MUTUAL SHARES CORPORATION v. Genesco, Inc.
266 F. Supp. 130, 1967 U.S. Dist. LEXIS 11035 (1967)
Rule of Law:
Section 10(b) of the Securities Exchange Act of 1934 is directed solely at misrepresentation or fraudulent practices associated with the sale or purchase of securities, not at general fraudulent mismanagement of corporate affairs or breaches of fiduciary duty, and requires the plaintiff to be an actual purchaser or seller of the securities in question.
Facts:
- Plaintiffs, citizens of New York, purchased a total of 16,608 shares of common stock of S. H. Kress & Co. (Kress) between November 15, 1963, and August 17, 1964.
- In October 1963, defendant Genesco, Inc., a Tennessee corporation controlled by defendant W. Maxey Jarman, acquired over 94% of the outstanding common stock of Kress, partly from the Kress Foundation and partly through a public tender offer.
- Plaintiffs alleged that Genesco and Jarman failed to disclose the true value of Kress’ real estate or their intention to finance the Kress acquisition through “paper sales” of a substantial portion of Kress’ real estate during the initial tender offer and subsequent purchases of Kress stock.
- Plaintiffs alleged that after acquiring control of Kress, Genesco and Jarman unfairly appropriated Kress assets, including $60,000,000 in real estate and $72,000,000 in cash, for Genesco’s exclusive enrichment without adequate consideration, disregarding the interests of Kress’ minority stockholders.
- Plaintiffs alleged that Genesco and Jarman manipulated the market price of Kress stock and kept dividends to a minimum to acquire shares of minority stockholders at less than their true value.
- Defendants disclosed the transactions involving Kress' real estate in a proxy solicitation in March 1964 and in the 1964 and 1965 annual reports to Kress stockholders.
- Defendant Jarman made a statement shortly after Genesco acquired control that Kress would continue under the same management and not be operated as a subsidiary of Genesco.
- Defendant Jarman made a statement at the 1964 Kress shareholders’ meeting that Genesco would satisfy its notes held by Kress in cash before the end of December 1964.
Procedural Posture:
- Plaintiffs filed a complaint in federal district court against defendants Genesco, Inc. and W. Maxey Jarman.
- Defendants moved pursuant to Rule 12(b) of the Federal Rules of Civil Procedure for an order dismissing the complaint for lack of jurisdiction, arguing it failed to state a Federal claim and lacked diversity of citizenship.
- Plaintiffs subsequently amended their complaint.
- Defendants' motion to dismiss was then treated as addressed to the amended complaint.
- Prior to the court's current decision, Judge McLean denied plaintiffs’ motion for a preliminary injunction.
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Issue:
Does a complaint alleging corporate mismanagement and breach of fiduciary duty by controlling shareholders, without direct misrepresentation in connection with the plaintiffs' purchase of securities, state a federal claim under Section 10(b) of the Securities Exchange Act of 1934?
Opinions:
Majority - Bonsal, District Judge
No, a complaint alleging corporate mismanagement and breach of fiduciary duty by controlling shareholders, without direct misrepresentation in connection with the plaintiffs' purchase of securities, does not state a federal claim under Section 10(b) of the Securities Exchange Act of 1934. The court affirmed that Section 10(b) is specifically aimed at misrepresentation or fraudulent practices directly associated with the sale or purchase of securities, rather than general corporate mismanagement or breaches of fiduciary duty, citing Birnbaum v. Newport Steel Corp. and O’Neill v. Maytag. Plaintiffs, as purchasers of Kress stock, could not claim a Section 10(b) violation based on alleged fraud committed against sellers in the tender offer, as they did not meet the 'purchaser or seller' requirement for the relevant transaction. Furthermore, any alleged fraud in the defendants' initial purchase of Kress stock would have arguably benefited the plaintiffs by allowing them to purchase shares at allegedly depressed prices. The court found that defendants' failure to characterize disclosed transactions, such as real estate sales, as unfair or constituting corporate waste did not create a Section 10(b) cause of action, as this would improperly transform a state law claim for unfairness into a federal claim. The court also dismissed claims regarding two alleged affirmative misrepresentations by Jarman because plaintiffs could not demonstrate reliance: the first statement about Kress management was contradicted by plaintiffs' own concessions about Jarman installing his nominees before their purchases, and the second statement about satisfying notes was made after plaintiffs had purchased substantially all their Kress shares. Finally, absent a federal question, the court lacked diversity jurisdiction because Kress, a New York corporation, was deemed an indispensable party to a derivative action for waste and, when properly aligned as a defendant, would destroy diversity with the New York plaintiffs. Claims under Sections 14(a) and 18(a) also failed due to lack of reliance or proper filing.
Analysis:
This case significantly reinforces the narrow interpretation of Section 10(b) of the Securities Exchange Act of 1934, firmly distinguishing claims of corporate mismanagement and breach of fiduciary duty—which fall under state corporate law—from claims of fraud directly connected to the purchase or sale of securities. It upholds the 'purchaser or seller' requirement, preventing individuals who were not directly involved in the fraudulent transaction as a buyer or seller from bringing a federal claim. The decision reiterates that federal securities laws are not a blanket remedy for all corporate wrongdoing, thus limiting federal jurisdiction and maintaining the traditional division between federal and state oversight of corporate governance.
