The opinion of the court was delivered by: Marovitz, District Judge.
Motion of Defendants to Dismiss.
This is a two-count action purportedly arising under the
Securities Act of 1933 and the Securities Exchange Act of 1934.
In Count I, plaintiffs, shareholders of The Susquehanna
Corporation, have sued derivatively for injunctive relief and
damages, asserting violations by defendants of Section 17(a) of
the 1933 Act (Sec. 77q, Title 15, U.S.C.), Section 10(b) of the
1934 enactment, (Sec. 78j, Title 15, U.S.C.) and Rule 10b-5 of
the Securities Exchange Commission promulgated thereunder.
Jurisdiction is based on Section 22(a) of the 1933 Act and
Section 27 of the 1934 Act respectively. (Secs. 77v, 78aa, Title
15, U.S.C.). In essence, plaintiffs charge that prior to March
25, 1965, thirteen individual defendants, hereinafter referred to
as the "Lannan Group" entered into a conspiracy with defendant
H.F. Korholz, under which they, upon election as directors of
Susquehanna, would sell or cause to be sold to Korholz 435,000
shares of Susquehanna stock for $6,525,000, a sum alleged to be
$1,740,000 in excess of the fair market value of such shares, and
then pass control of said corporation to Korholz through planned
resignation and election of directors. Upon accomplishing this
result, it is alleged, Korholz, as a part of the conspiracy,
transferred the aforesaid shares to the American Gypsum Co., in
connection with which said company incurred a bank loan for
substantially all of the purchase price. Thereafter, it is
asserted, Korholz caused the Board of Directors of Susquehanna to
approve a merger of the two companies, under which Susquehanna
assumed the bank loan, and, in effect, acquired the 435,000
shares at the excessive price. This, plaintiffs contend,
constituted a fraudulent sale of securities to Susquehanna, and,
derivatively, to them, in violation of the aforesaid statutes.
Further, it is alleged, in Count I, that the defendants herein,
under threat of a shareholder's derivative suit by a Kansas City
group, caused Susquehanna to transfer in May, 1965, 140,000
shares of common stock of Vanadium Corporation of America to said
shareholders for a price, paid in Susquehanna stock and boot,
$700,000 less than its true market value. By causing such sale to
be made, without disclosing the threatened derivative suit, it is
alleged, defendants further violated Section 17(a) and Section
In Count II, added on December 21, 1965, as the Third Amendment
to the Complaint, plaintiffs allege that in furtherance of the
aforesaid scheme, defendants caused Susquehanna to disseminate a
false proxy statement in violation of Section 14(a) of the 1934
Act (Sec. 78n, Title 15, U.S.C.) and S.E.C. Rule 14a-9
All defendants have filed motions herein requesting dismissal
of both counts. As all these motions are predicated on similar
grounds, except for the motion of defendant Lauhoff as to Count
II, they will be considered by this Court as one.
We must initially be concerned with defendants' assertions that
the Complaint at issue fails to state a cause of action under the
Securities Acts, and thus, in the absence of diverse citizenship
among the parties, must be dismissed for lack of federal
As we have several times held, Sections 17(a) and 10(b), are of
limited scope, having been drafted by Congress and the Securities
Exchange Commission (Rule 10b-5) to protect sellers and
purchasers of securities from persons who seek to defraud them in
such sales. It is clear that only parties to a sale, however
fraudulent, can maintain a suit under the aforesaid sections.
Birnbaum v. Newport Steel Corp. (2d Cir. 1952), 193 F.2d 461, at
page 464, cert. den. 343 U.S. 956, 72 S.Ct. 1051, 96 L.Ed. 1356,
"* * * that section [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 and Rule X-10b-5 extended
protection only to the defrauded purchaser or
See also Jachimec v. Schenley Industries, Inc. (7th Cir., 1965)
Cause No. 15,027, approving Birnbaum, supra; Keers & Co. v.
American Steel & Pump Corp. (D.C.N.Y., 1964), 234 F. Supp. 201.
Thus, no meaningful determination can be made without an
analytical breakdown of the multi-faceted transaction before us.
It is clear, to begin, that some line must be drawn between the
Lannan-Korholz sale and the Susquehanna-Gypsum merger. While
certain defendants may well have intended both actions to occur,
and, indeed, participated in one in anticipation of the other, it
would be improper to gloss over the facts and look only to end
We are satisfied that, under Birnbaum, supra, the
Lannan-Korholz sale is not actionable by these plaintiffs under
the Federal Securities laws. None of the plaintiffs, nor
Susquehanna, on whose behalf plaintiffs derivatively sue, was a
party to that sale. Their injury, if any, came as a result of the
merger, or from a breach by defendants of a fiduciary duty owing
to them, but, surely, plaintiffs and Susquehanna were not in any
way defrauded by that initial private sale to which they were not
Therefore, if plaintiffs are to have standing here, it will
have to be derived from the merger itself. That is, the gravamen
of the offense, as plaintiffs repeatedly assert in their brief,
is based on the forced acquisition by Susquehanna of the 435,000
shares sold by its directors at an inflated price, through the
merger with Gypsum. This merger is the only transaction to which
Susquehanna, and plaintiffs, were direct parties, and is the
transaction which must be scrutinized in connection with Sections
17(a) and 10(b).
We must conclude that the merger as stated in the complaint is
not actionable under the fraudulent sale provisions of the
Securities Acts. A statutory merger of the type with which we are
concerned results in the automatic involuntary conversion of
one type of security into another. That is, Susquehanna stock was
not "sold" for shares of Gypsum, but, rather, upon merger, the
corporation converted shareholders' security from one form to
another. This distinction was clearly upheld by the Ninth Circuit
Court of Appeals in National Supply Co. v. Leland Stanford Jr.
University (9th Cir., 1943), 134 F.2d 689, at p. 694:
"The Securities and Exchange Commission has filed an
exhaustive brief amicus curiae indicative of its
view that the consolidation did not involve a `sale'
of securities, or an exchange amounting to a sale,
hence the civil liability provisions of the Act have
no application. Without going into the ...