OAKES, Circuit Judge:
This appeal is from a judgment dismissing a complaint for failure to state a claim upon which relief may be granted under Fed.R.Civ.P. 12(b) (6). The action is one for damages for alleged violations of the federal securities laws,
The dismissed complaint alleges that between October, 1967, and October, 1969, Penn-Dixie acquired 1,111,514 shares or approximately 52.9 per cent of the outstanding common stock of Continental. Having thus acquired voting control over Continental, Penn-Dixie instituted management control over the corporation by placing six of its directors and officers on Continental's nine member board of directors. Appellant claims that Penn-Dixie then exercised its control of Continental so as to defraud Continental shareholders.
Generally, Penn-Dixie is said to have manipulated and depressed the market value of Continental stock in relation to that of Penn-Dixie by utilizing Continental's assets for the benefit of Penn-Dixie and to have caused Continental to enter into a merger agreement providing for an unfair exchange ratio based upon manipulated and artificial stock values of the merging parties. On March 14, 1973, the boards of directors of both companies unanimously approved an agreement of merger
On the basis of these general obligations, the complaint contains four claims of relief, in separate counts. The first alleges a violation of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) (1970), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5 (1974) ; count two claims a violation of the proxy solicitation provision of Section 14(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78n(a) (1970), and Rule 14a-9 thereunder, 17 C.F.R. § 240.14a-9 (1974) ; the third and fourth counts of the complaint are common law counts based upon fraud and unfairness, each of which is pendent to the federal claims. Thus the whole complaint must fail unless one of the federal counts is viable. United Mine Workers v. Gibbs, 383 U.S. 715, 86 S.Ct. 1130, 16 L.Ed.2d 218 (1966).
The district court found that the proxy count of the complaint was defective in that it failed to present "any allegation of injury which was caused by the proxy violations, aside from that claimed to flow from the unequal ratios." Schlick v. Penn-Dixie Cement Corp., No. 73, Civ. 1467 (S.D.N.Y., decided Sept. 26, 1973). In effect, the district court seemed to be saying that the appellant failed to show that the appellees' misstatements or omissions contributed to the kind of injury which the federal securities laws were intended to redress.
In reaching this conclusion, the district court relied heavily on the fact that the allegedly false and misleading proxy statement did not cause Continental minority stockholders any harm other than that caused by the unfair exchange ratio. They were not misled about their rights so as to have failed to take protective action in the form of seeking injunctive relief ; rather, the court below continued, appellant chose to bring this action for damages before the merger was finalized. Nor did the complaint allege that other rights such as appraisal rights were lost as a result of appellees' action.
The dismissal by the court below of appellant's 10b-5 count was based first upon what the district court said was a concession by the appellant that if his "basic claim under the proxy rules cannot be sustained, the 10b claim must also fall for want of the necessary causal connection" and secondly upon a determination that the count was defective because it contained "only conclusory allegations without any specific allegations of fraud or deception as required to support a 10(b) claim." Segal v. Gordon, 467 F.2d 602, 607 (2d Cir. 1972) ; O'Neill v. Maytag, 339 F.2d 764, 767-768 (2d Cir. 1964).
I. THE RULE 10b-5 CLAIM.
A. The sufficiency of the complaint. We go first to the 10b-5 count of the complaint. That count does allege generally "the engagement in a course of business which operated as a fraud and deceit on the purchasers and holders of Continental stock." If that were all that were alleged, it would fall within this court's rule that "mere conclusory allegations to the effect that defendant's conduct was fraudulent or in violation of Rule 10b-5 are insufficient." Segal v. Gordon, 467 F.2d at 607, quoting Shemtob v. Shearson, Hammill & Co., 448 F.2d 442, 444 (2d Cir. 1971), and O'Neill v. Maytag, supra. But here the complaint contains more than conclusory allegations. Paragraph 15 specifically alleges that Continental bank accounts were utilized by Penn-Dixie as compensating balances for Penn-Dixie's own borrowings and for Penn-Dixie's benefit without compensation or benefit to Continental, thereby depriving Continental of its ability to use its own capital to expand its business and thereby obtaining a more favorable merger exchange ratio. The same paragraph specifically alleges that Continental funds were utilized by Penn-Dixie to engage in a real estate venture in Florida with a "special customer" of Penn-Dixie, for the benefit of Penn-Dixie and without compensation to Continental for the use of its funds. The complaint alleges the charging of excessive intercompany costs to Continental, thus reducing Continental's income and increasing that of Penn-Dixie. It alleges an accounting change,
B. The nature of the fraud. It is well to put to rest, in the light of Judge Metzner's holding, a slow-to-die contention advanced by appellees principally in oral argument but to some extent in their brief — a contention first authoritatively set forth in 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), viz., that § 10(b) "was directed solely at that type of misrepresentation or fraudulent practice usually associated with the sale or purchase of securities rather than at fraudulent mismanagement of corporate affairs. . . ." Here, appellees tell us, all that appellant is complaining about is "corporate mismanagement," and as such is in the wrong forum. As long ago as A. T. Brod & Co. v. Perlow, 375 F.2d 393, 397 (2d Cir. 1967), this Birnbaum proposition was no longer the law of this circuit as 10b-5 was there construed to include "all fraudulent schemes in connection with the purchase or sale of securities, whether . . . a garden type variety of fraud, or . . . a unique form of deception." While Birnbaum was principally relied upon in O'Neill v. Maytag, supra, which in turn was relied upon by the court below in terms of stating the restrictive view, the authority of these cases (Birnbaum and O'Neill) was, as stated by District Judge Moye in First American Corp. v. Foster, 51 F.R.D. 248, 251 (N.D.Ga.1970), "seriously undercut" by Schoenbaum v. First-brook, 405 F.2d 215 (2d Cir. 1968), rev'g, 405 F.2d 200, cert. denied, 395 U.S. 906, 89 S.Ct. 1747, 23 L.Ed.2d 219 (1969). Thus Judge Feinberg could write in Popkin v. Bishop, 464 F.2d 714, 718 (2d Cir. 1972), that "assertions by a defendant
404 U.S. at 10-12, 92 S.Ct. at 168-169. It can thus truthfully be said as Professor Bromberg points out that "[a]fter Supt. of Insurance, then, Birnbaum survives significantly only for the buyer-seller requirement, which has been much reduced by other decisions."
We come then to the causation question, that is, whether the scheme which appellant alleges took place brought about the injury in fact. As we have said, it is difficult to tell whether Judge Metzner felt that this element of causation was lacking in view of his finding that the proxy violations in question — the misrepresentations and omissions of the appellees — did not cause a federally remediable injury to the appellant. Having thus disposed of the proxy count, Judge Metzner seemingly regarded the 10b-5 claim to be based on precisely the same operative facts, and for that reason dismissed it as well "for want of the necessary causal connection." We disagree with these conclusions.
This is not a case where the 10b-5 claim is based solely upon material omissions or misstatements in the proxy materials. Were it so, concededly there would have to be a showing of both loss causation — that the misrepresentations or omissions caused the economic harm — and transaction causation — that the violations in question caused the appellant to engage in the transaction in question.
Under the 10b-5 count, proof of transaction causation is unnecessary by virtue of the allegations as to the effectuation of a scheme to defraud which includes market manipulation and a merger on preferential terms, of which the proxy omissions and misrepresentations are only one aspect.
It is not seriously argued that there is a failure to state a claim for relief because there was no "connection" under Rule 10b-5 between the misconduct and the security transaction here involved. Nor could there be, particularly in view of the specific allegation that defendants caused the Continental pension fund to purchase the common stock of Penn-Dixie in the market in order to create a higher price for Penn-Dixie shares and thus obtain a more favorable exchange ratio. In any event, Superintendent of Insurance v. Bankers Life & Casualty Co., supra, and our own Drachman v. Harvey, 453 F.2d 736 (2d Cir. 1972) (en banc), rev'g, 453 F.2d 722 (2d Cir. 1971), make it clear that the violations here alleged had a connection with the sale of Continental shares and purchase of Penn-Dixie shares effectuated by the merger. See also 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).
Thus, the complaint completes the showing necessary to state a claim under Rule 10b-5. It alleges a specific scheme to defraud (a scheme which includes the proxy solicitation as a part, but which included substantial collateral conduct as well) ; the fraud was accomplished in connection with a securities transaction; the appellant was a seller in that transaction ; and as a result of the sale, appellant alleges a loss was sustained.
II. THE 14a-9 CLAIM.
As to count two of the complaint based upon alleged proxy violations, as we have said, quite plainly appellant has alleged loss causation or economic loss in that there was an unequal, unfair and disadvantageous merger ratio, undisclosed in the proxy materials, by which he obtained fewer Penn-Dixie shares and warrants than he would have had the appellees' manipulative scheme been revealed. It is axiomatic that fewer shares are worth less on the open market than more shares, and while it is true that "damages should be recoverable only to the extent that they can be shown," Mills v. Electric Auto-Lite Co., 396 U.S. 375, 389, 90 S.Ct. 616, 624, 24 L.Ed.2d 593 (1970), the complaint alleges that appellant was the holder of 2,000 shares of Continental. Depending upon what the evidence shows in terms of damages, he might well have received in excess of the 3,000 shares of Penn-Dixie which he did in fact obtain had a fair exchange ratio been adopted. Therefore, we must immediately confront the issue whether the proxy violations themselves caused the transaction in question, the exchange.
The premise underlying the strict view of transaction causation is that Penn-Dixie would have voted to proceed with the merger in any event, irrespective of any misstatements or omissions in the proxy. Even by dissenting to the merger minority stockholders of Continental could not have secured a higher price for their stock than the merger terms offered since under Indiana law, stockholders in a company listed on the NYSE have no appraisal rights. Burns, Ind. Stat.Ann. Title 23, art. I, ch. 5, § 7 (1972). The argument is in short that minority stockholders' votes must be viewed as meaningless since the insiders with a conflict of interest had enough votes to approve the transaction in any event.
This court has said, however, in affirming the second Laurenzano case, in which Judge Dooling found on the merits against the plaintiff that "[minority shareholder] approval was not meaningless; minority shareholder approval has value whether or not it is strictly essential to the power to act." Laurenzano v. Einbender, 448 F.2d 1, 5 (2d Cir. 1971). See also Lewis v. Bogin, 337 F.Supp. 331, 337 (S.D.N.Y.1972). As the Seventh Circuit said in Swanson v. American Consumer Industries, Inc., 415 F.2d 1326 (7th Cir. 1969) (Swanson I), "[t]he power to effect a given result certainly does not negative all possibility of injury resulting from the fraudulent or manipulative use of that power." Id. at 1331-1332. While one need not go so far perhaps as Judge Sprecher, dissenting and concurring in Swanson v. American Consumer Industries, Inc., 475 F.2d 516, 522 (7th Cir. 1973) (Swanson II), by saying that causation should be conclusively established by the mere solicitation of votes, in a very real sense the shareholders were deceived by the action of those making the corporate decision to merge. Cf. Crane Co. v. Westinghouse Air Brake Co., 419 F.2d 787, 797 (2nd Cir. 1969), cert. denied, 400 U.S. 822, 91 S.Ct. 41, 27 L.Ed.2d 50 (1970). See also Vine v. Beneficial Finance Co., 374 F.2d at 635.
We have previously said that a controlling shareholder's "ability to push through the merger — with or without any other shareholder's vote — cannot by itself defeat a claim for federal injunctive relief." Popkin v. Bishop, 464 F.2d at 718 (emphasis added) (but denying injunction since full disclosure was made). Again, as was recognized in Heyman v. Heyman, 356 F.Supp. 958, 967-968 (S.D.N.Y.1973), minority shareholders may "have recourse to measures other than the casting of proxies" to oppose those who have "the naked strength to consummate a fraudulent transaction." At least they are in a better position to protect their interests if they have full disclosure of the facts. Cf. Chris-Craft Industries, Inc. v. Piper Aircraft Corp., 480 F.2d 341, 375 (2d Cir.), cert. denied, 414 U.S. 910, 94 S.Ct. 231, 38 L.Ed.2d
In the end we must remember the "broad remedial purposes" of the Securities Act. J. I. Case Co. v. Borak, 377 U.S. 426, 431, 84 S.Ct. 1555, 12 L. Ed.2d 423 (1964); SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 195, 84 S.Ct. 275, 11 L.Ed.2d 237 (1963). Indeed, Mills itself, while leaving the question open, as we have pointed out, by holding that there was a sufficient causal relationship in a proxy case by proof that the proxy solicitation itself rather than the particular defect in the solicitation materials was an essential link in the accomplishment of the transaction, 396 U.S. at 385, 90 S.Ct. 616, lends some support to a more moderate view of transaction causation. Causality, we think, is sufficiently pleaded; the proof may, of course, be something else.
Causation is a concept stemming from the law of torts, but we are here talking about the statutory purpose of the proxy rules, a purpose which, as Mills itself pointed out, arises from Congressional belief in "fair corporate suffrage" to obtain which "explanation to the stockholder of the real nature of the questions for which authority to cast his vote is sought." Congressional concern was specifically with conflict of interest transactions. Stock Exchange Practices, S. Rep.No.1455, 73d Cong., 2d Sess., 74-76 (1934). See also S.Rep.No.792, 73d Cong., 2d Sess., 12 (1934). Indeed, the addition in 1964 of Securities Exchange Act § 14(c), 15 U.S.C. § 78n(c) (1970), which operates when shareholder action is taken but proxies are not solicited, applies to the very situation when typically no minority votes are needed. That section requires dissemination to shareholders of "information substantially equivalent to the information which would be required to be transmitted if a solicitation were made . . . ." Id. There has to be at least as strong a policy for accurate and complete information to the holder, such as the appellant here, whose vote is solicited but not needed. See Bromberg § 4.7(556), at 86.23 (1973). As Judge Fulham wrote in Weiss v. Sunasco Inc., 316 F.Supp. 1197, 1205 (E.D. Pa.1970), a post-Mills decision, "As I understand Mills, the proper test is whether the proxy solicitation is `an essential link in the accomplishment of the transaction' giving rise to the litigation, irrespective of the fact that other possibilities were available to management." The equities call for protection of the minority shareholder when he is the most helpless, as when neither disinterested director nor disinterested shareholder voting exists as a safeguard. To require strict causation would "sanction all manner of fraud and overreaching in the fortuitous circumstance that a controlling shareholder exists." Swanson v. American Consumer Industries, Inc., 415 F.2d at 1331.
It is true that appellant brought his action for damages before the merger when indeed he could have sued to enjoin. The argument is made that by failing to seek an injunction the appellant is precluded from recovery. We disagree. Appellant may well have felt that in the end an injunction would cost everyone more money and create greater problems for all. Or he might have been required to post a bond for damages and been unable to pay the premium.
The court below said that "the deficiency of the instant complaint stems from the absence of any allegation of injury which was caused by the proxy violations, aside from that claimed to flow from the unequal ratio" (emphasis added). Of course, there was injury flowing from the unequal ratio in terms of a lesser value of stock received by the minority Continental shareholders in the merger. Again, if it is reliance to which Judge Metzner was referring, the analogous 10b-5 cases of Superintendent of Insurance v. Bankers Life & Casualty Co., supra, and Affiliated Ute Citizens v. United States, supra, put this defense aside. To hold otherwise would make the proxy requirements a farce. Affiliated Ute holds that reliance is satisfied
The minority shareholders, aside, there are two other purposes served by the disclosure requirements which make a strict causation rule — whether under a 10(b) or a 14(a) claim — antithetical to it:
1. By disclosure the market will be informed, so as to permit well-based decisions about buying, selling and holding the securities involved in the transaction. See generally SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968) (en banc), cert. denied, 394 U.S. 976, 89 S.Ct. 1454, 22 L.Ed.2d 756 (1969). Thus, had there been full disclosure here, the merger ratio would have been unfair on its face and the shares of Penn-Dixie in the open market would have sold for less.
2. By virtue of the disclosure either modification or reconsideration of the terms of the merger by those in control might be effectuated. We cannot assume that even a rapacious controlling management would necessarily want to hang its dirty linen out on the line and thereby expose itself to suit or Securities Commission or other action — in terms of reputation and future takeovers.
In short, we refuse to adopt the narrow view of causation for which the appellees argue. Instead in the light of the Mills footnote, Affiliated Ute, supra, the Seventh Circuit's Swanson I and Swanson II, and the other cases in our own circuit above referred to, we are of the view that sufficient causation is alleged so that the complaint must not be dismissed. None of what we say, of course, goes to the merits of the case; that must await trial on the facts.
Judgment dismissing the complaint is hereby reversed and remanded.
FRANKEL, District Judge (concurring):
I concur in the result and in most of the court's opinion. With all deference, however, I am unable to join completely in the opinion because of those portions which employ the concepts of "loss causation" and "transaction causation." While these terms have had some scholarly currency, as the majority shows, and while they may prove eventually to be useful, I am not convinced at this time that the Circuit ought to be committed to their employment or to their still uncertain implications.
The appeal before us arises on a bare pleading. The terminological questions explored by the majority have not been briefed or argued. It does not appear that the issues as the parties presented them require such exploration.
I am not prepared to find these labels either useful or harmful. I conclude only that, being unnecessary, they ought not to enter into an opinion on the limited questions before the court.
Id. Without putting too much emphasis upon citations by the Supreme Court in footnotes, the Court then cited the first Laurenzano decision, Laurenzano v. Einbender, 264 F.Supp. 356, 360-362 (1965), and cited the strict view of causation taken in Barnett v. Anaconda Co., 238 F.Supp. 766, 771 (S.D.N.Y.1965), as a "But see."