Goldberg v. Meridor

Court of Appeals for the Second Circuit
567 F.2d 209 (1977)

ELI5:

Rule of Law:

A cause of action under § 10(b) and Rule 10b-5 exists when a corporation is caused by its controlling shareholder to issue securities in a transaction for grossly inadequate consideration, and the transaction is accompanied by misleading disclosures or non-disclosures that deceive minority shareholders, thereby causing them to forgo an available state law remedy to prevent the transaction.

Facts:

In May 1972, Universal Gas & Oil Company, Inc. (UGO) issued a prospectus for a public offering, stating the proceeds would be used to finance the construction and purchase of three tankers.
In 1974, defendants caused UGO to sell contracts for two of the vessels for a profit.
Throughout 1974 and up to August 1975, defendants caused UGO to make loans to its parent company, Maritimecor, S.A., resulting in Maritimecor owing UGO $7 million.
In August 1975, defendants orchestrated a transaction where UGO agreed to acquire all of Maritimecor's assets in exchange for issuing up to 4.2 million new UGO shares to Maritimecor.
As part of the deal, UGO also assumed all of Maritimecor’s liabilities, which allegedly exceeded the value of its assets and included the forgiveness of the $7 million debt Maritimecor owed to UGO.
Press releases issued in August and December 1975 described the transaction in positive terms but failed to disclose Maritimecor's dire financial condition, including its $42.5 million in current liabilities.
Because Maritimecor was the controlling shareholder of UGO, the transaction did not require approval from UGO's minority shareholders.

Procedural Posture:

David Goldberg filed a shareholder derivative action in the U.S. District Court for the Southern District of New York, alleging violations of § 10(b), Rule 10b-5, and state law.
On a motion by defendant UGO, the district court ordered Goldberg to either post security for costs as required by state law or amend his complaint to remove all state law claims.
Goldberg chose to amend his complaint, proceeding solely on the federal securities law claims.
Defendants then moved to dismiss the amended complaint for failure to state a claim, arguing that no deception was alleged.
The district court granted the motion to dismiss and denied Goldberg leave to amend the complaint a second time.
Goldberg, the plaintiff-appellant, appealed the district court's dismissal to the United States Court of Appeals for the Second Circuit.

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Issue:

Does a parent corporation's act of causing its subsidiary to issue its own stock for grossly inadequate consideration constitute a deceptive practice in violation of § 10(b) and Rule 10b-5 when the subsidiary's minority shareholders are misled by non-disclosures, even if the subsidiary's board of directors was not deceived and state law did not require shareholder approval for the transaction?

Opinions:

Majority - Friendly, J.

Yes. A parent corporation engages in a deceptive practice violative of § 10(b) and Rule 10b-5 when it causes its subsidiary to issue stock for inadequate consideration and misleads minority shareholders about the transaction. The court reasoned that this case is distinguishable from Santa Fe Industries, Inc. v. Green, which held that a breach of fiduciary duty alone is not a federal securities violation. Here, unlike in Green, the complaint alleged deception, specifically the misleading press releases that concealed the unfairness of the transaction from the minority shareholders. This deception was material because, had the minority shareholders been properly informed, they could have sought an injunction in New York state court to block the transaction. The misleading disclosures lulled them into inaction, causing them to forgo this state law remedy. Thus, the conduct violated the 'philosophy of full disclosure' at the heart of the Securities Exchange Act, and a federal claim under Rule 10b-5 can proceed.

Concurring-in-part-and-dissenting-in-part - Meskill, J.

No. While agreeing that the plaintiff should have been allowed to amend the complaint, the complaint still fails to state a cause of action because the alleged deception was not 'material.' Materiality requires showing a substantial likelihood that a reasonable shareholder would have acted differently with full disclosure. Since the shareholders had no vote, their only recourse was a state-law injunction. The plaintiff failed to allege how they would have acted differently or that they could have successfully obtained an injunction, a requirement emphasized by the Supreme Court in Green. By allowing the claim to proceed on the theory that failure to disclose the breach of fiduciary duty is itself deception, the majority effectively undoes the holding of Green and improperly transforms a state-law claim for corporate mismanagement into a federal securities fraud case.

Analysis:

This decision established the 'Schoenbaum-plus' or 'Goldberg v. Meridor' doctrine, significantly clarifying the scope of Rule 10b-5 after the Supreme Court's restrictive ruling in Santa Fe v. Green. While Green eliminated claims based solely on corporate unfairness, Goldberg preserved a federal remedy by holding that when such unfairness is combined with a material misrepresentation or omission that deprives shareholders of a state-law remedy (like an injunction), a federal claim exists. This ruling prevents controlling shareholders from using their power to approve unfair transactions in secret, reaffirming that the core 'full disclosure' purpose of federal securities law protects shareholders even when they lack voting power. It effectively created a federal cause of action to protect state procedural rights in the context of securities transactions.

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