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April 15, 1966


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 10(b).

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 promulgated thereunder.

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 jurisdiction.

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, (1952):

  "* * * 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 results.

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 privy.

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 ...

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