Opinion ID: 329274
Heading Depth: 1
Heading Rank: 1

Heading: The Hidell Claim

Text: 8 Defendants argue that the statement in the September 17 letter and any oral statements made to the Hidells on September 20 that an investment of $190,000 had been made in I.D.I. were not false when made because the repurchase agreement was not entered into until nine days after the Hidells consented to the subscription agreement amendment. Alternatively, they contend that the repurchase agreement entered into between Donald Rosenbloom and Dougherty was not a material fact, as the term is used in Rule 10b-5 and § 12, subd. G of the Illinois Securities Act. We disagree on both grounds. 9 The record discloses that Donald Rosenbloom was aware of Dougherty's reluctance to sign the subscription agreement amendment before he went to Philadelphia on September 20 to meet with the Hidells. Dougherty testified that he had had conversations with Rosenbloom about a buy-back agreement prior to his receipt of the September 17 letter. Tr. 197. And Rosenbloom admitted that, although Dougherty had requested concessions prior to September 17, he never so advised the Hidells. Tr. 435. Consequently when Rosenbloom convinced the Hidells to sign the amendment, by stating that an investment of $190,000 had been made, he failed to disclose the fact that one of the subscribers had indicated that he might not so agree with a repurchase agreement. The $190,000 investment statement was, therefore, seriously misleading, even if not wholly false, when made. Whether we view this as a false affirmative statement or as an omission, Rosenbloom himself had reason to believe that it was less than a completely truthful statement of the then-current status of the corporation's financing. 7 10 Having informed the Hidells that $190,000 had been invested, when he knew of Dougherty's demands and the significant likelihood that a repurchase agreement might be a condition of Dougherty's assent, we believe that Donald Rosenbloom was under an affirmative duty to notify the Hidells of the repurchase agreement on or after September 29 and to afford them the opportunity to cancel their consent to the subscription agreement amendment. 8 Similarly, Sally Rosenbloom, who signed the September 17 resolution approving the amendment to the subscription agreement, and who knew on September 29 of the repurchase agreement, was, as an officer and director of I.D.I., under the same duty of disclosure and is similarly liable under § 10(b), Rule 10b-5, and § 12 of the Illinois Act. 9 11 Defendants present us with several alternative arguments with regard to the materiality of the failure to inform the Hidells of the repurchase agreement. They agree that the test of materiality was properly set forth by the court in S.E.C. v. Texas Gulf Sulphur Co., 401 F.2d 833, 849 (2d Cir. 1968), cert. denied, 394 U.S. 976, 89 S.Ct. 1454, 22 L.Ed.2d 756: 12 The basic test of materiality    is whether a reasonable man would attach importance    in determining his choice of action in the transaction in question. . . .  This, of course, encompasses any fact     which in reasonable and objective contemplation might affect the value of the corporation's stock or securities   . 13 Quoting List v. Fashion Park, Inc., 340 F.2d 457, 462 (2d Cir. 1965), cert. denied, 382 U.S. 811, 86 S.Ct. 23, 15 L.Ed.2d 60 (emphasis in original). 14 They argue first, however, that, because the repurchase agreement entered into between Dougherty and Donald Rosenbloom on behalf of I.D.I. was illegal, and hence unenforceable, under Delaware law, it could not have been material to a decision on the amendment to the subscription agreement. Even assuming the illegality premise, we must disagree with defendants' conclusion. For it ignores the subsequent activity concerning the repurchase of Dougherty's shares. On advice of counsel, Donald Rosenbloom gave Dougherty a second letter, dated October 1, 1971, agreeing personally to repurchase the shares. This letter was accepted by Dougherty on April 14, 1972. On September 30, 1972, Dougherty exercised his repurchase option, and on December 29, 1972, Dougherty's shares were repurchased by I.D.I. as treasury stock, with funds provided the corporation by the Rosenblooms. 10 15 Thus, the record demonstrates that the Rosenblooms were willing to provide Dougherty with the assurances he sought even if it required personally guaranteeing the repurchase. The shares were repurchased, using I.D.I. funds donated by the Rosenblooms. The net effect of the transaction was that the number of outstanding shares of I.D.I. was reduced and the risk assumed by the Hidells was proportionately increased. 11 Thus, regardless of the legality of the September 29 agreements, the repurchase of Dougherty's shares in fact did take place. A reasonable man, even if he knew of the illegality, might well have attached importance to the agreement because of the possibility of just such an eventuality. 16 Focusing on the possible illegality of the agreement also overlooks the fact that a reasonable investor would have attached importance to the very fact that one of the five other subscribers felt the need to demand such a buy-back option as a condition to agreeing to reduce further the capitalization of the corporation. Original plans had called for the sale of 20,000 shares for a minimum capitalization of $500,000. The failure to obtain the necessary 20 subscribers mandated the reexamination of the corporation's goals which resulted in the September 17 letter and the announcement that I.D.I. could go into business with a capitalization of only $175,000 to $200,000. The knowledge that another of the six subscribers was having serious second thoughts about going forward with the scaled-down venture would clearly have been material to the Hidells' decision. 12 17 Finally, defendants argue that, even assuming the exercise of the Dougherty option, the capitalization of the corporation would still have been $165,000, only $10,000 below the $175,000 minimum stated in the September 17 letter. It is clear, however, that, in light of the already significant reduction in planned capitalization and the fact that the September 17 letter referred to the $175,000 to $200,000 range as sufficient to commence operations, knowledge of this further decrease would have been material to a reasonable man. 13 18 Consequently, we conclude that the unqualified statement of defendants in the September 17 letter and of Donald Rosenbloom in his September 20 meeting with the Hidells that $190,000 had been invested in I.D.I. was material and misleading and that defendants violated § 10(b) of the 1934 Act, Rule 10b-5, and § 12, subd. G of the Illinois Act 14 by not informing the Hidells at those times of Dougherty's demands or, alternatively, informing them of the existence of the repurchase agreement and resoliciting their assent to the subscription agreement amendment.