## Facts

- Caremark International, Inc. was a wholly owned subsidiary of Baxter International Inc.
- The federal government began investigating Caremark in 1991 for suspected Medicare and Medicaid fraud while Caremark remained within Baxter.
- Baxter allegedly sought to reduce exposure to potential Caremark-related liability by spinning off Caremark to Baxter shareholders.
- The spin-off was structured as a pro rata distribution: each Baxter shareholder received Caremark shares proportional to their Baxter holdings, and Caremark became an independent company.
- To avoid registering the distributed Caremark shares, Baxter sought and obtained an SEC no-action letter.
- The shareholders alleged Baxter made materially misleading statements to the SEC to obtain the no-action letter by giving benign business reasons for the spin-off while omitting the ongoing government investigation.
- In 1995, Caremark pleaded guilty to fraud and paid $160 million to the government.
- Baxter shareholders who received Caremark shares alleged they were injured when Caremark’s shares declined in value after the fraud became public.

## Issues

1. Whether alleged misrepresentations to the SEC made to obtain a no-action letter for a pro rata spin-off were made “in connection with the purchase or sale of any security” under § 10(b) and Rule 10b-5.
2. Whether shareholders who received stock through a pro rata spin-off distribution qualify as “purchasers” or “sellers” for a private Rule 10b-5 action.

## Decision

- The Seventh Circuit affirmed dismissal of the Rule 10b-5 claim for failure to plead a qualifying “purchase or sale” connected to the alleged fraud.
- The court held that a pro rata distribution to existing shareholders in a spin-off, without a bargained-for investment decision to buy or sell, did not satisfy the purchaser-seller requirement for a private § 10(b) action.
- The court agreed that alleged deception aimed at obtaining regulatory relief (a no-action letter) was not sufficiently connected to any securities purchase or sale by the plaintiffs.
- With the federal claim dismissed, the court affirmed the district court’s decision to relinquish supplemental jurisdiction over the state-law claims and dismiss them without federal adjudication.

## Legal Principles

- A private action under § 10(b) and Rule 10b-5 requires a fraudulent statement or omission “in connection with the purchase or sale of any security,” demanding a concrete transactional nexus to a plaintiff’s purchase or sale.
- A pro rata corporate spin-off distribution to existing shareholders, standing alone, generally does not make recipients “purchasers” or “sellers” for Rule 10b-5 purposes because it lacks a voluntary, price-mediated investment transaction.
- Alleged misstatements made to the SEC to obtain a no-action letter, without linkage to a plaintiff’s securities purchase or sale, are insufficient to support a private Rule 10b-5 claim.
- When all federal claims are dismissed, a federal court may decline supplemental jurisdiction over related state-law claims under 28 U.S.C. § 1367(c)(3).

## Conclusion

The Seventh Circuit held that shareholders could not maintain a private Rule 10b-5 action based on alleged misstatements to the SEC used to facilitate a pro rata spin-off because the distribution did not constitute a purchase or sale by the recipients, and the asserted fraud lacked the required connection to a securities transaction; the state-law claims were left to nonfederal adjudication.


Isquith v. Caremark Int'l, Inc., 136 F.3d 531 (7th Cir. 1998)