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OAKHILL CEMETERY OF HAMMOND v. TRI-STATE BANK

April 30, 1981

OAKHILL CEMETERY OF HAMMOND, INC., AN INDIANA CORPORATION, AND ROY A. ROARK, PLAINTIFFS,
v.
TRI-STATE BANK, AN ILLINOIS BANKING CORPORATION; DAVID J. ROBINSON; ARTHUR FRANKLIN CORP., AN INDIANA CORPORATION; JOHN F. WILHELM; WAYNE BRENEMAN; JEAN BRENEMAN; GUY CALLAHAN; J.R. GUESS, A/K/A ELBERT GUESS, JR.; MARSHALL L. HANNON; ROSEMARY HANNON; HENRY MALEN; JEROLD O. WRIGHT; HOOSIER STATE BANK OF INDIANA, AN INDIANA BANKING CORPORATION; FIRST NATIONAL BANK OF KOKOMO, A NATIONAL BANKING ASSOCIATION, DEFENDANTS.



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

  MEMORANDUM OPINION

Introduction

Plaintiffs Oakhill Cemetery of Hammond, Inc. (Oakhill) and Roy A. Roark bring this action against several corporate and individual defendants alleging violations of the federal securities laws and state law. Roark, an Illinois resident, is an officer, director, and shareholder of Oakhill. Defendants include: Tri-State Bank (Tri-State), an Illinois banking corporation; David Robinson, an Illinois resident and a loan officer in Tri-State's employ; Arthur Franklin Corporation (A.F. Corporation), an Indiana corporation and former principal shareholder of Oakhill; John Wilhelm, an Indiana resident and a former trustee of Oakhill's Perpetual Care Fund (the "Fund");*fn1 Wayne Breneman, a Missouri resident and former director, officer, and shareholder of Oakhill; his wife Jean, a former shareholder of Oakhill; Guy Callahan, an Illinois resident and a former director, officer, and shareholder of Oakhill and a former trustee of the Fund; J.R. Guess, an Illinois resident and former director, officer, and shareholder of Oakhill; Marshall Hannon, an Illinois resident and a former director and officer of Oakhill, and a debtor of Roark; his wife Rosemary, a debtor of Roark; Henry Malen, an Illinois resident and former director and officer of Oakhill; Jerold Wright, an Illinois resident and a guarantor of the Hannons' debt to Roark; Hoosier State Bank of Indiana (Hoosier), an Indiana banking corporation and a former trustee of the Fund; and First National Bank of Kokomo (Kokomo), an Indiana banking corporation and a trustee of the Fund. The jurisdiction of the Court is allegedly invoked pursuant to 15 U.S.C. § 77v*fn2 and 78aa*fn3 and the doctrine of pendent jurisdiction. Pending before the Court are motions to dismiss made by Hoosier, Kokomo, Tri-State, and Robinson, and a motion for summary judgment made by A.F. Corporation and Wilhelm.

Plaintiffs' complaint alleges, inter alia, that during the past decade Oakhill has been injured by several securities transactions violative of federal and state law and that its assets have been mismanaged by those owing a fiduciary duty to it. Plaintiffs' claims are set forth in Counts III through XV of their complaint. Count III concerns the sale by Callahan to Roark on December 29, 1978 of a promissory note in the amount of $55,000 executed by the Hannons and a security interest in 500 shares of Oakhill stock. The note and security agreement were given to Callahan by the Hannons when Callahan transferred the 500 shares of Oakhill stock to the Hannons on April 11, 1978. Roark alleges that his purchase of the note and security agreement was intentionally induced by certain misstatements and omissions by Callahan as to the financial health of both the Hannons and Oakhill. Roark alleges that neither the Hannons nor their guarantor have made payment under the note and that the shares of Oakhill are inadequate security for the note. Roark asserts in Count III that the alleged misstatements and omissions by Callahan violated 15 U.S.C. § 77q(a)*fn4 and 78j(b), 17 C.F.R. § 240.10b-5,*fn5 Ind.Code ch. 23, § 2-1-11,*fn6 and the common law of Indiana. Roark seeks $100,000 in compensatory damages, $300,000 in punitive damages, and costs and attorneys' fees. In Count IV Roark seeks the same recovery from Guess based upon Roark's allegation that in early December 1978, Guess, who was then an officer, director, and shareholder of Oakhill, made certain misrepresentations to Roark about the financial stability of Oakhill in order to aid Callahan in his alleged scheme to defraud Roark.

In Count V of the complaint Roark seeks recovery from the Hannons on their $55,000 note. Roark seeks in Count VI the same recovery against Marshall Hannon as he seeks in Counts III and IV from Callahan and Guess, respectively, alleging that prior to December 29, 1978 Hannon misrepresented both his and Oakhill's financial health to Roark. Count VII seeks recovery from Wright as a guarantor of the Hannons' note.

Counts VIII and IX contain claims asserted by Oakhill against Callahan and Breneman, respectively, that challenge the propriety of Oakhill's acquisition of 500 of its shares on October 28, 1977. Specifically, these counts allege that Callahan, then an officer and director of Oakhill, and Breneman, then a former officer and director of Oakhill, caused Oakhill to purchase the stock from Breneman when under Indiana corporation law Oakhill had insufficient unreserved and unrestricted earned surplus available to purchase the stock. Oakhill alleges that the $10,000 purchase price for the stock was paid from the proceeds of a $11,000 loan made to Oakhill by Tri-State on October 28, 1977. Counts VIII and IX allege that the above stock transaction defrauded Oakhill in violation of the federal securities laws, as well as violated Indiana corporation law. Counts VIII and IX seek recovery of $11,000 in compensatory damages, costs, and attorneys' fees. In Count X Oakhill seeks the same recovery as in Counts VIII and IX against Tri-State, alleging that Tri-State made the loan to Oakhill with knowledge of the alleged scheme to defraud Oakhill.

Counts XI and XII seek recovery on behalf of Oakhill against the Brenemans and Callahan, respectively, for certain other transactions allegedly undertaken by those defendants on Oakhill's behalf. Counts XI and XII allege that on March 26, 1977 Callahan purchased 500 shares of Oakhill stock from the Brenemans. The purchase price, Oakhill alleges, was paid from the proceeds of a $60,000 loan obtained by Callahan and Mr. Breneman on Oakhill's behalf from Tri-State. The loan was allegedly secured by Oakhill's real property. Oakhill alleges that the above transaction was not duly authorized as required by its by-laws and Indiana law and that Callahan's resulting indebtedness to Oakhill was not adequately secured. Further, Oakhill alleges in Counts XI and XII that Callahan and the Brenemans violated the federal securities laws. Oakhill seeks recovery of $60,000 in compensatory damages, $180,000 in punitive damages, costs, and attorneys' fees. Oakhill seeks the same recovery in Counts XIII and XIV of the complaint against Robinson, a Tri-State loan officer, and Tri-State, respectively, alleging their complicity in the acts complained of in Counts XI and XII.

Count XV, the final count in plaintiffs' complaint, asserts the liability of defendants A.F. Corporation, Wilhelm, Callahan, Malen, Hoosier, Kokomo, Breneman, Guess, and Hannon to Oakhill for their alleged failure to comply with provisions of The Indiana General Cemetery Act, Ind.Code ch. 23, §§ 14-1-1 through 14-1-28 (the "Cemetery Act"). Section 14-1-12 of the Cemetery Act requires every cemetery to establish an irrevocable perpetual care fund. See note 1, supra. The amount placed in a fund is fixed by the provisions of section 14-1-12. Section 14-1-18 of the Cemetery Act mandates certain investment practices with respect to a fund, precludes use of a fund's monies for the benefit of directors, officers, shareholders, or employees, and provides that whenever a fund is not managed by a corporate trustee, the cemetery's treasurer shall furnish a fidelity bond. Count XV alleges that each of the defendants to that count engaged in at least one transaction violative of sections 14-1-12 or 14-1-18. Oakhill seeks an order compelling defendants to produce all writings concerning the complained of transactions, an accounting of the transactions, that defendants be ordered to pay Oakhill any sums found to be due it and any property found by the accounting to have been improperly conveyed, and that defendants be restrained from disposing of any assets or proceeds of assets obtained from the fund pending disposition of this count.

Jurisdiction Under The Federal Securities Laws

Before addressing any of the pending motions, all of which raise narrow jurisdictional issues, the Court turns to a general examination of plaintiff's allegations of jurisdiction under the federal securities laws. At first blush, plaintiffs' complaint suggests acts of common law fraud and corporate mismanagement more than they do violations of the federal securities laws. See Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 97 S.Ct. 1292, 51 L.Ed.2d 480 (1977).*fn7 Accordingly, the Court has chosen to carefully scrutinize plaintiffs' jurisdictional allegations, see Fed.R.Civ.P. 12(h)(3), while fully bearing in mind that all of the well-pleaded allegations of plaintiffs' complaint shall be taken as true at this, the pleading stage, of this litigation. Cruz v. Beto, 405 U.S. 319, 92 S.Ct. 1079, 31 L.Ed.2d 263 (1972).

As can be culled from the above discussion of plaintiffs' complaint, it sets forth three security transactions upon which plaintiffs predicate this Court's jurisdiction. In chronological order they are: (1) the March 26, 1977 purchase by Callahan of 500 shares of Oakhill, comprising one-half of its outstanding shares, from the Brenemans; (2) the October 28, 1977 purchase by Oakhill of its remaining 500 outstanding shares not then held by Callahan; and (3) Roark's December 29, 1978 purchase from Callahan of a note secured by the 500 shares of Oakhill formerly acquired by Callahan from the Brenemans.

The threshold jurisdictional question to be resolved as to each of the above transactions is whether it involves a "sale" of a "security" within the meaning of the federal securities laws.*fn8 The fact that a transaction may literally involve the transfer of a security does not necessarily bring that transaction within the ambit of the federal securities laws. Fredriksen v. Poloway, 637 F.2d 1147, 1150-51, and cases cited therein, (7th Cir. 1981). Rather, the pertinent inquiry is whether the wrongful conduct alleged to have accompanied the transaction is the sort of conduct which Congress intended to address when drafting the securities laws. Id. Simply stated, the securities laws were intended to address investment, as opposed to commercial transactions. Id. at 1149-1150, and cases cited therein. Whether a transaction is primarily commercial or investment in character is determined by examining the "economic reality" of the transaction. United Housing Foundation, Inc. v. Forman, 421 U.S. 837, 849, 95 S.Ct. 2051, 2059, 44 L.Ed.2d 621 (1975). In order for a transaction in "economic reality" to be primarily for investment purposes the Forman Court required the following three elements: (1) an investment in a common venture; (2) premised on a reasonable expectation of profits; and (3) to be derived from the entrepreneurial or managerial efforts of others. Id. at 852, 95 S.Ct. at 2060.

In Fredriksen, the Seventh Circuit held that a securities transaction which is intended to transfer ownership and management control of a corporate entity does not involve the transfer of a "security" within the meaning of the federal securities laws because such a transaction fails the first and third of the above recited elements, at least insofar as the purchaser is concerned. That holding is dispositive of Oakhill's federal securities claims based upon Callahan's March 1977 purchase of 500 Oakhill shares from the Brenemans. Those shares comprised one-half of Oakhill's then outstanding shares. Further, one of the conditions of their transfer was that Callahan would resume control and management of Oakhill. Complaint, Count XI, ¶ 3. The injured party in Fredriksen was the party that assumed control of the corporation involved therein, while in the instant case the injured party is alleged to be the corporation itself. However, the Court does not find that distinction to remove the instant case from the reach of Fredriksen's holding. Indeed, to do so would require a determination that the same transaction could be deemed as involving a security as to some of the parties thereto, but not as to others. The Court declines to find that Fredriksen was intended to spawn such anomalous results. Accordingly, the Court finds that Callahan's March 1977 purchase of Oakhill stock did not involve "securities" within the meaning of the federal securities laws and that any injury caused Oakhill as result of that transaction was the product of mere corporate mismanagement rather than any violation of the federal security laws.*fn9 See Santa Fe Industries, Inc. v. Green, 430 U.S. at 479, 97 S.Ct. at 1304.

The Court also finds that Oakhill's October 1977 purchase of 500 of its own shares, while arguably involving the sale of securities within the meaning of the securities laws, is nonetheless not within the scope of the federal securities laws. First, it is abundantly clear that Oakhill has not alleged a violation of 15 U.S.C. § 78j(b) or 17 C.F.R. ยง 240.10b-5. Those remedial provisions are directed only at deceptive or manipulative conduct. Id. at 473, 97 S.Ct. at 1301. Manipulative conduct involves ...


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