## Facts

- Newport Steel Corporation was a publicly held steel manufacturer whose shares were widely dispersed among thousands of investors.
- C. Russell Feldmann, Newport’s president and board chairman, owned about 40% of Newport’s common stock, sufficient to exercise voting control.
- Newport and Follansbee Steel Corporation negotiated a proposed merger that allegedly would have been highly profitable to Newport’s shareholders on the terms offered.
- Feldmann, acting as Newport’s president, rejected the merger proposal.
- Feldmann then sold his personal control block to Wilport Company for about $22 per share, roughly twice the market price.
- Minority shareholders sued in federal court, purportedly on behalf of the corporation and similarly situated shareholders, alleging that defendants used the mails and engaged in a fraudulent scheme connected to Feldmann’s sale.
- Plaintiffs did not allege that they, or Newport, purchased or sold securities as part of the challenged transaction; the only alleged purchase and sale was Feldmann’s sale to Wilport.

## Issues

1. Whether § 10(b) of the Securities Exchange Act of 1934 and SEC Rule 10b-5 allow a private action by an issuer or non-trading shareholders based on alleged fraud tied to a third party’s purchase or sale of securities.
2. Whether allegations that a controlling officer diverted a control premium and merger-related value constitute fraud “in connection with the purchase or sale of any security” as to plaintiffs who neither bought nor sold.

## Decision

- The Second Circuit affirmed dismissal for failure to state a claim.
- The court held that § 10(b) and Rule 10b-5 protect only defrauded purchasers or sellers in the relevant securities transaction.
- Because Newport was not a purchaser or seller, and plaintiffs did not buy or sell shares in connection with Feldmann’s sale, neither had standing to sue under § 10(b)/Rule 10b-5 on these allegations.

## Legal Principles

- A private plaintiff seeking relief under § 10(b) and Rule 10b-5 must be an actual purchaser or seller of securities in the transaction alleged to be fraudulent.
- Rule 10b-5 may not extend beyond the authority granted by § 10(b), which targets manipulative or deceptive conduct “in connection with the purchase or sale” of securities.
- Claims framed as corporate mismanagement or breach of fiduciary duty, without a purchase or sale by the complaining party, fall outside § 10(b)/Rule 10b-5 as construed here.

## Conclusion

The court held that § 10(b) and Rule 10b-5 do not provide a federal remedy to an issuer or to shareholders who did not trade, even if they allege a fraudulent scheme surrounding a controlling shareholder’s private sale of stock; only purchasers or sellers in the challenged transaction may sue under these provisions.


Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2d Cir. 1952)