USCA1 Opinion

UNITED STATES COURT OF APPEALS

FOR THE FIRST CIRCUIT
____________________

No. 94-1405

ESTATE OF JAIME SOLER,

Plaintiffs, Appellants,

v.

JOAQUIN RODRIGUEZ, ET AL.,

Defendants, Appellees.

____________________

APPEAL FROM THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF PUERTO RICO

[Hon. Jose Antonio Fuste, U.S. District Judge]

___________________

____________________

Before

Boudin, Circuit Judge,

_____________

Campbell, Senior Circuit Judge,

____________________

and Boyle,1 Senior District Judge.

_____________________

____________________

Pedro A. Jimenez,
_________________

with

whom

Katarina Stipec Rubio

_______________________

and

Gonz lez Oliver, Correa Calzada, Collazo Salazar, Herrero &

_________________________________________________________________
Jim nez were on brief for appellants.
_______
Jorge E. P rez D az,
______________________

with

whom

Pietrantoni Mendez & Alvarez were on

_____________________________

Jorge I. Peirats
__________________

brief for appellee

and

Centro

Medico Del Turabo, Inc.

Eli B. Arroyo
_____________

for appellee Universidad de

San Juan Bautista, Inc.

____________________

August 15, 1995

Ciencias Medicas

____________________

____________________

1Of the District of Rhode Island, sitting by designation.

CAMPBELL,

shareholder's

Senior
Circuit
Judge.
________________________

derivative

suit brought

on behalf

In

this

of Centro

M dico del Turabo, Inc. ("CMT"), Plaintiffs-Appellants Ivette

Perez Vda. de Soler, Marie Ivette Soler Perez, Jaime A. Soler

Perez, and

Estate of

Antonio Soler

Dr. Jaime

Perez (as

Soler, or the

representatives of

"Soler Estate")

Jose A. Badillo appeal from the district

Order and Order on

the

and Dr.

court's Opinion and

Reconsideration dismissing their verified

complaint under Fed. R. Civ. P. 12(b)(6) for failure to state

a claim upon which relief may

ex rel. Soler
_____________

be granted.1

v. Rodriguez, 847 F. Supp.

_________

Estate of Soler
________________

236 (D.P.R. 1994).

____________________

1.

In

its Opinion and

the district court said

failure to state
the judgment that

Order and Order

it was dismissing the complaint

a claim under Rule 12(b)(6),

the complaint

subject matter jurisdiction.

and the

on Reconsideration,

existence of a

was dismissed

for

but stated in
for lack

of

Where both federal jurisdiction

federal claim turn upon

whether the

complaint states a federal question, the preferable

practice

is

to

assume

determine

that

whether

the

12(b)(6).

See
___

(where the

merits of

issue

jurisdiction
claim

Bell v.
____

passes

Hood, 327
____

the action

exists

and

muster

U.S. 678,
are

proceed
under

to
Rule

682-83 (1946)

intertwined with

the

of jurisdiction, the federal claim should be dismissed

for lack of subject matter

immaterial

and

made

jurisdiction or if

jurisdiction only if the claim is

solely for

the

purpose

of obtaining

the claim is clearly frivolous

or wholly

insubstantial); Arroyo-Torres v. Ponce Fed. Bank, F.B.S., 918

_____________
_______________________
F.2d

276, 280 (1st

that federal

Cir. 1990) (since

law implied a

plaintiff's assertion

private right of action

was not

frivolous, the district court had subject matter jurisdiction

to determine whether or
dismissal
of

not a claim existed; therefore,

the

entered by the district court, ostensibly for lack

jurisdiction,

should

have

been

premised

upon

Rule

12(b)(6)); see also 2A James W. Moore et al., Moore's Federal

________
_______________
Practice
________

12.07[2.-1] (2nd ed.

1993).

However, "we are not

bound by the label employed below," Carr v. Learner, 547 F.2d

____
_______
135, 137 (1st Cir. 1976), and will treat the dismissal as one
made pursuant to Rule 12(b)(6).

-22

The district court

"in connection with"

Section

10(b)2 and

held that appellants failed to

requirement of a cause

Rule 10b-5,3 but

plead the

of action under

rather alleged

only a

____________________

2.

Section 10(b) of the Securities Exchange

U.S.C.

Act of 1934, 15

78j(b), states:

It

shall

be

unlawful

for any

person,

directly or indirectly, by the use of any

means

or

instrumentality

commerce

or

facility

of

of

of interstate

the mails,

any

or

national

of

any

securities

exchange . . .
(b)

To use or employ, in connection with

the purchase
registered
exchange

or

sale

on

or

of

any

national

any

security
securities

security

not

so

registered, any manipulative or deceptive

device or contrivance in contravention of
such

rules

and

regulations

Commission may prescribe

as

the

as necessary or

appropriate in the public interest or for

the protection of investors.

3.

Rule 10b-5, 17 C.F.R.

It shall

be

240.10b-5 states:

unlawful

for

any

person,

directly or indirectly, by the use of any

means

or

commerce,
facility

instrumentality
or of
of

the

any

of interstate

mails

or

national

of

any

securities

exchange,
(a) To

employ

any

device,

scheme,

or

artifice to defraud,
(b) To
material

make any
fact

untrue
or

to

statement of
omit to

state

a
a

material fact necessary

in order to make

the statements made, in the light

of the

circumstances under which they were made,

not misleading, or
(c) To

engage in

course

of

any act,

business

would operate as

which

practice, or
operates

a fraud or deceit

or
upon

any person,
in connection

with the purchase

or sale

of any security.

-33

case

of breach of fiduciary duty and corporate mismanagement

under Puerto Rico law.

We reverse.

I.

The

FACTS.
_____

facts alleged

in

the complaint

extending

every reasonable inference in plaintiffs' favor, see Coyne v.

___ _____

City of Somerville, 972 F.2d 440, 443 (1st Cir.

__________________

as

follows.

corporation

the

eastern

CMT

is a

private,

organized in 1978

central region

of

1992)

for-profit Puerto

are

Rico

to offer medical

services in

Puerto Rico.

Through its

subsidiary, Turabo Medical Center Partnership,4 CMT

owns and

operates

Avanzada

the Hospital

Interamericano

de Medicina

("HIMA"), a hospital located in Caguas, Puerto Rico.

The

individual

plaintiffs

are

the

widow

and

children of Dr.

Jos

Badillo,

disputed

owned

sale

Jaime Soler, one of CMT's

the other

of securities

217,500 shares

constituted

founder

Dr. Soler

CMT.

Prior

below,

voting stock of

to

CMT, which

of common

then issued and outstanding.

passed away,

leaving

the

Dr. Badillo

total 1,293,942 shares

voting stock of the company

1990,

described

of common

16.81% of the

of

founders, and Dr.

his 435,000

In

shares,

which constituted 33.62% of CMT's common voting stock, to the

Soler Estate.

Appellants thus collectively owned

CMT's common voting stock.

____________________

4.

Not a party to this suit.

-4-

50.43% of

Appellee Joaqu n Rodr guez

Drs. Soler and Badillo to

manage CMT and eventually became a

minority shareholder as well as

directors.

was originally hired by

the chairman of its board of

The founders gave Rodr guez full

administrative,

financial, and operational control over all of the affairs of

CMT.

On November 14, 1991, Mrs. Soler replaced her deceased

husband

on

relevant

Juan

the

periods were

Chaves,

Cordero.

Rodr guez

treasurer.

The

other directors

appellant Dr.

Carlos M.

vice-president;

Pi eiro,

was CMT's

Chaves

its

during

Badillo and

and Dr.

Jos

president;

secretary;

appellees

J. Vargas-

Dr. Badillo

and

the

Pi eiro

its

its

Appellee Fernando E. Agrait was an attorney hired

by Rodr guez

Appellee

board.

Luis

Construction,

to handle

Garc a

the in-house

Passalacqua

Inc., which had

legal affairs

was

owner

a pending business

of CMT.

of

Miramar

deal with

CMT.

Appellees

respectively

Chaves

the owner and

Ciencias M dicas San

and

Vargas-Cordero

dean of appellee

were

also

Universidad de

Juan Bautista, Inc. ("UCMSJB"),

a non-

profit company operating an independent school of medicine at

HIMA.

UCMSJB.

Appellees

UCMSJB

Rodr guez and

operated its

rented from CMT for

sale, UCMSJB

Pi eiro

medical school

$1.00 per year.

also owned

-55

trustees of

from a

Prior to the

10,000 shares,

common voting stock.

were

space

disputed

or 0.77%, of

CMT's

In 1987, CMT's shareholders authorized the issuance

of 300,000 common

those

shares in a

voting shares of CMT and

public sale at $10

registration under the Blue Sky

distribution

was

the placement of

per share, subject to

laws of Puerto Rico, and for

solely to residents of Puerto

not

successful; very

few

of

the

Sometime

between 1991 and

the fall of

Rico.

shares

This sale

were

sold.

1993, Rodr guez told

Dr. Ramon Carlos, a physician with privileges at HIMA who had

approached him to

purchase shares

in CMT,

that the

public

sale had been closed and that CMT's shares were no longer for

sale.

During

shareholders

all

meetings

of

of

1992

and

until

CMT

were

not

October

held,

1993,

because,

according to

the

Rodr guez, the audited financial

company were

Badillo

[the

"plaintiff

experts should

felt

that

encumbered

not ready.

corporate

until

Mrs. Soler

directors"] decided

be hired to

no

In 1993,

done

should

and

be

the

and Dr.

that

analyze CMT's future

assets

this was

statements of

outside

plans, and

conveyed

board was

or

fully

informed.

Notwithstanding this

upon the sale of surface

to Miramar

of

CMT's board of

insisted

rights over HIMA's parking facility

Construction for

office building.

decision, Rodriguez

the development

Mrs. Soler opposed this sale

directors held on September

-6-

of a

doctor's

at a meeting

9, 1993.

At

this same meeting,

Rodriguez reiterated a prior

approval of a three-year lease

partly owned by CMT.

request for

to UCMSJB of land managed and

Mrs. Soler and

Dr. Badillo opposed the

lease because of the nominal yearly rent of $1.00, because no

independent evaluation of the best

use of that land had ever

been performed, and because no outside independent advice had

ever

having

been obtained

as to

the financial

benefit to

CMT of

UCMSJB's school of medicine, long unaccredited by the

nationwide

plaintiff

accrediting

directors also felt

CMT and UCMSJB,

Rodr guez,

body,

and

affiliated

that the

with

CMT.

transaction between

which was effectively controlled

Dr.

Vargas,

needed

The

to

be

by Chaves,

independently

analyzed for conflicts of interest.

Unbeknownst to

the

plaintiff

directors,

to

the

board of CMT, and to CMT as a corporate entity, Rodr guez and

Chaves had designed a scheme

historic majority ownership

of CMT for themselves.

to deprive plaintiffs of

in the company and

their

gain control

The scheme consisted of the issuance

by Rodr guez and Chaves, on September 16, 1993, without prior

knowledge or approval

of the board of

directors, of 200,000

shares of CMT

stock to UCMSJB at

for a total price of $2,000,000.

of $500,000, and agreed to

promissory

notes in

consecutively

per share,

UCMSJB made a down payment

pay CMT the balance through eight

the amount

on August 1

a price of $10

of

$100,000 each,

and February 1

-77

payable

through February,

1997, at

6% annual

interest, and a

amount of $700,000 on

These

between

Puerto

receive

notes

the

Department

by

an assignment

of Health

UCMSJB by

of

virtue

have been

of

the

a contract

Commonwealth of

of which

monthly payments of $249,864.08.

alleged to

in the

the same terms due on August 1, 1997.5

were secured

Rico and

promissory note

UCMSJB was

to

This collateral is

"fictitious" because

the contract

in

question was supposedly non-assignable under Puerto Rico law.

The purposes of the scheme were allegedly to,

a) secure control by Rodr guez and Chaves

and approval of the

lease with UCMSJB at

CMT's expense, b) to procure and

a substantial
at

block of shares

wholly inadequate

fictitious

collateral,

management and validate

and/or

situations

of

price
c)

to

finance
to UCMSJB
and with
entrench

sweetheart deals
conflicts

of

interest,

d)

to

dilute

and

eliminate

plaintiffs' majority ownership in CMT, e)

to

evict plaintiffs

from the

board, and f) to prevent the

of independent

corporate
appointment

outside directors

to the

company board at the annual shareholders'

meeting.

At

Rodr guez

the next board

again

insisted

meeting on September

that

the

three-year

approved at no

charge, ostensibly in order to

space occupied

by the medical

plaintiff

directors decided at

29, 1993,

lease

be

free up other

school in the hospital.

this point firmly

The

to oppose

____________________

5.

The verified complaint

be

made

on

yearly

contradicted by the
complaint.

basis

for

seven

years.

were to
This

is

Agrait letter, infra and included in the

_____

According to

described above.

states that the payments

the letter, payment

was to

be as

-88

the lease

until

mention was made

independent analysis

at this

could

meeting of the

be done.

sale of shares

No

to

UCMSJB.

In

early

noticed that certain

the

September 29th

October

1993, the

plaintiff

statements contained in the

meeting were

inaccurate

directors

minutes of

or misleading.

Specifically,

for

the minutes stated

approval of

the minutes

that Mrs. Soler

of the September

had moved

9th meeting,

which she had not done; reflected a motion made by Mrs. Soler

and

Dr.

Badillo

consideration

setting

of the

sale

forth

of

certain

surface

requirements

rights

to

for

Miramar

Construction, but omitted the principal requirement that such

sale

not be approved

that it

was in CMT's

Badillo had proposed

until it was

independently determined

best interest; and reflected

approval of the

that Dr.

lease to UCMSJB,

when

both he and Mrs. Soler had strongly opposed such lease.

The

to

deal

appoint

plaintiff directors decided

with the

increasing conflicts

that the only way

of interest

was to

to CMT's board reputable and experienced independent

outside directors at the

be held

that

on October 28, 1993,

and to do so in

to

such a manner

these outside directors would hold a determinative vote

in case of

the

upcoming shareholders' meeting,

an impasse.

Dr. Badillo

plaintiff shareholders'

also considered selling

majority block

as

a means

of

ending the tense situation, but the Soler Estate decided that

-99

until such time as outside directors were appointed, it would

not consider or

decide whether it wished to

sell its shares

in CMT.

The plaintiff

in a letter

directors formalized

their position

dated October 7, 1993, a copy of which was hand-

delivered to the directors of CMT at a board

that date.

The letter

meeting held on

stated their formal opposition,

both

as directors and as majority shareholders, to the approval of

the

lease

with

UCMSJB,

complained

of

the

absence

of

information concerning the transaction, and demanded that the

board not approve

the lease until such

received and analyzed.

nonetheless approved the

information had been

The board, controlled

lease.

Again, no

by Rodr guez,

mention was made

of the sale of shares to UCMSJB.

Following

commenced

search

financial ties

directors.

this

to CMT

for

Cordero,

to serve

were located and agreed to serve.

the

reelection

and themselves,

directors, and

to retain

operating officer of

Rodr guez

directors

individuals

who would agree

directors intended at the

for

qualified

plaintiff

with

no

as outside

Between October 10 and October 28, 1993, two such

individuals

vote

meeting, the

CMT.

of their plans

The plaintiff

upcoming shareholders' meeting

of

as

Rodr guez,

well as

Rodr guez as

It was their

on the night

the

to

Pi eiro,

Vargas-

two new

outside

president and

chief

intention to inform

of the shareholders'

-1010

meeting,

prior to

its

commencement.

However,

when

the

plaintiff directors arrived at the meeting with their counsel

and

the outside directors, Rodr guez informed them that they

no longer had

a majority position in the

company, by virtue

of the sale of shares to UCMSJB.6

Upon learning of this sale, the plaintiff directors

walked

out of

the

shareholders'

meeting.

The

meeting,

allegedly in the absence of a quorum, then removed Mrs. Soler

and Dr. Badillo as

Passalacqua.

directors, and replaced them

Rodr guez then

with Garc a

informed the newly constituted

board of the sale to UCMSJB, and the sale was ratified.

Prior to the

obtained

shareholders' meeting, Rodr guez

a letter from

October 11,

CMT's inside counsel,

1993 ("the Agrait

the proposed sale

Agrait, dated

letter"), to the

of stock to UCMSJB was

had

legal.

effect that

Plaintiffs

contend that this letter was deliberately intended to conceal

the

illegality of

directors.

the

sale

from

other

shareholders

and

The letter first recited the details of the sale,

as recounted above.

It then stated that the

sale was valid

under

the

1987

shareholders'

resolution

issuance of 300,000 common voting

concluded that since

authorizing

shares of CMT.

not all of the 300,000

the

The letter

shares had been

____________________

6.

Following the sale to UCMSJB, there were 1,493,942 shares

of

CMT common

voting stock

652,500

shares

represented

210,000

represented

14.06%,

outstanding.
43.68% of
with

the

The

the

total; UCMSJB's

remaining

shares, or 42.27%, held by other shareholders.

-1111

plaintiffs'

631,442

sold, and since

the sale to UCMSJB

single purchaser

for part of

was a private sale

the balance of

to a

the authorized

but unsold shares, the sale had been implicitly authorized by

the

shareholders in

registration

the

sale was

1987,

under the Blue

not

part of

and

no

public

disclosure

Sky laws were

an

offering

and

required because

to more

than

ten

purchasers.

The complaint

letter states that

1993, Agrait

also notes that although

the sale

wrote another

was effected

the Agrait

on September

letter on behalf

of CMT

16,

to the

Commissioner of Financial Institutions on September 27, 1993,

inquiring whether a

private sale of

securities to a

single

entity

was

subject

to

the

requirements of Puerto Rico Blue

latter stated that CMT was

disclosure

Sky laws.

and

registration

The September 27

"going to sell" 200,000 shares to

one of its shareholders.

The complaint

share

was an

adequate price in

financial straits and

and Chaves knew

support

of

also

alleges that

1987, when CMT

on the verge of

$10

per

was in dire

bankruptcy, Rodr guez

that it was no longer an adequate price.

this

Rodr guez had hired

allegation,

the

complaint

the services of Clark

and Merrill Lynch to conduct an appraisal in

the refinancing of

shortly.

while

CMT's debt, which

On the day of the

states

In

that

Melvin Securities

connection with

was expected to

close

shareholders' meeting, Rodr guez

-1212

and

Chaves were

appraisal,

voting

told by

that the

shares

upon

approximately $24

a Mr.

market

approval

million, or

Montilla, pursuant

value of

of

the

at least

all

to that

of CMT's

financing

$18 per

common

would

be

share (not

counting the 200,000 shares sold to UCMSJB).

Finally, the complaint states

that on November

3,

1993,

the plaintiffs sent

a formal

demand letter

to CMT's

management and "the illegally appointed directors,"

advising

them that

any actions taken

by the new board

28,

were

illegal

1993

invalid and

and

after October

demanding various

remedial actions including the convening of an

shareholders'

defendants

meeting.

responded

plaintiffs be

After various negotiated delays, the

that

under

reinstated to the

plaintiffs' shares at

extraordinary

no

circumstances

board, and

offered to

approximately $5 per share.

would

buy

They also

rejected plaintiffs' demand for an extraordinary shareholders

meeting,

notwithstanding

the

requirement

in

Article

IV,

Section 2 of the company by-laws that such meetings "shall be

called by

the president"

at the request

of the

holders of

more than 25% of the outstanding voting stock.

II.

THIS LAWSUIT.
____________

Plaintiffs' complaint alleged, on

behalf of CMT, a

violation of Section 10(b) of the Securities Exchange

1934, 15

U.S.C.

78j(b) and Rule

Exchange

Commission, 17 C.F.R.

-1313

Act of

10b-5 of

the Securities

240.10b-5.

The complaint

also

sought,

under

jurisdiction, see 28
___

the

U.S.C.

purchase agreement for

of

district

court's

supplemental

1367, rescission

of the stock

lack of corporate authority

proper consideration, annulment

board election,

and a new

The complaint was

requests

temporary

election under

filed on November

28, 1993

Puerto Rico

24, 1993, and

law.

included

for preliminary and permanent injunctions and for a

restraining

disbursement

corporate

of the October

and lack

of

assets,

order prohibiting

corporate

and

funds,

the holding

meetings during the next ten days.

any

sale or

of

extraordinary

encumbrance

board

of

of directors

The district court issued

the temporary restraining order on the same day the complaint

was filed and set a hearing on the preliminary injunction for

December 3, 1993.

1993, the

At a status conference held on December 2,

district court

preliminary and permanent

of February

7, 1994.

consolidated consideration

injunctions, and set a

of the

trial date

The temporary restraining order lapsed

by its own terms on December 3, 1993.

CMT then filed a motion requesting realignment as a

defendant, and

moved

to

judgment.

for dismissal

joint

Agrait

CMT's

or summary

motion

for

judgment.

dismissal

filed a motion for summary

remaining defendants filed a motion to dismiss.

court, in

an opinion

and order filed

or

UCMSJB

summary

judgment.

The

The district

on February

7, 1994,

decided the motions based on the pleadings only, treating all

-1414

motions as motions to dismiss under Fed. R. Civ. P. 12(b)(6).

Finding that the alleged securities

claim under

the

claim

fraud did not make out a

10(b) of the Securities Exchange

district court

for failure

dismissed

to

state a

the federal

claim under

Act of 1934,

securities fraud

Rule 12(b)(6).7

Because

the

federal jurisdiction was based solely on that claim,

court declined to retain jurisdiction over the remaining

state law claims, and dismissed them without prejudice.

The plaintiffs filed

on February 21,

in

1994.

written order

a motion for

The district court

dated

March

24,

reconsideration

denied the motion

1994.

This

appeal

followed.

III. THE DISTRICT COURT'S DECISION.

_____________________________

The

district

court

characterized

the

presenting the question

whether a corporation can be said to have

been deceived in connection with the sale
of its

securities within the

section 10(b) of
Act of

the Securities Exchange

1934, when the

secretary

meaning of

authorized

president and the

the

sale

of

case

as

allegedly

previously-issued

shareholder,
board

of

without

stock

approval

directors

or

of

the

to a
the
other

shareholders.

Estate of Soler,
_______________

847 F. Supp. at

238.

The court

said that

the "in connection with" element requires a showing "that the

wrongful

conduct caused

the

plaintiff

____________________

7.

See supra n.1.

___ _____

-1515

to

engage

in

the

disputed

sale

plaintiff's

deception and

(citing

injuries

to the

purchase

are

of

securities

directly

resulting

and

that

the

to

the

Id. at
___

239

attributable

transaction."

Wilson v. Ruffa & Hanover, P.C., 844 F.2d 81, 85 (2d

______
_____________________

Cir. 1988)).

inherent

or

If the alleged

fraud does not relate

nature, characteristics

or value

and, therefore, could not have influenced the

of

to "the

the security

plaintiff in a

decision to sell or purchase the security," id. at 240, there

___

is no causal link to the disputed sale.

The

court then said

that the alleged

omission in

this case was

the failure of the

defendants to reveal,

in

advance, the sale of the stock of CMT

to

UCMSJB.

Where

corporation

is

fraudulently induced into issuing its own

securities for less than their fair value
because of the misappropriation of inside
information

regarding

corporation

itself

shareholder

the

is

stock,

injured

derivative

appropriate.

Frankel v.
_______

and

action

is

Slotkin,
_______

984

F.2d 1328, 1334 (2d Cir. 1993).

the

the

However,

sale in this case did not take place

because

the

corporation

was uninformed

about the nature of the stock, or because

defendants

misappropriated

information

about

securities to
that the
from

the

be sold.

value

corporation

corporation
to

enter

of

We cannot

concealment of the

the

inside
the
find

sale itself
caused

into

the

the
sale.

Rather than "in connection with" the sale

of

security, the

deception

"of" the sale of a security.

here was

Id.
___

(footnote

incongruity

omitted).

The

district

court

noted

the

of suggesting "that disclosure of a sale without

-1616

full disclosure of some material

a violation of

all is

not

aspect of the sale would be

10b-5, while failing to disclose

violation."

Id. at
___

241.

the sale at

However, the

court

concluded, Rule

10b-5 is not

corporate mismanagement.

order to

ensure

correct decision as

sale."

instances of

"Rather, it was intended to promote

full and fair disclosure to

in

meant to address

that

those who buy or sell securities

investors are

able

to whether to carry out

to make

the purchase or

Id. (citing Santa Fe Indus., Inc. v. Green,

___
_____________________
_____

462, 477-78 (1977);

the

430 U.S.

O'Brien v. Continental Ill. Nat. Bank &

_______
_____________________________

Trust Co.,593 F.2d54, 60(7th Cir.1979)). The courtthen noted,

_________

While we

recognize that

the failure

reveal the sale at all necessarily

that information about
shares

was also

meant

the nature of the

concealed, because

company

did

not

selling

any

securities,

entity

cannot

be

as

to the

deceived

to

"know"

said

that
the
to

it

the
was

corporate
have

characteristics

been
or

value of the securities, or

to have made

any

decisions

knowledge

based

about

the

on

nature

lack

of

of

the

securities.

Id.
___

The

without

court

prejudice

then exercised

the

remaining

its

discretion to

supplemental

dismiss

state

law

claims.

On reconsideration, the district court first noted,

in response to the argument

subjective test of

had not

the

causality, that it had not

relied on the

omission was

that it had applied an incorrect

omitted information, but

not of the

type Rule

-1717

held that CMT

rather that

10b-5 was

meant to

remedy.

that

Id.
___

it had

The court then discussed

applied a

decision applicable to

entities,

not

to

test of

awareness of

an investment

transactions between individuals

transactions in

own

plaintiffs' argument

deceived

by

its

management.

Goldberg
________

v.

Meridor, 567
_______

F.2d

which

The

209 (2d

corporation is

court noted

Cir.

and

that

1977), cert.
_____

denied, 434 U.S. 1069 (1978) and its progeny recognize that
______

even though some controlling directors or

shareholders
they

can

utilize

have complete

conceal that
it

to

the

information,

information

detriment

of

and
the

corporation, thus deceiving the corporate

entity in

violation of

Rule 10b-5.

agree that in the case before us,

the facts

as alleged by

taking

plaintiffs, the

corporation

was

deceived

members

of

the

board

sale

of

conducted

We

when

of

directors

corporate

without informing the full

some

stock

board and the

remaining shareholders.

Id.
___

at 242.

Nevertheless,

that the deception

of securities

Id.
___

the court reiterated its holding

here was not in connection

as required

for liability

with the sale

under Rule

The court distinguished Goldberg, saying,

________

In

Goldberg,
________

the

minority shareholders

knew that the disputed transaction was to

take place,

but they were

forgoing

possible

deceived into

state

injunction

10b-5.

because

pertinent

transaction

facts

were

defendants.

not

about

the

revealed

by

Therefore, a decision by the

minority shareholders not to seek a state

injunction

was

completed

benefit of

complete information.

because the minority

without

the
Here,

shareholders had no

knowledge that the transaction was taking

place,

there

was

no

process of either type.

-1818

decision-making

Id. (citation and footnote omitted).

___

The court also addressed plaintiffs' argument

the

transaction

found

actionable

under

Rule

10b-5

that

in

Superintendent of Ins. v. Bankers Life & Casualty Co., 404

_______________________
_____________________________

U.S. 6 (1971), involved a deception unrelated to the inherent

nature, characteristics or

in effect conceded

value of the security.

that this was so, saying

The court

that in Bankers
_______

Life,
____

[t]he deception related to

the

transaction

the nature of

-- that

the

plaintiff

would be paying for its own securities -and

not

to

transactions.
create

securities

existence

We were not

a hard and

should be deemed

point to

the

of

intending to

fast rule as

to what

"in connection with"

transaction,

the

but

illustrative cases in

merely

a
to

order to

demonstrate why the

instant action falls

outside the purview of Rule 10b-5.

Estate of Soler,
________________

847 F.

Supp. at

242

(citation omitted).

Finally, the court compared this case with

557

F.2d 1022

(1977).

certain

result

1977), cert. denied, 434

_____________

In that case, a

secret scheme was

employees/shareholders,

of forcing

corporation.

holding

(3d Cir.

The

"that the

under Rule

struggle

connection

them to

which

sell

had

the

disputed transaction

control

of the

with the sale

occurred in

the

additional

back to

Third Circuit

was not

rather

Id.
___

the

as

actionable

connection with

corporation,

of securities."

U.S. 940

hatched to oust

their shares

court interpreted

10b-5 because it

for

Ketchum v. Green,
_______
_____

than in

at 243.

The

-1919

court

dispute

court.

concluded that the

over control

of

present case similarly

CMT, and

thus

belonged in

Id.
___

IV.

A.

involved a

The Standard of Appellate Review.8

state

For purposes of

Fed. R. Civ. P. 12(b)(6),

a court must

accept all well-pleaded facts as true and draw all reasonable

inferences

in favor

of the

non-movant.

Found. v. Massachusetts Bar Found., 993

______
_________________________

Cir. 1993) (citing

granted under

F.2d 962, 971

Coyne, 972 F.2d at 442-43).

_____

dismiss a complaint only if it is

be

Washington Legal
_________________

any

set

"A court may

clear that no relief could

of facts

consistent with the allegations."

(1st

that

could be

proved

Hishon v. King & Spalding,

______
_______________

____________________

8.

The district court ruled that plaintiffs

lacked standing

to maintain a private action in their individual behalves for

securities
purchase

fraud
or sell

transaction,

under

Rule 10b-5,

the securities

because

involved

they

in the

did not
disputed

citing Blue Chip Stamps v. Manor Drug Stores,

_________________
__________________

421 U.S. 723 (1975),

plaintiffs

have

district

court

standing

to

reh'g denied, 423 U.S. 884 (1975).

____________

not

appealed

held,

however,

bring a

derivative

from

this

that

decision.

the

The

plaintiffs

action on

behalf

The

had

of CMT.

Appellees challenge this ruling on the ground that an "action

that is
seeks to
not

not for the

benefit of the corporation,

enforce the rights

a derivative

verified

action."

complaint

of one or more
But as

adequately

but merely

shareholders is

we discuss,

alleges

infra, the
_____

injury

to

the

corporation, stating that certain of its board members caused

it

to

sell

transaction
without

its
to

other,

disclosure to

behalf of the
actual

own

value,

collateral.

stock,

without

disclosure

disinterested board
all those

charged by

corporation, at a price far

with partial

payment

That the plaintiffs

of

the

members,

hence

law to

act on

below the stock's

secured

by fictitious

may also have been injured

in a personal capacity is irrelevant to the question of their

standing to bring a derivative suit for the corporation.

-2020

467 U.S. 69, 73 (1984) (citing Conley v. Gibson, 355 U.S. 41,
______
______

45-46

(1957)).

legal grounds

An appellate

relied upon

by

court is

not limited

the district

to the

court, but

affirm on any independently sufficient grounds.

may

Willhauck v.
_________

Halpin, 953 F.2d 689, 704 (1st Cir. 1991).

______

B.

Fraud Upon a Corporation by its Directors.

"To

prevail under

Rule 10b-5,

'a plaintiff

must

prove, in connection with the purchase or sale of a security,

that

the

defendant, with

scienter, falsely

represented or

__

omitted to disclose a material fact upon which the plaintiff

____________________

justifiably

relied.'"

Willco Kuwait (Trading) S.A.K.

________________________________

deSavary, 843 F.2d 618, 623 (1st Cir. 1988) (quoting

________

v.

Kennedy
_______

v. Josephthal & Co., Inc., 814 F.2d 798, 804 (1st Cir. 1987))
______________________

(emphasis

supplied).

"The Act protects corporations as well

as individuals who are sellers of a security."

404

U.S. at 10.

We hold

that the district

ruling that the verified complaint

CMT under

Bankers Life,
____________

court erred in

did not state a claim for

10(b) and Rule 10b-5.

Briefly

recounted,

the

scheme described

in

the

complaint was allegedly hatched by CMT's president and by its

secretary, both of whom were

also its directors.

The scheme

was to cause CMT to issue and

authorized

common voting

sell 200,000 shares of earlier

stock9

to

UCMSJB

medical

____________________

9.

The

issuance of

300,000 shares

of new

stock

had been

authorized by the shareholders in 1987, six years earlier, at

a

price of

$10 a

share, when

-2121

CMT was

allegedly close

to

school of which

CMT's

CMT's president was a trustee,

secretary was

share.

The

accomplished

the owner

issuance

without

plaintiff directors,

corporate

entity

largely in

notes

and

the

of

CMT's

affiliated

sale

of

knowledge

of the board

itself.

secured by

between the Department of

Two

for

other

and of which

the price

stock

or

of

was

allegedly

approval

of

of directors, and

UCMSJB

paid CMT

an

assignment of

for

were at

the

the

of the

the stock

contract

Health of Puerto Rico and

directors

$10 a

time

UCMSJB.

closely

with UCMSJB, while the two plaintiff directors

who between them controlled a bare majority of CMT's stock

were

As

unhappy with CMT's developing relationship with UCMSJB.

result

of

the

deliberately

concealed

sale,

the

proportion of CMT stock controlled by the plaintiff directors

fell

below 50%, leaving UCMSJB

in practical control

objective

of CMT.

of selling

the

and those associated with it

The complaint

200,000 shares

alleged that an

of

CMT stock

to

UCMSJB was to enable the latter to obtain a substantial block

of CMT shares at a wholly inadequate price and to finance the

stock

purchase with fictitious collateral.

complaint, the

sold

appraised market

to UCMSJB in

1993 was $18,

value of

According to the

CMT's stock

not $10, a

when

share; and the

government contract constituting collateral for the notes was

____________________

bankruptcy.

Efforts to

sell the shares

at that

time were

unavailing and, it might be inferred, were abandoned.

-2222

non-assignable,

rendering the

collateral

fictitious.

The

complaint further alleged that, although the stock was issued

to UCMSJB on September 16,

fact at the two board

one

1993, no mention was made of

of director meetings held in September

held before and one after

the October shareholders' meeting,

in

control

revealed

the

the 16th.

defendants

the stock transaction

By

the time of

now

firmly

for the first

time

to

the

shareholders.

It

plaintiff

directors

and

former

majority

Plaintiffs were then ousted as directors.

is by now

has a claim under

well established that

a corporation

10(b) if the corporation was defrauded in

respect to the sale of its own securities by some or even all

of its directors.

See, e.g., Goldberg, 567 F.2d at 215.

_________ ________

In

Ruckle v. Roto Am. Corp., 339 F.2d 24 (2d Cir. 1964), a case
______
_______________

factually

close to the

present, a director

more than half the stock entitled

meeting

of the defendant

derivative

constituted

alleged

who represented

to vote at the 1964 annual

corporation successfully brought a

action against his six fellow directors, who also

the

that the

corporation's

officers had

officers.

sought

The

complaint

to perpetuate

their

control by, among

other ways, having

issuance

75,000

resold

of some

to

the president

the board approve

treasury shares

or

voted

as

that

were to

he directed.

the

be

The

plaintiff alleged that the defendants had withheld the latest

financial statements from the board, had arbitrarily ascribed

-2323

$3

value

to

the

shares,

and

had

approved

several

transactions involving the stock without disclosing pertinent

facts

to

the

entire

board.

Id.
___

at 26.

Reversing

dismissal, the Second Circuit held that it was possible under

Rule 10b-5 for a corporation to be defrauded by a majority of

its directors "or

even the entire board."

Id. at 29.
___

court went on to say,

If, in this case, the board defrauded the

corporation into issuing shares either to
its members or others, we can think of no
reason

to say

that

redress under

Rule

10B-5 [sic] is precluded, though it would

have

been

committed
more

available
the fraud.

effective

policies
than to

had

way

of the
deny

anyone

There can

be no

emasculate

the

federal securities

law

relief

to

else

solely

because

The

fraud was committed

by a director rather

than

an outsider.

Denial of

this

basis

would

congressional
the

public

surely

undercut

determination
distribution

relief on

to
of

the

prevent
worthless

securities.

Id.
___

While Ruckle predated

______

in Santa Fe,
________

Ruckle's
______

Maytag,
______

nothing in Santa Fe and

________

relevant holding.

1334 (citing

339

Firstbrook,
__________

the Supreme Court's decision

Ruckle
______

F.2d

405

See, e.g., Frankel, 984 F.2d at

__________ _______

with approval);

764

(2d

F.2d 215

denied sub nom. Manley

________________ ______

its progeny invalidate

Cir.

(2d Cir.

see also O'Neill

_________ _______

1964);

Schoenbaum
__________

1968) (en

v. Schoenbaum, 395
__________

v.

v.

banc), cert.
_____

U.S. 906 (1969);

Santa Fe,
________

430 U.S. at

462; Goldberg,
________

567 F.2d at

209; see
___

-2424

also
____

7 Louis

Loss &

Joel

Seligman, Securities Regulation

______________________

3530-41 (3rd ed. 1991) (discussing this line of cases).

As

in Bankers Life, it is
_____________

here alleged

that the

corporation

"injured

on behalf

as an

deprived it of

valuable

of which

investor through

suit has

been brought

deceptive device

[adequate] compensation for

block

of

securities."

deceptive device

was that

other

deliberately

parties

at

interested directors

omitted

which

the sale of

404 U.S.

to

was

its

10.

The

of CMT

and

inform

CMT's

disinterested directors and shareholders, at a time when they

might

still have

acted

to protect

CMT,

of an

impending,

allegedly deleterious, sale of stock to UCMSJB.

CMT

upon" this

omission to its

its managers

issued and

sold its stock

detriment, in that

at an allegedly

and without

adequate security, CMT having

deprived of

the judgment of

"relied

inadequate price

been fraudulently

its full board of

directors on

the

matter and,

directors

personally

in

particular, of

and stockholders

who

connected with UCMSJB.

the

judgment of

were disinterested

Such facts

those

and not

plainly make

out a claim of defendants' knowing deception of and injury to

CMT in connection with the sale of its stock.

The district

before us,

court recognized

taking the facts

corporation was deceived

directors

conducted

as alleged

that, "in

by plaintiffs,

when some members

sale

of

-2525

the case

corporate

of the board

stock

the

of

without

informing

the full

Estate of Soler,
_________________

board and

847 F.

acknowledged that a

the directors

the remaining

Supp.

at

been told

of the proposed

as to related material facts.

however,

that no violation

concealment

We

sale of

court even

stock but

The court believed,

occurred here, because

concealed, resulting,

making process at all.

calculated

The

10(b) violation would have occurred had

deceived

itself was

242.

shareholders."

it said,

in no

the sale

decision-

do not see the distinction.

of the

sale itself,

The

thus depriving

CMT's disinterested

steps to

directors

prevent it before

provide

essential

regarding

of the

it occurred, was an

material

the stock sale.

information

as true, it is a

concealment

the

directors

the

proposed

was essential to

plaintiff

outstanding

directors

to

to

take

omission to

the

company

Indeed, accepting the allegations

of the complaint

of

opportunity

reasonable inference that

sale

from

CMT's

the success of

controlled

shares and would

board

of

the fraud, since

majority

doubtless have acted

of

CMT's

to block

the sale had they known.

We see

between this case

fraud

or

Delaware's

no merit

and Santa Fe.

________

concealment,

"short

in the

district court's

In Santa Fe, acting without

________

controlling

form merger"

analogy

statute

company

to

utilized

force minority

stockholders in a subsidiary to

latter

sued under

sell back their shares.

10(b) asserting

a breach

The

of fiduciary

-2626

duty.

Noting the

absence of a

device," the Supreme Court

"manipulative or

held that

deceptive

10(b) is not meant to

remedy

corporate mismanagement, but

rather to

promote full

disclosure to those who buy or sell securities.

The Court in

Santa Fe
________

nowhere suggested

involving the

directors

selling

deliberate stock

calculated omission

to tell

its

that a

other

treasury

by personally

directors

stock at

that

below

the

interested

company

market

without adequate security, was beyond the reach of

The allegations

full disclosure to

go

beyond

here are

precisely of

CMT, the seller of the

mismanagement to

the

was

price and

10(b).

a lack

securities.

calculated and

concealment, by interested directors,

fraud,

of

They

deliberate

of information that

substantial block of the company's stock was being sold at an

improperly

interested

low

price

directors

to

were

another

linked.

company

with

whom

The

sale

of

the

CMT's

securities,

and the

price

and

terms

of

the

sale,

were

deliberately withheld to prevent the disinterested members of

CMT's

board

of

directors, who

were

also

its controlling

shareholders, from taking action prior to the completed sale.

Hence those

sharing in

the legal

responsibility to

manage

CMT's affairs were kept in the dark until the time had passed

when

they

interests.

might

still

As there

have

acted

was no "full

to

and fair

safeguard

CMT's

disclosure" to

those legally empowered to act for the corporation, there was

-2727

no

full and

fair

disclosure

situation in Santa Fe, the

________

corporate

mismanagement

complaint is

fiduciary."

to CMT

Unlike

the

facts alleged go well beyond mere

"in

which

that shareholders

the

were treated

essence

of

unfairly by

the

430 U.S. at 477.

Appellees

contend

that

alleges no more than violations

of fiduciary

itself.

duty, and that

the "exception" to

the

verified

complaint

of state law, such as breach

therefore this case

falls into

10(b) liability created by Bankers Life.

____________

We

do not

agree.

available

to the

That

plaintiff does

action will not lie

read

flexibly,

state causes

under

not

of

not mean

10(b).

action are

that a

also

right of

"Section 10(b) must

technically and

restrictively.

be

Since

there was a 'sale' of a security and since fraud was used 'in

connection with' it, there is redress under

might be

Life,
____

available as

404 U.S.

"[C]ongress by

which

constitute

of

12.

The

10(b) did not

mismanagement,"

breach

at

a remedy under

fiduciary

duty,

state law."

statement in

Bankers
_______

that case

that

seek to regulate transactions

no
more
than
_________________

id. (emphasis
___

10(b), whatever

added),

internal

means

"without

any

corporate

only

that

deception,

misrepresentation, or

476,

does not violate

deceive

key

nondisclosure," Santa Fe, 430

________

10(b).

other board members

information pertinent to

U.S. at

Where corporate fiduciaries

and stockholders by withholding

the corporation's sale

-2828

of its

own

securities, the corporation

may have redress

through

10(b).

In dismissing the corporation's

district

court

also

held

that

the

10(b)

claim, the

defendants'

alleged

deception here was not sufficiently linked causally to a sale

of

securities.

The

misrepresentations

inherent nature,

or

court

cited

omissions

to

"did

cases

not

characteristics or value of

where

relate

to

the

the

the security."

See, e.g., Chemical Bank v. Arthur Anderson & Co., 726 F.2d
_________ ______________
______________________

930

(2d Cir.),

cert. denied,
____________

these, the court reasoned that

directors and

of CMT's

469

U.S. 884

(1984).

simply omitting to tell CMT's

majority shareholders of the fact

authorized stock

From

was different

of the sale

from feeding

them

false information

reasoning,

about the

the court

sought to

Bankers Life, 404 U.S. at 6,

____________

20, and

Frankel v.
_______

The short

this

case did

Supp. at

appraisal of the

$10, a share.

and had it

In so

cases such

as

Goldberg, 567 F.2d at 209, 219________

1328 (2d

think, is that

these cases

Cir. 1993).

cannot be

The district court asserts that "the sale in

not take

place because

uninformed about the nature of

847 F.

distinguish

sale.

Slotkin, 984 F.2d

_______

answer, we

distinguished.

specifics of the

240.

the corporation

the stock."

Yet the

Had the board of

been told of other

Estate of Soler,
_______________

complaint alleges

stock indicated that it was

was

that an

worth $18, not

directors been so

advised,

aspects of the sale

(such as

-2929

the alleged fictitious security), it might not have agreed to

the sale, and, in any

case, the minority directors (who were

majority shareholders) might have been able to take action to

block the sale.

Nor do

Ketchum v.
_______

we agree that

Green, 557 F.2d

_____

this case

1022 (3d

is controlled

Cir. 1977).

In

by

that

case, the Third Circuit wrote:

Upon review

of the stipulation

and the record

of facts

of the proceedings before

the district court, it becomes clear that

the

case at

than

involved little

allegations

internal
the

hand

pertaining

corporate

complaint

importance

of

plaintiffs'

to

conflict.

seemingly
the

more
an

Although

stresses

the

relinquishment

of

shares

under

the

stock

retirement plan, the

factual stipulation

and

of the

other

segments

largely

silent

example,

it is

on
only

paragraphs of the
is

any mention

securities.

this

record
point.

in the

are
For

concluding

stipulation that there

of

the

forced sale

of

It thus is manifest that the

essence of the plaintiffs' claim concerns

their dismissal as officers of Babb, Inc.

557 F.2d at 1027 (footnote omitted).

The

alleged

fraud

in

Ketchum
_______

was

defendants'

failure to reveal

of

the

their intentions to oppose

plaintiffs

plaintiffs

as

officers.

as corporate

employees

While

the reelection

termination

would trigger

of

by-law

forcing them to sell their stock, the Third Circuit concluded

that

10(b)

sought

was directed

officers, not

did not

apply as

against

to the sale

the

essence of

termination

of securities.

-3030

the relief

of plaintiffs

In

as

contrast with

Ketchum, the
_______

detailed

from

stock sale

to UCMSJB is

in the complaint here.

which to

connection

hold

with"

that

We

central to

see no basis in Ketchum

_______

the present

the sale

of

the fraud

scheme

was not

security, as

Rule

"in

10b-5

requires.

We

including

under

merit.

have

considered

those related

Fed. R.

Civ. P.

appellees'

to the

9(b), and

We hold that the complaint

light most

action under

say is meant

favorable to

10(b)

adequacy

other

arguments,

of the

complaint

find them

to be

without

in this case, viewed in a

the plaintiffs, states

and Rule 10b-5.

Of course,

to relieve appellants of their

a cause

of

nothing we

burden of proof

as to

the matters alleged

in the complaint, nor

to suggest

that we accept those matters as necessarily being complete or

true.10

____________________

10.

Appellees Agrait, Pi eiro, and Vargas-Cordero argue that

the

verified

complaint

alleges only

abetted the sale of stock to UCMSJB.

v.

First Interstate Bank,

______________________

during the

pendency

of

they

Ct. 1439

(1994) (issued

appeal), which

held

private plaintiff could

not maintain an aiding

suit under

Rule 10b-5.

that it was

10(b) and

under no duty

purchase of CMT's
445

U.S.

222,

described as a catchall
be

fraud.

nondisclosure,

When

to inform

an

there

(1980)

that

UCMSJB argues

the appellants of

("Section

its

United States,
_____________
10(b)

is

aptly

provision, but what it catches

allegation of
can

be

no

fraud

and abetting

Appellee

stock, citing Chiarella v.

_________
234-35

aided and

They cite Central Bank

____________

114 S.

this

that

is

fraud absent

based
a

duty

must
upon
to

speak."), and Taylor v. First Union Corp., 857 F.2d 240 (4th
______
__________________

Cir.

1988).

judgment

Because we

dismissing

issues are

now

reverse the

district court's

appellants' complaint,

best left in

we

the first instance to

think these
the district

court.

-3131

C.

Conclusion.

We reverse the district court's judgment dismissing

the complaint in this case for failure to

which

relief

may

be

granted,

and

state a claim upon

remand

for

further

proceedings consistent with this opinion.

Reversed and remanded.

_____________________

-3232