Court Opinion

ID: 9469223
Source: CourtListenerOpinion
Date Created: 2023-08-05 02:35:37.119058+00
Date Added: 2024-06-11T17:41:17.642466
License: Public Domain

LUMBARD, Circuit Judge,
dissenting:
I dissent. The majority today extends the protections of the securities laws to plaintiffs not in need of those protections, thereby adding to the burdens on the federal courts without furthering any of Congress’s purposes in enacting those laws. I would affirm the judgment of the district court dismissing the complaint for want of subject matter jurisdiction.
I.
The defendant, Anthony Garafalo, owned and operated a ticket brokerage business in New York City, conducted under the name of Mackey’s Inc. (“Mackey’s”).* This business consisted of buying and reselling tickets to various sporting, theatrical, and other entertainment events.
In the fall of 1980, Garafalo entered into negotiations with the two plaintiffs, Arthur and Gladys Golden, for the sale of his business. The Goldens were already engaged in the ticket brokerage business at that time. The two parties reached a basic agreement on terms in November 1980. Garafalo then contacted his lawyer, William B. Aronstein, and informed him of the basic terms of the proposed sale.
After speaking with Garafalo, Aronstein telephoned the Golden’s counsel, Edward Labaton, to work out the details of the sale. The two lawyers discussed whether the sale should take the form of a sale of assets or a sale of stock; after Aronstein informed La-baton that the lease of the premises in which Mackey’s was located contained a non-assignment clause, the two agreed to proceed by a sale of 100% of the stock in Mackey’s.
The contract of sale was signed and the closing took place on December 31, 1980. The contract provided that the Goldens would pay an amount equal to the “Net Assets” of Mackey’s, plus $108,296 payable in two installments. The lease of the premises and the 49 shares of Mackey’s stock, constituting 100% of the outstanding shares, were put in escrow pending payment of the two promissory notes evidencing the installment debts. Delivered to the Goldens were the resignations of all the officers and directors of Mackey’s; the corporate minute books and corporate seal; all the business records, files, and account books relating to Mackey’s; and all the contracts pertaining to the business.
Simultaneously with the signing of the sales contract, the parties entered a consulting agreement. This recited that Garafalo had “sold his interest in Mackey’s” and “is no longer employed by Mackey’s,” but was contracting as an “independent contractor” to provide consulting services to Mackey’s upon reasonable notice for $100 per day. Garafalo’s obligation to provide such services was not to exceed 150 days during the year 1981. He further agreed not to compete with Mackey’s for a period of five years.
Although the Mackey’s stock was to remain in escrow pending final payment of the purchase price, the parties understood that the Goldens were to operate the business as they saw fit. The escrow agreement stated that “Mackey’s will continue to conduct its business solely in the usual and ordinary course thereof. . .. ” On the day of the closing, Labaton sent Aronstein a letter in which he acknowledged their understanding that under the escrow agreement, “the new owners will have full operational control of the business and may change currently existing practices and policies.”
Apparently dissatisfied with the business they had purchased, the Goldens sued for *1148recission and damages under the Securities Act of 1933, § 17(a), 15 U.S.C. § 77q(a); the Securities Exchange Act of 1934, § 10(b), 15 U.S.C. § 78j(b); and under Rule 10b-5, 17 C.F.R. 240.10b-5. Appended to these claims were claims under state law. The Goldens claimed that Garafalo had overstated the value of his business by exaggerating the percentage of corporate, as opposed to individual, customers that it served, and that the financial statements delivered by Garafalo overstated the business’s sales and income.
Judge Conner dismissed the complaint, relying on United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 95 S.Ct. 2051, 44 L.Ed.2d 621 (1975), in holding that the stock purchased by the Goldens was not a “security” under the securities laws and that the court therefore lacked subject matter jurisdiction. 521 F.Supp. 350 (S.D.N.Y.1981). I agree with Judge Conner substantially for the reasons stated in his thoughtful opinion and write separately here only to address the points made by the majority.
II.
The majority interprets Forman to require a “two-part, seriatim test,” asking first whether the instrument constitutes “stock” as that term is commonly understood, and only then, if it is not stock, asking whether it is an “investment contract” under the economic reality test. This interpretation misconstrues the Court’s analysis.
In Forman, the issue was whether stock in a state-subsidized cooperative apartment constituted a security. The Second Circuit held that the co-op stock was a security on two alternate grounds. 500 F.2d 1246 (2d Cir. 1974). First, it held that the shares fell within the literal meaning of the definitional section since they were denominated “stock.” Second, it held that the shares constituted an “investment contract” within the meaning of SEC v. W. J. Howey Co., 328 U.S. 293, 66 S.Ct. 1100, 90 L.Ed. 1244 (1946).
The Supreme Court rejected both of the Second Circuit’s arguments. First, it held that the mere fact that shares were denominated “stock” did not make them securities under the Securities Act of 1933. Rather, “ ‘In searching for the meaning and scope of the word ‘security’ in the Act[s], form should be disregarded for substance and the emphasis should be on economic reality.’ Tcherepnin v. Knight, 389 U.S. 332, 336, 88 S.Ct. 548, 553, 19 L.Ed.2d 564 (1967).” Forman, supra, 421 U.S. at 848, 95 S.Ct. at 2058. Nor, said the Court, could the plaintiffs justifiably assume that the securities laws applied merely because these shares were called “stock” since these shares lacked the features commonly associated with stock.
After disposing of the “literalist” argument, the Court disposed of the claim that the co-op shares constituted an investment contract. It stated that the “test for distinguishing [such a] transaction from other commercial dealings is ‘whether the scheme involves an investment of money in a common enterprise with profits to come solely from the efforts of others.’ ” Id. at 852, 95 S.Ct. at 2060 (citing Howey, supra, 328 U.S. at 301, 66 S.Ct. at 1104). As the plaintiffs had been attracted by the prospect of acquiring housing, not profit, the co-op shares did not constitute securities.
From this summary, it is clear that the Forman Court applied a two-part test only in response to the alternate grounds for the Second Circuit’s holding. There is nothing in the opinion that suggests such a two-part test is required and that a finding that an instrument possesses the common characteristics of corporate stock forecloses an inquiry into the economic reality of the transaction. On the contrary, the Court stated that the Howey economic reality test, “in shorthand form, embodies the essential attributes that run through all the Court’s decisions defining a security.” For-man, supra, 421 U.S. at 852, 95 S.Ct. at 2060.
Marine Bank v. Weaver,-U.S.-, 102 S.Ct. 1220, 71 L.Ed.2d 409 (1982), handed down since the district court’s opinion here, supports Judge Conner’s restrictive interpretation of the scope of the securities *1149laws. Weaver held that a 6-year, $50,000 certificate of deposit issued by the defendant bank did not constitute a “security” notwithstanding the fact it seemed to satisfy the statutory definition of a security. Noting that the “broad statutory definition” is preceded by the qualifying phrase, “unless the context otherwise requires,” the Court admonished that “Congress, in enacting the securities laws, did not intend to provide a broad federal remedy for all fraud.” Id. at-, 102 S.Ct. at 1223. In finding that the context otherwise required, the Court emphasized that the plaintiff did not need the protections of the federal securities laws “since the holders of bank certificates of deposit are abundantly protected under the federal banking laws,” id. at -, 102 S.Ct. at 1225, and because the plaintiff was almost certain to receive payment in full.
The majority concedes that the plaintiffs here do not need the protections of the securities laws. Those laws protect investors by requiring full and accurate disclosure in connection with the purchase or sale of securities, by requiring the issuer periodically to disclose facts about itself, and by providing a broader range of remedies than the common law. Here, the Goldens were in a position to inspect the business before they bought it; they obtained specific warranties and representations regarding the business’s tangible and intangible assets; and they obtained “full operational control of the business” from the moment they signed the purchase agreement. Garafalo stepped aside, delivering his resignation and all the corporate books, records, and contracts. Garafalo’s obligation to work as a consultant for a year specifically was as an “independent contractor” with no powers over the business’s practices or policies. In short, the Goldens were in a “position to protect their investment,” Hannan & Thomas, The Importance of Economic Reality and Risk in Defining Federal Securities, 25 Hastings L.J. 219, 249 (1974), quite unlike the investor who places his money in the hands of others or purchases shares on an open market where he cannot obtain firsthand information about the enterprise.
Ultimately, the reason the majority extends the coverage of the securities laws to these plaintiffs is to avoid “the danger of allowing the application of the ’33 and ’34 Acts to turn on uncertain and slippery factors, ease by case.” I believe the majority’s fears are unfounded. None of the courts that have found the sale of a business not to be the sale of a security have experienced unusual difficulties in reaching that conclusion. Most have faced facts similar to those here, where plaintiffs bought a business that they clearly intended to manage. E.g., King v. Winkler, 673 F.2d 342 (11th Cir. 1982); Canfield v. Rapp & Son, 654 F.2d 459 (7th Cir. 1981); Frederiksen v. Poloway, 637 F.2d 1147 (7th Cir.), cert. denied, 451 U.S. 1017, 101 S.Ct. 3006, 69 L.Ed.2d 389 (1981); Chandler v. Kew, [1979 Transfer Binder] Fed.Sec.L.Rep. (CCH) 196,966 (10th Cir. 1977); Seagrave Corp. v. Vista Resources, Inc., 534 F.Supp. 378 [Current] Fed.Sec.L.Rep. (CCH) 198,469 (S.D.N. Y.1982); Reprosystem, B. V. v. SCM Corp., 522 F.Supp. 1257 (S.D.N.Y.1981); Zilker v. Klein, 510 F.Supp. 1070 (N.D.Ill.1981); Anchor Darling Indus, v. Suozzo, 510 F.Supp. 659 (E.D.Pa.1981); Dueker v. Turner, [1979-80 Transfer Binder] Fed.Sec.L.Rep. (CCH) 197,386 (N.D.Ga.1979). The majority apparently fears the extension of these cases to ones where the purchaser acquires, or the seller sells, less than the whole business or less than absolute control. Indeed, some commentators have urged just that, e.g., Seldin, When Stock is Not a Security: The “Sale of Business” Doctrine Under the Federal Securities Laws, 37 Bus.Law 637 (1982); Thompson, The Shrinking Definition of a Security: Why Purchasing All of a Company’s Stock is Not a Federal Securities Transaction, 57 N.Y.U.L.Rev. _ (May 1982) (forthcoming), and one court has even found the purchase of 50% of a company’s stock not to be the purchase of a security, Oakhill Cemetery, Inc. v. Tri-State Bank, 513 F.Supp. 885 (N.D.Ill.1981). Although the majority implies that the uncertain contours of the “sale of business” doctrine may interfere with business planning, doubts as to the coverage of the antifraud *1150provisions of the securities laws are unlikely to impede otherwise profitable transactions by persons able to protect themselves by contract. People who can protect themselves by contract will do so whether or not the securities laws apply. However, we need not decide that question today. I would hold simply that the purchase of 100% of the stock of a business that the purchaser intends to operate and control does not constitute the purchase of a “security” under the federal securities laws. Consequently, I would affirm the judgment of the district court.

 The Manhattan telephone directory lists a ticket broker under the name of “Mackey’s” at 210 West 44th Street.