found customarily in tort and rule 10b-5 law by applying the Vincent court's causality requirement. They are better resolved through an application of the law of damages, as the Vincent court's causality approach suggests, rather than through the erection of standing barriers supposedly anchored in the statute itself but which are frequently
The Vincent court's application of the rule of causal connection to the pertinent facts pleaded in that case resulted in dismissal. There the defendants allegedly made a fraudulent purchase of controlling stock in a corporation which in turn held controlling interest in a family partnership. Once at the helm of the partnership, defendants purportedly undertook through mismanagement to plunder it. Plaintiffs, who at the outset held a minority interest in the partnership and later sold out under pressure, claimed injury under rule 10b-5. The court determined the defendants' mismanagement, not defendants' fraudulent purchase, to be the cause of plaintiffs' injury. As a result of this separate analysis of the frauds perpetrated by defendants, no causal connection between the stock transaction and the plaintiffs' injury was found to exist. The court contrasted these facts with those in Tully v. Mott Supermarkets, Inc., supra, where defendants' fraudulent purchase of controlling treasury stock was directly connected to plaintiffs' injury which was the loss of control itself. Vincent v. Moench, supra 473 F.2d at 435; Tully v. Mott Supermarkets, Inc., supra, 337 F. Supp. at 838.
On the facts pleaded before this court, it is claimed that defendants fraudulently procured uncollectible loans from the bank. Also, it is represented that these fraudulent transactions resulted directly in the collapse of the bank and injury to the plaintiffs
In the opinion of the court, under plaintiffs' claim both the deposit transactions and the loan transactions would be purchases or sales of securities within the meaning of section 3(a)(10) of the Securities Exchange Act of 1934,
As a result, plaintiffs have standing to bring this action under section 10(b) of the Securities Exchange Act of 1934 and rule 10b-5.
Defendants apparently contend that, even conceding plaintiffs' standing under rule 10b-5, they must join with the bank's receiver in a derivative suit in order to properly present their claims. Defendants note that the bank's receiver alone is authorized under the bankruptcy laws to collect all claims belonging to the bank and that the comptroller of currency is to distribute the collected money among the bank's creditors. However, as the earlier discussion should illustrate amply, plaintiffs' claims against the defendants under rule 10b-5 are their own and not the bank's (which through its receiver might, of course, assert its own claims of securities fraud as in Superintendent of Insurance v. Bankers Life & Casualty Co., supra). Indeed, the conclusion that the plaintiffs assert their own claims under the securities law follows necessarily from the court's earlier determination that plaintiffs have standing under rule 10b-5. Furthermore, since the plaintiffs are not creditors of the bank asserting their claims against the bank, they are not proper participants in any recovery made by the bank's receiver. And, since the defendants are not bankrupt, any separate recovery by the plaintiffs need in no way reduce the recovery available to the receiver. In any event, the vehicle of derivative suit is of questionable utility to shareholders of a bankrupt institution. Derivative suits almost never result in any money for the shareholders
The court has also considered the claims of plaintiffs under section 17 of the Investment Company Act of 1940, 15 U.S.C. § 80a-17, and section 206(4) of the Investment Advisors Act of 1940, 15 U.S.C. § 80b-6(4). They appear sufficient to withstand the present motion to dismiss.
Plaintiffs moved February 12, 1973, to amend their complaint to describe more clearly defendants' $1 million deposit in the bank as involving fraudulent securities transactions. The motion should be granted.
Pursuant to Fed.R.Civ.P. 23, plaintiffs seek to maintain this action as a class action. Accordingly, a hearing shall be set to determine whether the requirements of the rule are met.
In any event, the logic of the Birnbaum rule may be defective since it declares a shareholder suing derivatively to have the requisite personal stake, i. e. standing, to bring a rule 10b-5 action for the corporation's fraudulent transactions while the shareholder suing for himself does not. E. g., Comment, The Birnbaum Doctrine Revisited: Standing to Sue Under Rule 10b-5 Analyzed, 37 Mo. L.Rev. 481 and esp. 488-90 (1972); Comment, The Purchaser-Seller Requirement of Rule 10b-5 Reevaluated, 44 U. Colo.L.Rev. 151, 154-59 (1972).
The form of suit, i. e. class action, chosen by the plaintiff shareholder is not uncommon. E. g., Korn v. Franchard Corp., 456 F.2d 1206 (2d Cir. 1972); Esplin v. Hirschi, 402 F.2d 94 (10th Cir. 1968), cert. denied, 394 U.S. 928, 89 S.Ct. 1194, 22 L.Ed.2d 459 (1969).