STEIN, Vice Chancellor
Syllabus by the Court.
Misrepresentation by word, conduct, or in any manner with respect to subsidiaries and plants in operation and past earnings record of a corporation in connection with the sale or offer for sale of its stock is prohibited by the New Jersey Securities Act, as amended by P. L. 1931, p. 566 (Comp. St. Supp. § *186—10a(l) et seq.), and will be enjoined.
Suit by William A. Stevens, Attorney General, against the Rayon Industries Corporation and others.
Decree in accordance with opinion.
Richard C. Plumer, of Newark, for complainant.
Merritt Lane, of Newark, for defendants Rayon Industries Corporation and others.
Murphy, Makepeace & Paley, of New York City, for Samuel Vance and First Continental Corporation.
Mack, McCauley & Spiegelberg, of New York City, for Marshall Ward and Henry J. Patten.
John Milton, of Jersey City, for National Inv. Transcript, Inc., Clement H. Congdon. and Edward Manchell.
STEIN, Vice Chancellor.
The bill of complaint is filed under the New Jersey Securities Act, as amended by P. L. 1931, p. 566 (Comp. St. Supp. § *186—10a(l) et seq.). Rayon Industries Corporation is a Delaware corporation organized May 20, 1933, with a capitalization of 1,000,000 shares of class A stock, par value $1, and 500,000 shares of class B stock, par value $1.
At the first meeting of the board of directors on May 29, 1933, Simon Levin, one of its members, and the president of the corporation, made an offer, dated May 24, 1933, which was accepted, to sell the corporation 48 1/2 per cent. of the stock of Norfolk Weavers, Inc., a Virginia corporation, together with all of the stock of College Weavers, Inc., and College Throwsters, Inc. (Massachusetts corporations), Beldray Industries Corporation, and Beldray Throwsters, Inc. (Michigan corporations), and S. Levin & Co., a New York corporation. By the terms of the offer, Simon Levin was to receive 500,000 shares each of the class A and B stock, $150,000 in cash, and a three-year employment contract as general manager at $25,000 per year, with an option of renewal for two years. Later a change was made whereby Levin gave back the 500,000 shares of class A stock, and, in lieu of the $150,000 in cash agreed to be paid to him, accepted 75,000 shares of class A treasury stock.
In 1931, while industry generally was in the throes of a business depression, an idle plant at Norfolk, Va., was brought to the attention of Levin, and he negotiated for the purchase of the plant, formed Norfolk Weavers, Inc., and interested local capital in the enterprise. Shortly, the plant under his management employed upwards of 300 employees, and was operating day and night. Between the time of the organization of the plant and its subsequent sale to the Rayon Industries Corporation, the Norfolk Weavers, Inc., paid in dividends to the Norfolk interests upwards of $100,000, or at the rate of 400 per cent. on an investment of $25,000. He next acquired a plant (College Weavers, Inc.) in the early part of 1931, located at Northampton, Mass. Later, in connection with the operation of the Northampton plant, he leased a throwing plant at Haydenville, Mass., and another at Florence, Mass. (both of which last two plants are being leased by College Throwsters, Inc.), College Weavers, Inc., was organized March 11, 1932, and College Throwsters, Inc., in August, 1932, both in Massachusetts. Both plants soon operated at full capacity day and night, the one employing approximately 550 people, and the other about 80 people. S. Levin & Co., while not incorporated until June, 1933, had been an operating organization for years, buying and selling profitably on a commission, and had between 75 and 100 contracts for the production and sale of rayon. Levin testified the demand was so great that he could not meet it.
Also at the first meeting of the board of directors the defendants Vance and his corporation, the First Continental Corporation, offered to sell to the Rayon Industries Corporation Belding-Hemingway mills Nos. 1, 2, and 3, at Belding, Mich., and Haydenville mill No. 13, at Haydenville, Mass., and the Norfolk real estate; the first plant subject to a lease held by Simon Levin, dated January 18, 1933; the second subject to a lease held by Levin dated January 18, 1932; and the third subject to a lease held by College Throwsters, Inc. In addition to the real estate and machinery, the offer included the remaining 51 1/2 per cent. of the stock of Norfolk Weavers, Inc. The real estate was subject to mortgages aggregating $155,000. In exchange for the real estate and stock, the offer contemplated the issuance to the First Continental Corporation of 500,000 shares of Rayon Industries Corporation class A stock, par value $1 a share, and it was accepted. The actual cash investment of the First Continental Corporation in the properties and stock was $83,750. The properties thus conveyed were appraised at depreciated values at $676, 180. This valuation does not take into consideration the value of the 51 1/2 per cent. of the stock of Norfolk Weavers, Inc., which represented control of that company, and upon which, as hereinbefore stated, there had been paid in dividends over a short period of time upwards of $100,000, or a return of 400 per cent. on an original investment of $25,000.
Complainant contends that Levin's investment in the properties of the various corporations whose stock was the subject-matter of the sale to the Rayon Industries Corporation was not more than $131,000, and that the difference between that amount and the $575,000 of the par value of the stock of Rayon Industries Corporation which he received constitutes a secret undisclosed profit obtained by a promoter at the expense of the corporation, and charges that the other members of the board of directors, Donovan, Hecht, and Wilson, were merely "dummies." The uncontradicted proof, however, by Levin and two of the other directors is that Levin made full and complete disclosure of all of the facts and details of the transaction, and the charge is not sustained. The properties transferred by Levin to the corporation were appraised by Ford, Bacon & Davis, appraisal engineers of high repute, as of the date of the sale at a reproduction cost of $2, 194,720, and after depreciation at $1,562,430. Under our decisions, a promoter may purchase property on his own account for any price he can, with the intention of selling if at a higher price to a company formed or to be formed and sell to that company at a profit, so long as he does so fairly. (Italics mine.) Plaquemines Tropical Fruit Company v. Buck, 52 N. J. Eq. 219, 27 A. 1094. Under such circumstances, no rule of law or equity prohibits such profits. Bigelow v. Old Dominion Copper Mining & Smelting Co., 74 N. J. Eq., 496, 71 A. 153; Allenhurst Park Estates v. Smith, 101 N. J. Eq. 581, 138 A. 709. In 1 Thompson on Corporations (3d Ed.) vol. 1, § 123, at page 152, the author says: "And where promoters formed a syndicate for acquiring and working a gold mine for their own profit; and some time thereafter, for the purpose of acquiring additional capital, they organized a corporation and sold their mine to it, it was held that they were not placed in any fiduciary relation at the time of the original agreement to the corporation which they subsequently promoted. Where no fiduciary relation exists the mere suppression by a promoter of the amount of profit being made by him on a sale does not amount to a fraud. Where a person purchased and paid for land, and thereafter organized a corporation, to which ho offered to sell such land, it was held that he did not thereby stand in any fiduciary relation to the subscribers to the capital stock." English and American cases are cited in support of the statement
Levin had been actively engaged in the manufacture of rayon and kindred lines long before the acquisition of some of the properties in question. For nineteen years past he was variously engaged either as salesman, broker, or importer of textiles, and finally owner and operator of textile plants. In a true promoter's case, where there is an allegation of a secret profit, and where the property was purchased with the intent of forming a corporation and turning the property over to it, it has been held that such profit could not be retained unless the same was disclosed either to an independent board of directors or to the stockholders, or unless the promoters themselves take all of the stock. In such case responsibility is not based upon fraud, but upon the rule of fiduciary relationship. 1 Thompson on Corporations (3d Ed.) § 120, p. 149, if the property turned over is of the value that the corporation paid for it there may still be responsibility, but there is no fraud.
The complainant charges that the directors of the Rayon Industries Corporation were "dummies." The proof is that one of them is a graduate of Lowell Textile School of Massachusetts; was connected for 4 1/2 years with a prominent commission house engaged in the textile and cotton business; identiliedfor 7 1/2 years with the largest manufacture of textiles, in charge of their rayon division, and connected with S. Levin & Co. for the past four years; another director was engaged in the textile industry in various capacities for about 18 years, and associated with S. Levin & Co. for about 8 years; and the third director was for a number of years one of the members of the board of directors of the largest silk manufacturing concern in the world, and afterwards became superintendent of a silk plant in Norfolk, and was instrumental in organizing Norfolk Weavers, Inc., and represents the Norfolk group on the board of directors of the Rayon Industries Corporation who at this time have an interest in the class B stock. The directors, other than Levin, own no stock in the corporation, and indeed are not required to be stockholders under the law of the state of Delaware. The proof, it seems to me, refutes the charge that these men were "dummies," and under the thumb of Levin.
At the same directors' meeting the First Continental Corporation agreed to underwrite 425,000 shares of the class A treasury stock, par value $1, at $2 a share. The agreement for the purchase of the real estate and stock of the Norfolk Weavers, Inc., from the First Continental Corporation provided that 200,000 of the 500,000 shares of the class A treasury stock of Rayon Industries Corporation should be issued to First Continental Corporation on delivery of the 51 1/2 per cent. of the stock of Norfolk Weavers, Inc.; the deed covering the real estate at Norfolk and the balance of the stock to be issued upon delivery of title to the Belding and Haydenville properties. The deed to the Norfolk property was not delivered until June 27, 1933. Before that date, it is claimed that 118,696 shares of the treasury stock were issued to First Continental Corporation on the order of the Rayon Industries Corporation. The complainant insists that this was a violation of the agreement, and that it was necessary, in order to enable the First Continental Corporation to raise the moneys, to enable it to take the title to the real estate which it then was under contract to purchase. The First Continental-Rayon contract provided that title was to be delivered not later than September 18, 1933, but it also contained a provision that the purchaser had the right to require performance sooner than September, 1933, as follows: "The seller agrees that the date of closing may be advanced by the purchaser to any time prior to September 15, 1933." The proof is that the Rayon Industries Corporation elected to take advantage of this clause of the contract because of its desire to secure the title to the real estate as soon as possible, but that, upon investigation, its attorneys found that the title was subject to certain minor legal objections. Conferences were had between the president of the Rayon Industries Corporation and Vance, the president of the First Continental Corporation, and their attorneys, with respect to the situation; the Rayon corporation being desirous of securing the title to the real estate before converting the machinery and equipment in the buildings. Levin and Vance both testify that Vance offered to advance the moneys necessary to close the transactions, and deny that any of the stock of the Rayon Industries Corporation was issued to the First Continental Corporation in order that it be sold to the public and the money acquired used in the acquisition of these properties. The transactions were completed, the real estate was conveyed, and the stock of the Norfolk Weavers was transferred, as contemplated by the agreement. The First Continental Corporation also agreed to purchase the 75,000 shares of class A treasury stock issued to Simon Levin at $2 a share.
The consolidated balance sheet of Rayon Industries Corporation and subsidiaries as of May 31, 1933 (Exhibit D-5), shows land, buildings, machinery, and equipment, etc., appraised by Ford, Bacon & Davis, Inc., at reproduction cost $2,304,620, less depreciation to May 1, 1933, $742, 190—$1,562,430. Upon the final hearing according to the evidence, the company had cash on deposit with banks as of August 1, 1933, $714,327.53.
The defendant Marshall Ward & Co. agreed to take over the stock of the Rayon Industries Corporation from the First Continental Corporation at $2.25 a share. This included the original issue of 500,000 shares of class A stock acquired by the First Continental Corporation from Rayon Industries Corporation in exchange for the property and stocks heretofore referred to; also the 425,000 shares of class A treasury stock and the 75,000 shares of class A treasury stock purchased from Simon Levin.
Marshall Ward & Co. agreed to sell the stock to Patton & Co. at $3 a share, the difference of 75 cents a share, after the payment of all expenses of advertising and marketing the stock, to be divided equally between the two, and Marshall Ward & Co. caused a public offering of the stock to be made at $3 per share on June 23, 1933. Advertisements of the offering were published in approximately thirty newspapers throughout the country. The entire offering of 500,000 shares was sold to dealers, individuals, and to Patton & Co., and to a syndicate group. Of the second 500,000 shares, Marshall Ward & Co. purchased and paid for approximately 425,000 shares. On July 15, 1933, Marshall Ward & Co. and the First Continental Corporation entered into an agreement which was filed with the New York Produce Exchange, whereby it was provided that, when the closing price on the securities market of the New York Produce Exchange for shares of class A stock of theRayon Industries Corporation exceeded $5 a share, Marshall Ward & Co., in taking down shares of the treasury stock of the corporation, would be obliged to pay not merely $2.25 per share to the First Continental Corporation, but, in addition, 50 per cent. of the excess over $5 to the treasury of Rayon Industries Corporation, and Marshall Ward & Co. assert that it is the largest individual stockholder of Rayon Industries Corporation.
Through the defendant Patton & Co. a reservation of a quantity of the stock was made for Clement H. Congdon, the owner and publisher of a financial journal called the National Investment Transcript, a weekly publication published at Camden, N. J., by the National Investment Transcript, Inc. While the stock of the Rayon Industries Corporation was not offered for sale through the publication, a suggestion appeared therein that the editor, Clement H. Congdon, would shortly recommend a low-priced industrial stock to those subscribers inquiring for the name of the stock. Subsequently Congdon advised the purchase of Rayon Industries Corporation stock, and issued a brochure entitled "New Trends and Profits in the Rayon Industry as Exemplified by the Growth and Prospects of Rayon Industries Corporation." Letter by Congdon dated July 1, 1933, mailed about July 15, 1933, accompanied the brochure. In the letter he said that his interest "is not merely a passing interest, but dates back to 1888 when I contracted to publicize Ramie, the original fibre product." Further he wrote that, in order to comply with the new securities laws of the nation, "and also my desire to present the interest of myself as it complies with the new securities laws of the nation" in Rayon Industries Corporation, "that through the usual brokerage channels a reservation has been made on behalf of myself and my subscribers at $3.00 a share and I expect to make a profit if and when sold." He assures the reader that all he knows about the finances, property, etc., of Rayon Industries Corporation is fairly and fully set forth in the brochure; that his representations in previous communications were fairly conservative, and requests communication by wire on receipt of the letter. He predicts "a very active and higher over-the-counter market," and adds that quotations show tremendous interest in all affiliated issues with the Rayon Industry. "It is now my sincere belief," says he, "that the sequence of events carrying all such issues up from extreme 'low's' to sensational 'high's' will be repeated relatively in the future of Rayon Industries Corporation. * * * The public offering has been made and from my understanding was met with popular demand inasmuch as the issue was oversubscribed with the result that the books are now closed to any further reservations at the $3.00 price." Other statements in the brochure are:
"More than 2,000 skilled employees will soon be weaving Rayon fabrics under contracts involving no element of risk or credit —and at a substantial profit as proven by the results achieved by the plants controlled in 1931 and 1932."
"Rayon Industries Corporation has been one of the pioneers in the Rayon and Weaving Division of the great Textile industry. It is the unit that has made the most progress. Beginning with one mill, in 1931, the organization now operates six plants."
"Rayon Industries Corporation, having lead the way since 1931 in its profitable subsidiaries, may be and should be expected to retain its pre-eminence."
While the facts hereinbefore quoted are true as to the constitutent companies which made up the Rayon Industries Corporation, that company itself was not organized until May, 1933. Therefore the statement that Rayon Industries Corporation "lead the way" in 1931 is not true. Similarly with respect to statements concerning the number of subsidiaries and plants in operation and past earnings record.
Section 6 of the act amended by P. L. 1931, p. 570 (Comp. St. Supp. § * 186—10a(6), provides that, if "it shall appear to the court that any such person, * * * corporation, * * * has engaged in, or is engaging in, * * * any practice declared to be illegal and prohibited by this act, the court may issue an injunction restraining such person, * * * corporation, * * * from continuing such practices or engaging therein or doing any acts in furtherance thereof, and the court may also issue an injunction restraining the issuance, sale, offer for sale, * * * within or from this State of any securities by such person, * * * corporation, * * * until the court shall otherwise order." (Italics mine.)
Regardless of Congdon's honesty of purpose, the inaccuracies to which I have referred constrain me to find that he and the National Investment Transcript, Inc., must be enjoined from selling, or offering for sale, or recommending, either through the columns of the National Investment Transcript or otherwise, Rayon Industries Corporation stock by or through the use of said brochure, or by or through the use of any of the statements contained in such brochure and found herein to be untrue, or by any misrepresentation by word, conduct, or in any manner of. any material fact, either present or past, in relation to Rayon Industries Corporation and the stock of said corporation.
As to the other defendants the bill of complaint is dismissed.