United States District Court, Northern District of Illinois, E.D
March 28, 1973
MADIGAN, INCORPORATED ET AL., PLAINTIFFS,
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
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)
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
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
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
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
No other plaintiff purchased or held Fidelity stock at any
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.
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:
B. Damages based on loss of profits and other expected
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
(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
(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
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
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
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
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.