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MADIGAN, INCORPORATED v. GOODMAN

United States District Court, Northern District of Illinois, E.D


March 28, 1973

MADIGAN, INCORPORATED ET AL., PLAINTIFFS,
v.
GILBERT GOODMAN ET AL., DEFENDANTS.

The opinion of the court was delivered by: Bauer, District Judge.

MEMORANDUM OPINION AND ORDER

This cause comes on defendants' (Gilbert Goodman, Edward Hollander and Sidney L. Morris) motion to dismiss the complaint or alternatively for summary judgment.

This action was brought to recover damages for alleged fraudulent misrepresentations in the sale of a security in violation of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b); Rule 10B-5, 17 C.F.R. § 240.10b-5 promulgated thereunder and Illinois common law fraud. The plaintiffs are a group of corporations and individuals including Madigan, Incorporated (hereinafter jointly referred to as the Madigan Group) who purchased Fidelity General Insurance Company ("Fidelity") stock. The defendants are Gilbert Goodman and Clyde L. Korman, who are officers, directors and shareholders of Fidelity; Samuel Jastromb, Samuel Bernstein, Edward Hollander and Sidney L. Morris, who are directors and shareholders of Fidelity; Fred H. Pearson, who is a shareholder of Fidelity; and Tom I. McFarling, who is the Receiver of Dealers National Insurance Company and Liberty Universal Insurance Company and presently has title to 1,071,650 shares of the common stock of Fidelity. These defendants have allegedly made false representations concerning the financial condition of Fidelity to the detriment of the Madigan Group.

The following facts are relevant to the proper disposition of the instant motion. On December 20, 1968, Mading-Dugan Drug Company (the predecessor to Madigan, Inc.) purchased 51% of the common stock of Fidelity from the defendants and other shareholders for the sum of $1,750,895 in cash. At the same time, Mading-Dugan contracted to make a tender offer for the remaining Fidelity shares before June 30, 1969.*fn1

On or about May 13, 1969, Mading-Dugan sold the Fidelity stock it had purchased from defendants to Contran Corporation ("Contran") for 250,000 shares of Contran common stock, the value of which was approximately $1,750,895.*fn2

On or about September 19, 1969, Contran sold all of the Fidelity General stock that it had acquired from Mading-Dugan to Texas Consumer Finance Corp. for $1,750,895 in cash.*fn3

At the time that Contran purchased Fidelity stock, Contran agreed to assume Mading-Dugan's obligation to make the tender offer for the remaining Fidelity shares.*fn4 Contran subsequently assigned the obligation to make the tender offer to Texas Consumer Finance Corp. Between June and August, 1969, Texas Consumer Finance Corp. purchased 502,845 shares of Fidelity from shareholders other than defendants.

Plaintiffs allege that the defendants' false and misleading representations concerning Fidelity's financial condition caused the following damages:

  1.  Plaintiffs have lost the amount paid for
      Fidelity stock (Complaint paragraphs 18(a)
      and 41(a)).

  2.  Plaintiffs have lost additional capital
      contributed to prevent the insolvency of
      Fidelity and the profits and other benefits
      that they reasonably could have expected to
      receive from the purchase of Fidelity stock
      had its financial condition been what the
      defendants represented it to be (Complaint
      paragraphs 18(b) and 41(b)).

  3.  Plaintiffs have incurred and will continue to
      incur substantial expenses in defending
      lawsuits (Complaint paragraphs 18(c) and
      41(c)).

  4.  Plaintiffs have been unable to plan and
      conduct their financial affairs as a result
      of such litigation (Complaint paragraphs
      18(d) and 41(d)).

The defendants Gilbert Goodman, Edward Hollander and Sidney L. Morris, in support of their motion contend:

  1.  Plaintiffs have suffered no damage
      attributable, as a matter of law, to any of
      the acts allegedly performed by defendants.

  2.  Certain plaintiffs do not have standing to
      assert a claim under Section 10(b) of the
      Securities Exchange Act of 1934 and the Rules
      promulgated thereunder.

  3.  Plaintiffs' claims are barred by the
      applicable statute of limitations.

The plaintiffs, in opposition to the instant motion, contend that their losses exceed two million dollars as a result of the fraudulent conduct of defendants and that the Madigan Group has been exposed to claims exceeding $48 million in case of Baylor, Director of Insurance v. Mading-Dugan Drug Company et al., D.C., 57 F.R.D. 509 ("Liquidator's case") which has been consolidated with the instant action.

It is the opinion of this Court that since the plaintiffs have resold the securities purchased from the defendants for the same price at which those securities were acquired, plaintiffs have suffered no loss and thus have no cause of action.

  I. Plaintiffs have suffered no damages which are legitimately
  attributable to the alleged acts of the defendants or
  recoverable under the Securities Exchange Act.

It is well settled that the failure to show actual damages is a fatal defect in bringing a cause of action based on the Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq. This legislation permits recovery of actual damages based on violations of the Act. "Actual damages" for one who through fraud or misrepresentation has been induced to purchase bonds or corporate stock, is the difference between the contract price, or the price paid, and the real or actual value at the date of the sale, together with such outlays as are attributable to the defendants' conduct. In other words, the federal rule of damages for such fraud is an "out of pocket rule", the difference between the amount parted with and the value of the thing received. Smith v. Bolles, 132 U.S. 125, 10 S.Ct. 39, 33 L.Ed. 279 (1889); Sigafus v. Porter, 179 U.S. 116, 21 S.Ct. 34, 45 L.Ed. 113 (1900); Hindman v. First National Bank, 112 F. 931 (6th Cir. 1902), cert. denied, 186 U.S. 483, 22 S.Ct. 943, 46 L.Ed. 1261; Tooker v. Alston, 159 F. 599 (8th Cir. 1907); Chandler v. Andrews, 192 F. 543 (2nd Cir. 1911); Nashua Savings Bank v. Burlington Electric Lighting Co., 100 F. 673 (S.D.Iowa, 1900); Morris v. United States, 303 F.2d 533 (1st Cir. 1962); Mott v. Tri-Continental Financial Corporation, 330 F.2d 468 (2nd Cir. 1964).

The pleadings and recent pre-trial discovery demonstrate that the plaintiffs have failed to properly show actual damages based on the alleged violation.

A. Damages based on loss of purchase price.

Plaintiffs claim in paragraphs 18(a) and 41(a) of their Complaint that they have lost $3,322,155, the price paid for 1,067,650 shares of Fidelity common stock. As noted earlier, the Fidelity stock was purchased in two transactions. 564,805 shares were purchased from defendants and other shareholders by Mading-Dugan in December, 1968, and 502,845 shares were purchased by Texas Consumer Finance Corp. ("TCFC") pursuant to a tender offer between June and August, 1969.

With respect to the Fidelity stock purchased in December 1968 from defendants, the following facts have been disclosed during pre-trial discovery.*fn5

  1.  Mading-Dugan Drug Company purchased all of
      the Fidelity General shares transferred in
      December 1968 for $1,750,895 in cash.

  2.  In May, 1969, Mading-Dugan sold those
      Fidelity shares to Contran in exchange for
      250,000 shares of Contran stock. The Contran
      stock was valued, by the seller and buyer, at
      20% below its market value of $8.50 per
      share. Thus the total value of Contran shares
      traded approximately equaled the amount at
      which Mading-Dugan had originally purchased
      the Fidelity shares.

  3.  In September, 1969, Contran sold all of the
      Fidelity shares it had purchased from
      Mading-Dugan to Texas Consumer Finance
      Corporation for $1,750,895 in cash, the same
      amount Contran had paid in Contran stock, and
      the same amount Mading-Dugan had earlier paid
      in cash in acquiring the Fidelity stock.

Plaintiffs Madigan and Contran therefore fully recovered the purchase price that they paid for Fidelity stock. Thus there is no out of pocket loss or actual damages to the plaintiffs in their purchase of Fidelity stock.

The Fidelity stock purchased pursuant to the tender offer during the summer of 1969 was not purchased by any of the plaintiffs, but was purchased by Texas Consumer Finance Corporation, Trans-Texas Life Insurance and Consumers Casualty Company.*fn6

No other plaintiff purchased or held Fidelity stock at any time.*fn7 Kaufman v. Mellon National Bank and Trust Company, 366 F.2d 326 (3rd Cir. 1966); Chaney v. Western States Title Insurance Company, 292 F. Supp. 376 (D.Utah, 1968). Further, plaintiff's answer to Interrogatory No. 31(a) is illustrative of the lack of damages flowing from the purchase of Fidelity stock. Interrogatory No. 31(a) states:

    State what portion of the $3,332,155, if any,
  plaintiffs claim in paragraph 18(a) of the
  Complaint to have lost is allocable to you.

The answer given for all plaintiffs states:

None.

  B. Damages based on loss of profits and other expected
  benefits.

It it clear that the question of damages turns not on what the plaintiffs might have gained, but what has been lost by being allegedly deceived into a purchase. The defendants are liable for such damages as naturally and proximately resulted from the alleged fraud; they are bound to make good the loss sustained. More specifically, the defendants are liable for losses as the plaintiff has sustained, with interest, and any other outlay legitimately attributable to the defendants' fraudulent conduct. It is clear that liability does not include the speculative fruits of unrealized profit. Smith v. Bolles, supra; Estate Counseling Service v. Merrill, Lynch, Pierce, etc., 303 F.2d 527 (10th Cir. 1962). Thus the plaintiff cannot recover the expectant profits claimed in paragraph 18(b) of the Complaint.

The plaintiffs also claim that they incurred great cost and expense in undertaking certain steps to prevent Fidelity's insolvency. More specifically, plaintiffs identify these steps as:*fn8

  (a) Defendant Goodman was terminated as an
      officer of Fidelity on March 25, 1970.

  (b) New management and personnel were brought
      into Fidelity in spring of 1970.

  (c) In May of 1970 the plaintiffs, acting in
      conjunction with the Illinois Department of
      Insurance, initiated a plan of redirection
      for Fidelity General.

  (d) An underwriting review of Fidelity General
      was made.

  (e) On April 30, 1970, a $500,000 contribution to
      the capital of Fidelity was made.

  (f) Reinsurance was instituted to shift some of
      the losses to Texas companies.

More specifically regarding (f), plaintiffs allege that plaintiff Madigan, Inc., has also suffered other damages in the amount of $2,053,629 as a result of the defendants' fraud. Losses in that amount were allegedly absorbed by Madigan in 1969 as a result of a reinsurance agreement between Fidelity and Dealers National Insurance Company, a subsidiary of Madigan, Inc.*fn9

These alleged indirect injuries which plaintiffs seek to recover, all relate to matters which occurred after plaintiffs sold their stock. For the purpose of the Securities Exchange Act when plaintiffs sold their stock, their interest in the transaction and Fidelity terminated. Mott v. Tri-Continental Financial Corporation, supra.*fn10

Thus, the plaintiffs have failed to show any damages due to lost profits and capital expenditures which are recoverable under the Security Exchange Act.

  C. Damages due to the expenses incurred in defending
  lawsuits.

In addition to the actual losses allegedly incurred as a result of alleged fraud of the defendant Fidelity sellers, the Madigan Group has been subjected to the claim, in the "Liquidator's suit," that they caused the insolvency and liquidation of Fidelity.*fn11 The plaintiffs allege in paragraphs 18(c) and 41(c) that they have incurred expenses in defending lawsuits resulting from their purchase of Fidelity stock from the defendants.*fn12 The cost of lawsuits, which is one basis for plaintiffs' allegation of damages, arose long after plaintiffs had divested themselves of all Fidelity shares at no loss whatsoever. There is no direct causal relationship between the commencement of the lawsuits and plaintiffs purchase of Fidelity stock.*fn13

The plaintiffs have failed to cite any case in support of their theory that such damages as the cost of defending lawsuits which are at best indirectly related are recoverable under the Securities Exchange Act. Further, it is the opinion of this Court that such damages are not proper under the Act.*fn14

  D. Damages due to the inability of the plaintiffs to plan and
  conduct financial affairs.

Plaintiffs allege in paragraphs 18(d) and 41(d) that they have been been damaged in being "unable adequately to plan and orderly to conduct their financial affairs" as a result of the litigation referred to in paragraphs 18(c) and 41(c) of plaintiffs' Complaint. Again, these events arose after the plaintiffs sold their shares of Fidelity stock and again this speculative damage is not legitimately attributable to the defendants' alleged fraudulent conduct nor recoverable under the Securities Exchange Act.

It is apparent that, as a matter of law, the damages alleged by the plaintiffs are not "out of pocket" losses representing the difference between the amount parted with and the value of the thing received. Further, the damages alleged by the plaintiffs are not outlays legitimately attributable to the defendants' alleged fraudulent conduct.

The plaintiffs have failed to show any loss recoverable under the Securities Exchange Act. Thus, since the plaintiffs have not shown a loss recoverable under the statute, they fail to state a cause of action and the Complaint should be dismissed.

  II. The standing of certain plaintiffs to assert a cause of
  action under Rule 10b-5 is questionable.

The defendants contend that certain plaintiffs lack standing to assert a cause of action under Rule 10b-5. Since the plaintiffs' Complaint is fatally defective, in not alleging damages recoverable under the statute, there is no need to decide whether certain plaintiffs have standing to assert a 10b-5 claim. In passing, the following is noteworthy. It is well settled that a plaintiff who is neither a purchaser nor a seller of securities does not have standing to assert a claim alleging a violation of Rule 10b-5. See Herpich v. Wallace,
430 F.2d 792 (5th Cir. 1970); Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2nd Cir. 1952).

Pre-trial discovery has disclosed that the following plaintiffs have neither purchased nor sold Fidelity General stock at any time: Ward Cut-Rate Drug Co.; Mading-Dugan Drug Stores, Inc.; Harold Simmons; Glenn Simmons; Max Blundell; D. Dale Wood; and John Brunson.*fn15

Accordingly, it is hereby ordered that the defendants' motion to dismiss the Complaint is granted.


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