Opinion ID: 316528
Heading Depth: 1
Heading Rank: 2

Heading: the fairfield group appeal

Text: 13 The factual basis for the preliminary injunction issued against the Fairfield Group is not disputed. Thus, Judge Stewart did not find it necessary to hold an evidentiary hearing as a predicate to granting injunctive relief. See SEC v. Frank, 388 F.2d 486 (id Cir. 1968). On its part, ICC filed four affidavits in support of its motion: (1) by David Butowsky, Special Counsel; (2) by Allen Shinn, a court-appointed director and President of ICC; (3) by Laurence B. Richardson, Jr., former President, Chief Operating Officer and director of ICC; (4) by Malcolm McAlpin, a former director of ICC. In response, the Fairfield Group submitted an affidavit by Joel M. Grady, President of Skyways and Fairfield Aviation, Executive Vice President of Fairfield General, and a director of all three corporations. 14 Our examination 6 of these affidavits reveals the following salient facts. On June 15, 1971, Skyways, then a wholly-owned subsidiary of Fairfield Aviation, which, in turn, was a wholly-owned subsidiary of ICC, purchased a Boeing 707 jet aircraft from Pan American World Airways, Inc. for $1,375,000. Thereafter, on October 1, 1971, Skyways leased the plane to ICC for a five-year period for an approximate gross rental of $3,500,000. This lease also provided that, upon five days notice, Skyways could terminate the lease should it desire to sell the aircraft and that all improvements to the aircraft would remain the property of Skyways. This lease was not submitted to the board of directors of ICC for approval until December 8, 1971. 15 During the six-month period from June to December 1971, ICC spent $600,000-$700,000 to refurbish the plane. These improvements, however, were not of the sort generally associated with business purposes but rather, suited the personal comforts, conveniences and zest for living of the primary user of the 707, Vesco. 16 On November 19, 1971, ICC incorporated Fairfield General as a whollyowned subsidiary. Subsequently, on December 8, 1971, at a board of directors meeting crucial to the alleged fraud, the ICC board first approved the transfer if ICC's Fairfield Aviation stock to Fairfield General, in return for additional stock in Fairfield General and second, voted to issue all of the Fairfield General stock to the shareholders of ICC as a dividend in kind. Both Richardson and McAlpin, members of the board of directors on December 8, stated in their affidavits that, at the time of this meeting, they had not been informed either of the improvement expenditures or of the termination and ownership of improvements provisions of the Boeing 707 lease and, had they known of these facts, they would not have approved the dividend of the Fairfield General stock. 17 Based on the foregoing facts, ICC claims in its complaint that it was fraudulently deprived of the Boeing 707 aircraft since, as a result of the spin-off of Fairfield General and its whollyowned subsidiaries, Fairfield Aviation and Skyways, that asset is no longer under its control. Moreover, in exacerbation of this loss, ICC contends that it remains obligated to Skyways under the oneruos 707 lease. ICC claims that the motive for the spin-off was Vesco's concern that he might lose control over ICC and, as a consequence, be forced to relinquish his personal use of the 707. Accordingly, to foreclose that eventuality, Vesco sought to shelter the aircraft in a corporate shall free from ICC's control, a corporation such as Fairfield General in which all of the directors were Vesco associates. 7 ICC concludes its complaint by praying, inter alia, that the fraudulently induced dividend of Fairfield General stock be declared null and void. 18 The Fairfield Group responded by filing a motion to dismiss the complaint, asserting a lack of subject matter jurisdiction under the 1934 Act. They urged that while ICC may have stated a claim of internal corporate mismanagement, it had not stated or proved a claim cognizable under Section 10(b), the only section of the 1934 Act relied on by ICC, and Rule 10b-5 thereunder. Absent subject matter jurisdiction under the 1934 Act, moreover, the Fairfield Group contended that the suit must be dismissed as to them because, as New Jersey corporations doing no business in New York, service of process could only be valid under the provision for nationwide service of process, 15 U.S.C. 78aa, if the 1934 Act were applicable.
Under Section 10(b) Section 10 of the 1934 Act provides: 19 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-- 20 (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. Rule 10b-5 of the Commission provides: 21 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, 22 (b) To make any untrue statement of a meterial 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 23 (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, 24 in connection with the purchase or sale of any security. 25 It is now well-settled that the failure or refusal of a majority of a board of directors to disclose to the remaining directors pertinent information, as Richardson and McAlpin claimed was the case concerning the dividend of Fairfield General Stock, constitutes a 'fraud' upon ICC within the meaning of section 10(b) and Rule 10b-5. Ruckle v. Roto American Corp., 339 F.2d 24 (2d Cir. 1964). The critical question remains, however, whether that 'fraud' was perpetrated on ICC 'in connection with the purchase or sale of any security.' Haberman v. Murchison, 468 F.2d 1305 (2d Cir. 1972); Iroquois Industries, Inc. v. Syracuse China Corp., 417 F.2d 963 (2d Cir. 1969), cert. denied, 399 U.S. 909, 90 S.Ct. 2199, 26 L.Ed.2d 561 (1970); 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 (1962). 26 ICC contends that its exchange of Fairfield Aviation stock for Fairfield General stock constituted the requisite 'sale.' Although the definition of 'sale' under the 1934 Act is indeed a broad one-- including 'any contract to sell or otherwise dispose of' (15 U.S.C. 78c(a)(14))-- we cannot agree that by transferring its ownership of Fairfield Aviation to its wholly-owned subsidiary, Fairfield General, ICC in any sense 'disposed of' its Fairfield Aviation stock. Quite simply, as long as ICC retained sole ownership of Fairfield General, it retained complete control over Fairfield Aviation and thus relinquished nothing in the exchange. Accordingly, that self-dealing transaction does not appear to satisfy the 'purchase or sale' requirement of 10(b) and Rule 10(b)-5. Cf. Blau v. Mission Corp., 212 F.2d 77, 80 (2d Cir.), cert. denied, 347 U.S. 1016, 74 S.Ct. 872, 98 L.Ed. 1138 (1954); 8 In re Penn Central Securities Litigation, 347 F.Supp. 1327, 1333-1339 (E.D.Pa.1972). 27 ICC also suggests that its dividend in kind of the Fairfield General stock represented a 'sale' under the relevant statute and rule. It urges us to follow a recent line of cases holding that such subsidiary spin-offs constitute 'sales' for purposes of the Securities Act of 1933 (1933 Act), 15 U.S.C. 77a et seq., thus requiring a registration statement to be filed covering the subsidiary's shares, as in fact Fairfield General did file in this instance. 9 SEC v. Datronics Engineers, Inc., 490 F.2d 250 (4th Cir. 1973), petition for cert. filed, 42 U.S.L.W.L.Rep. P94,334, 3388 (U.S. Dec. 27, 1973) (No. 1011); SEC v. Stern-Haskell Inc., (Current Volume) CCH Fed.Sec.L.Rep. P94,065 (S.D.N.Y.1973); SEC v. Harwyn Industries Corp., 326 F.Supp. 943 (S.D.N.Y.1971). Although each of these cases involved the 1933 Act definition of 'sale,' a definition which explicitly requires that the 'disposition' be 'for value,' 10 each cited case rested on facts wholly inapposite to the instant one. In each instance, the court held that the parent corporation had received 'value' or consideration for the 'disposition' of its subsidiary through the creation of a public market in the subsidiary's shares, an 'aftermarket' which substantially increased the value of the spun-off subsidiary's shares retained by the parent corporation or by the insiders in control of the parent. In contrast, the thrust of ICC's complaint is that it was fraudulently induced to part with its subsidiary, bearing with it a very valuable asset in the form of a Boeing 707 aircraft, without receiving any value whatsoever. 11 In short, we do not believe that ICC can find comfort in the Harwyn line of cases for the proposition that its spin-off of Fairfield General constituted a 'sale' under 10(b) and Rule 10b-5. 28 Finding the analogy to Harwyn and its progeny inapt, we searched, but in vain, for a precedential response to the precise question whether a dividend of portfolio securities might satisfy the 'purchase of sale' requirement of 10(b) and Rule 10b-5. Our attention, of course, was directed to the seminal case construing 'purchase' and 'sale' in the context of 16(b) of the 1934 Act, Shaw v. Dreyfus, 172 F.2d 140 (2d Cir.), cert. denied, 337 U.S. 907, 69 S.Ct. 1048, 93 L.Ed. 1719 (1949). In Shaw, a divided panel of this Court held that the receipt of stock rights, essentially analogous to a stock dividend because issued on a pro rata basis to all shareholders, did not constitute a 'purchase' of those rights by the stockholders. Although apprised of the broad definitional language of 'purchase' 12 and 'sale' 13 under the 1934 Act, we declined to interpret the term 'purchase' to include any 'acquisition' or the term 'sale' to include any 'disposition.' Instead, over the sharp dissent of Judge Clark, the majority stated that a 'purchase' or 'sale' meant an acquisition or disposition for consideration. Thus, Shaw held that since the shareholder recipients of the stock rights had not given the corporation any quid pro quo in return for these rights, their acquisition was not a 'purchase,' and there was no liability under 16(b) for any profit on their subsequent, short-swing sale. 29 The Fairfield Group strenuously argues that our decision in Shaw governs the instant case. They contend that the ICC dividend in kind of the Fairfield General securities is identical with the rights distribution in Shaw because both were distributed on a pro rata basis to all stockholders and neither required any payment by the recipient shareholders in return. Without in any way questioning the soundness of our decision in Shaw, we do not find it determinative, for we are mindful of the following words of caution uttered in a remarkable similar context by the Supreme Court: 30 Although the interdependence of the various sections of the securities laws is certainly a relevant factor in any interpretation of the language Congress has chosen, ordinary rules of statutory construction still apply. The meaning of particular phrases must be determined in context, SEC v. C. M. Joiner Leasing Corp., 320 U.S. 344, 350-351 (64 S.Ct. 120, 123-124, 88 L.Ed. 88) (1943). Congress itself has cautioned that the same words may take on a different coloration in different sections of the securities laws; both the 1933 and the 1934 Acts preface their lists of general definitions with the phrase 'unless the context otherwise requires.' 1933 Act, 2, 48 Stat. 74, 15 U.S.C. 77b; 1934 Act, 3, 48 Stat. 882, 15 U.S.C. 78c. We must therefore address ourselves to the meaning of the words 'purchase or sale' in the context of 10(b). Whatever these or similar words may mean in the numerous other contexts in which they appear in the securities laws, only this one narrow question is presented here. 31 SEC v. National Securities, Inc., 393 U.S. 453, 466, 89 S.Ct. 564, 571, 21 L.Ed.2d 668 (1969). 32 We must, therefore, in accordance with the teaching of National Securities, consider whether the fraudulent conduct alleged, in this case the withholding of information pertinent to the issuance of a portfolio security dividend, 'is the type of fraudulent behavior which was meant to be forbidden by the statute and the rule.' Id. 393 U.S. at 467, 89 S.Ct. at 572. In seeking to effectuate the purpose of 10(b), we recognize that it 'must be read flexibly, not technically and restrictively.' Supt. of Insurance v. Bankers Life & Cas. Co., 404 U.S. 6, 12, 92 S.Ct. 165, 169, 30 L.Ed.2d 128 (1971). Moreover, the Court, in Bankers Life, emphasized that 10(b) was intended by Congress to protect investors, including corporations, from deceptive devices and contrivances which would inhibit informed decision-making in the course of securities transactions. And, the Court quoted with approval the following language from Shell v. Hensley, 430 F.2d 819, 827 (5th Cir. 1970): 33 When a person who is dealing with a corporation in a securities transaction denies the corporation's directors access to material information known to him, the corporation is disabled from availing itself of an informed judgment on the part of its board regarding the merits of the transaction. In this situation the private right of action recognized under Rule 10b-5 is available as a remedy for the corporate disability. 34 Supt. of Insurance v. Bankers Life & Cas. Co., supra, 404 U.S. at 13, 92 S.Ct. at 169. 35 In light of this umbrella of protection placed over securities transactions by 10(b), we are of the view that ICC must be deemed to be a 'seller' of its Fairfield General stock at the time it disposed of its Fairfield General portfolio securities by way of a dividend in kind to its shareholders. The decision whether to retain or spin-off a subsidiary is indeed an important one for the parent corporation. The possible asset drain must be weighed against such considerations as the desirability of removing the blight of an unprofitable subsidiary from the consolidated income statistics reported to the public. In any event, it is a transaction involving, as it unquestionably does, the disposition of securities and, therefore, one for which the corporation is well deserving of and entitled to the protection of 10(b). 36 Nor do we believe, as our dissenting brother suggests, that because ICC's shareholders were not required to part with consideration in return for the dividend of Fairfield General portfolio stock, the transaction was beyond the purview of 10(b). By thus focusing on the absence of harm to the recipient shareholders, the dissent simply ignores the fact that the statute was intended to safeguard not only the shareholders of a defrauded corporation, but its creditors as well. The Court noted in Bankers Life,id. at 12, 92 S.Ct. at 169: 37 . . . the fact that creditors of the defrauded corporate buyer or seller of securities may be the ultimate victims does not warrant disregard of the corporate entity. The controlling stockholder (Vesco in this instance) owes the corporation a fiduciary obligation-- one 'designed for the protection of the entire community of interests in the corporation-- creditors as well as stockholders.' Pepper v. Litton, 308 U.S. 295, 307 (60 S.Ct. 238, 245, 84 L.Ed. 281). 38 And, to be sure, the creditors of ICC may be significantly and adversely affected when the asset base of the corporation is eroded by a portfolio security dividend. 14 39 We therefore reject our dissenting brother's paean to literalness in construing the term 'sale' to require the passage of consideration in order to inject the requisite significance into the disposition of securities. Learned Hand wisely counselled: 40 Of course it is true that the words used, even in their literal sense, are the primary, and ordinarily the most reliable, source of interpreting the meaning of any writing: be it a statute, a contract, or anything else. But it is one of the surest indexes of a mature and developed jurisprudence not to make a fortress out of the dictionary; but to remember that statutes always have some purpose or object to accomplish, whose sympathetic and imaginative discovery is the surest guide to their meaning. 41 Cabell v. Markham, 148 F.2d 737, 739 (2d Cir. 1945). Accordingly, although in other contexts the term 'sale' might appropriately be construed more narrowly, 15 we find a rote emphasis on consideration inconsistent with the broad scope of protection under 10(b) for those who engage in transactions eventuating in the acquisition or disposition of securities. 16
42 The Fairfield Group asserts a second jurisdictional defect in this action, contending that venue was improperly laid in the Southern District of New York. This argument merits short shrift. The applicable provision of the 1934 Act, 15 U.S.C. 78aa, states in pertinent part: 43 Any suit or action to enforce any liability or duty created by this chapter or rules and regulations thereunder . . . may be brought in any (district wherein any act or transaction constituting the violation occurred) . . .. 44 In this case, ICC claims that a 10(b) violation occurred when it was fraudulently induced to spin-off its Fairfield General subsidiary. An essential element of that fraudulent scheme was the actual mailing of the spin-off dividend to the ICC shareholders. It is uncontroverted that the mailing was performed by ICC's transfer agent, the Marine Midland Bank, from its offices in Manhattan. Accordingly, since 'any use of instrumentalities of the mails or other interstate facilities made within the forum district constituting an important step in . . . (the) consummation (of the fraudulent scheme) is sufficient', Hooper v. Mountain States Securities Corp., 282 F.2d 195, 204-205 (5th Cir. 1960), cert. denied, 365 U.S. 814, 81 S.Ct. 695, 5 L.Ed.2d 693 (1961), venue in the Southern District of New York is proper.
45 With these jurisdictional hurdles behind us, we have little difficulty in affirming the preliminary injunction insofar as it restrains the Fairfield Group from disposing of the Boeing 707. Although an extraordinary remedy, a preliminary injunction is properly granted to preserve the status quo pendente lite where the balance of hardships tips decidedly toward the party requesting the trmporary relief and that party has raised questions going to the merits so serious, substantial, and difficult as to make them a fair ground for litigation and thus for more deliberate investigation. Sonesta International Hotels Corp. v. Welligton Associates, 483 F.2d 247, 250 (2d Cir. 1973); Checker Motors Corp. v. Chrysler Corp., 405 F.2d 319, 323 (2d Cir.), cert. denied, 394 U.S. 999, 89 S.Ct. 1595, 22 L.Ed.2d 777 (1969); Hamilton Watch Co. v. Benrus Watch Co., 206 F.2d 738, 740 (2d Cir. 1953). ICC has easily satisfied both requirements. 46 Richardson and McAlpin, both former directors of ICC, have stated in their affidavits that information material to their decision to approve the spin-off of Fairfield General was withheld from them. Although raising an interesting application of the fraud provisions under 10(b), these uncontroverted statements certainly present 'a fair ground for litigation and thus for more deliberate investigation.' Id. 47 That the balance of hardships tips decidedly in favor of ICC cannot fairly be questioned. It appears from the record that the Boeing 707 is now 17 the sole substantial asset owned by Fairfield General or its subsidiaries. Its sale might well result in the dissipation of an important asset, leaving little for ICC to recapture if it should eventually succeed in this lawsuit. We have recognized that an asset freeze may be appropriate to assure compensation to those who are victims of a securities fraud. SEC v. Manor Nursing Centers, Inc., 458 F.2d 1082, 1105-1106 (2d Cir. 1972). Moreover, Judge Stewart has narrowly fashioned the injunctive decree so that it will not interfere with the operation of the aircraft. 18 Accordingly, we do not find that the district court abused its discretion by enjoining the sale of the Boeing 707 pendente lite. 48
49 We turn finally to appellants' contention that the district court was without authority to enjoin the prosecution of the pending state court actions, one of which was instituted by Skyways to enforce the Boeing 707 lease, while the second was initiated by the Fairfield Group to recover certain books and records which ICC has refused to release to the Group. The limited authority of a federal court to stay a pending state court proceeding is embodied in 28 U.S.C. 2283 which states: 50 A court of the United States may not grant an injunction to stay proceedings in a State court except as expressly authorized by Act of Congress, or where necessary in aid of its jurisdiction, or to protect or effectuate its judgments. 51 Moreover, in construing this statute, we are counselled to resolve 52 any doubts as to the propriety of a federal injunction against state court proceedings . . . in favor of permitting the state courts to proceed in an orderly fashion to finally determine the controversy. The explicit wording of 2283 itself implies as much, and the fundamental principle of a dual system of courts leads inevitably to that conclusion. 53 Atlantic Coast Line Railroad Co. v. Brotherhood of Locomotive Engineers, 398 U.S. 281, 297, 90 S.Ct. 1739, 1748, 26 L.Ed.2d 234 (1970). In light of this presumption against interference, we must agree with the Fairfield Group that the district court erred by enjoining the prosecution of the two state court suits. 54 In support of its request for this relief, ICC urges that the district court possessed the requisite authority under 21(e) of the 1934 Act (15 U.S.C. 78u) which, argues ICC, satisfies the 'except as expressly authorized by Act of Congress' language of 2283. 19 Section 21(e) provides: 55 Whenever it shall appear to the Commission that any person is engaged or about to engage in any acts or practices which constitute or will constitute a violation of the provisions of this chapter, or of any rule or regulation thereunder, it may    bring an action    to enjoin such acts or practices, and upon a proper showing a permanent or temporary injunction or restraining order shall be granted without bond. 56 Although this language empowers the SEC alone to obtain injunctive relief, we have held that, under certain circumstances, it may be construed to authorize a private party to enjoin a pending state court action where the very prosecution of that lawsuit furthers a violation of the securities laws. Studebaker Corporation v. Gittlin, 360 F.2d 692 (2d Cir. 1966). 57 ICC contends that our holding in Gittlin is applicable to this case. Its argument, accepted by Judge Stewart, is basically that but for the spin-off of Fairfield General, a transaction fraudulently induced in violation of 10(b), neither Skyways nor the balance of the Fairfield Group would enjoy the independent status effectively required to sue its former parent. Thus, ICC concludes that, as in Gittlin, where Gittlin's state court action against Studebaker was permanently enjoined because Gittlin had obtained the necessary stockholder authorizations by violating the Proxy Rules issued under 14(a) of the 1934 Act, here too, the state court actions are predicated on violations of the securities laws. 58 There is, however, a critical distinction between Gittlin and the instant case. In Gittlin, the injunction issued after a decision on the merits holding that Gittlin had, in fact, violated 14(a), while in this case, ICC's claim of a 10(b) violation, though presenting a fair ground for subject matter jurisdiction and a temporary injunction has yet to result in a judgment on the merits after trial. To be sure, the SEC, under 21(e), is empowered to secure a preliminary injunction, but, in view of the explicit words of caution appearing in Atlantic Coast Railroad, we decline to extend the Gittlin rationale to the facts of this case. 59 This conclusion, moreover, is buttressed by our decision in Vernitron Corporation v. Benjamin, 440 F.2d 105 (2d Cir.), cert. denied, 402 U.S. 987, 91 S.Ct. 1664, 29 L.Ed.2d 154 (1971), decided subsequent to Gittlin. In Vernitron, a preliminary injunction was sought and granted to restrain a pending state court action which, the moving party claimed, was brought to enforce a contract obtained by fraudulent conduct violative of 10(b). We reversed, finding Gittlin 'inapposite in that the prosecution of the state action there relevant would itself have furthered the violation of the Securities Exchange Act.' Vernitron Corporation v. Benjamin, supra, 440 F.2d at 108. Since the facts here bear greater resemblance to Vernitron than Gittlin, we believe our decision in Vernitron to be the more applicable. Accordingly, we vacate so much of the preliminary injunction against the Fairfield Group that enjoins further prosecution of the two actions pending in New Jersey Superior Court, without prejudice to renewal of the application upon a showing that prosecution of these actions has interfered or threatens to interfere with the district court's jurisdiction or a judgment issued by it.