Opinion ID: 595187
Heading Depth: 2
Heading Rank: 2

Heading: Plaintiff's Theories of Recovery

Text: 21 Plaintiffs in the present action seek recovery under four separate federal securities law provisions. In reversing the trial court's dismissal, we imposed liability only under § 14(a), without commenting on plaintiffs' other three causes of action. The necessary implication of our imposing liability under § 14(a) is the recognition of an implied private cause of action for minority shareholders who cannot affect the outcome of a corporate vote. In doing so, we did not comment on what theory of causation defendants' liability rested. Perhaps we presumed that plaintiffs had suffered an injury causally related to the defective proxy because defendants in Wilson I had not contested--and the district court found--causation. 22 Plaintiffs set forth two theories of causation to support their claims. They assert first that an implied action under any of the four securities law provisions pleaded should be recognized because 85 percent of the voting shares, or 12 percent of the minority shareholders in addition to the controlling majority shareholders, had to approve the merger in order for the exchange of stock to take place without tax consequences. Although an opinion letter stated the merger might have tax-free consequences for the majority shareholders if 85 percent of the shareholders approved it, such an approval level was not a requirement of the merger. If it was not an express condition of the merger, the higher rate of dissenting voters could only prevent the merger were it to influence the controlling majority. Such a speculative and hypothetical causal connection would make liability turn on 'hazy' issues [and invite] self-serving testimony, strike suits, and protracted discovery, with little chance of reasoned resolution by pretrial process. Virginia Bankshares, --- U.S. at ----, 111 S.Ct. at 2765 (rejecting causal theory promised on majority's desire for cosmetic vote and avoidance of minority shareholders' ill-will). Thus, we reject this theory of causation. 23 Plaintiffs' second theory of causation--one with more merit and upon which § 14(a) causes of action have been sustained in the past--is that their deceptively procured vote in favor of the merger deprived them of their state appraisal rights under N.Y.Bus.Corp. Law §§ 623(a), (b) (McKinney 1986); § 910(a)(1) (McKinney Supp.1992). We and other courts have recognized that plaintiffs might prevail on such a § 14(a) theory. See Cole v. Schenley Indus., Inc., 563 F.2d 35, 39-40 (2d Cir.1977) (on a motion to dismiss complaint, implied right recognized when insignificant minority shareholders had state law alternatives to accepting merger); Schlick v. Penn-Dixie Cement Corp., 507 F.2d 374, 381-84 (2d Cir.1974) (though insignificant minority shareholders had no appraisal rights under state law, deprivation of measures other than casting proxies may support implied right to recovery under § 14(a)). See also Swanson v. American Consumers Indus., Inc., 475 F.2d 516, 520-21 (7th Cir.1973) (insignificant minority shareholders entitled to recovery for lost state appraisal rights under § 10(b)). Cf. Scattergood v. Perelman, 945 F.2d 618, 626 n. 4 (3rd Cir.1991) (noting possibility that implied right of recovery might exist for lost state remedies). 24 As noted, Virginia Bankshares left open the possibility that § 14(a) might include this type of implied right to recover and did not address whether the causal relationship between a deceptive proxy and lost state remedies was sufficient to support a federal remedy. Defendants, having failed to contest causation prior to the present appeal, see Wilson I, 661 F.Supp. at 1562, should hardly be allowed to argue the point now, especially when to permit such puts them in a better position than if they had made this objection earlier and lost. See Fogel v. Chestnutt, 668 F.2d 100, 108-09 (2d Cir.1981), cert. denied, 459 U.S. 828, 103 S.Ct. 65, 74 L.Ed.2d 66 (1982). 25 We continue to believe that a minority shareholder, who has lost his right to a state appraisal because of a materially deceptive proxy, may make a sufficient showing of causal relationship between the violation and the injury for which he seeks redress. Mills, 396 U.S. at 385, 90 S.Ct. at 622. The transaction effected by a proxy involves not only the merger of the corporate entities, and the attendant exchange of stock, but also the forfeiture of shareholders' appraisal rights. The injury sustained by a minority shareholder powerless to affect the outcome of the merger vote is not the merger but the loss of his appraisal right. The deceptive proxy plainly constitutes an essential link in accomplishing the forfeiture of this state right. 26 That the causal nexus between the merger and the proxy is absent when the minority stockholder's vote cannot affect the merger decision does not necessarily mean a causal link between the proxy and some other injury may not exist. We recognize that loss causation or economic harm to plaintiffs must be shown, as well as proof that the misrepresentations induced plaintiffs to engage in the subject transaction, that is, transaction causation. Here loss causation may be established when a proxy statement prompts a shareholder to accept an unfair exchange ratio for his shares rather than recoup a greater value through a state appraisal. And transaction causation may be shown when a proxy statement, because of material misrepresentations, causes a shareholder to forfeit his appraisal rights by voting in favor of the proposed corporate merger. See Schlick, 507 F.2d at 380; Note, Causation and Liability in Private Actions for Proxy Violations, 80 Yale L.J. 107, 123-27 (1970). 27 Even though the proxy was not legally required in this case, when defendants choose to issue a proxy plaintiffs have a right to a truthful one. With the Securities Exchange Act of 1934, Congress sought to promote fair corporate suffrage with respect to  'every equity security'  by requiring an  'explanation to the stockholder of the real nature of the questions for which authority to cast his vote is sought.'  Mills, 396 U.S. at 381, 90 S.Ct. at 620 (quoting H.R.Rep. No. 1383, 73d Cong., 2d Sess. 13-14 (1934)); see also J.I. Case Co. v. Borak, 377 U.S. 426, 431-32, 84 S.Ct. 1555, 1559-60, 12 L.Ed.2d 423 (1964). Congress' interest in the protection of investors and the  'free exercise of [their] voting rights,'  Borak, 377 U.S. at 431, 84 S.Ct. at 1559 (quoting H.R.Rep. No. 1383, 73d Cong., 2d Sess. 14 (1934)), should not vary in degree according to the ability of the shareholder to affect the merger, if the vote nevertheless may result in a different sort of injury which full disclosure might have avoided. See Healey v. Catalyst Recovery of Pa., Inc., 616 F.2d 641, 646 (3d Cir.1980) (that harm to plaintiff from violation of 10b-5 was deprivation of a state remedy in no way lessens federal interest in preventing the violation); Schlick, 507 F.2d at 383. 28 The statute does not suggest that the prohibition of material misrepresentation in a proxy extends only to necessary proxies that are mailed to shareholders the solicitation of whose votes may affect the outcome of the proposed corporate action. That a controlling group of shareholders may accomplish any corporate change they want does not insulate them from liability for injury occasioned when they commit the sort of fraud that § 14(a) seeks to prevent. See Swanson v. American Consumer Indus., Inc., 415 F.2d 1326, 1331-32 (7th Cir.1969). To decline to extend the protection of § 14(a) to plaintiffs, we think, might sanction overreaching by controlling shareholders when the minority shareholders most need § 14(a)'s protection. See Schlick, 507 F.2d at 383. At the same time, allowing the action does not pose a threat of speculative claims and procedural intractability, Virginia Bankshares, --- U.S. at ----, 111 S.Ct. at 2765, because the forfeiture of state appraisal rights is a question separate from the effectuation of the merger and does not require courts to guess how or whether the majority shareholders would have proceeded in the face of minority dissent. 29 Although a finding of materiality in a proxy solicitation may satisfy the elements of loss and transaction causation for forfeited state appraisal rights, plaintiffs must also prove that they in fact lost state appraisal rights. See Virginia Bankshares, at ---- & n. 14, 111 S.Ct. at 2766 & n. 14. In Wilson II, we presumed, not only that there existed a sufficient causal relationship between the proxy and a loss, but also that plaintiffs had actually sustained a loss. After deciding Wilson III and IV in September of 1990 and April of 1991 respectively, the district court upon a motion for reconsideration in light of Virginia Bankshares aptly stated in a Memorandum-Decision and Order dated August 14, 1991, 770 F.Supp. 85 (N.D.N.Y.): [t]his court has never decided, and it is not clear, whether plaintiffs may have been deprived of some available state-law remedies by the misleading proxy statement. Accordingly, we must remand this matter for the limited purpose of determining whether the proxy solicitation actually resulted in the loss of any remedies available to plaintiffs under New York law. 30 We add--somewhat reluctantly at this late date--that the reversal in Wilson II resulted in the resurrection of all plaintiffs' claims regardless of the theory of liability advanced. Thus, plaintiffs' claims under §§ 10(b) and 18(a) of the Securities Exchange Act of 1934 and § 12(2) of the Securities Act of 1933 remain viable to the extent we found defendants at least negligently misrepresented or omitted material information in the proxy solicitation. II 31 Given the possibility that on remand defendants may again have liability imposed against them under § 14(a), we think it prudent to reach those aspects of the appeal and cross-appeal that challenge the trial court's calculation of damages. Defendants initially contend our mandate in Wilson II, that damages should be equal to the benefit of the bargain, is inappropriate when only state appraisal rights have been lost. In light of plaintiffs' inability to prevent the merger, defendants point out their acquisition of Chenango was not effected through fraud. Rather, they assert, only the forfeiture of the appraisal rights was caused by the deceptive proxy solicitation. We think our instructions in Wilson II still valid. 32 The benefit of the bargain rule set forth in Janigan v. Taylor, 344 F.2d 781 (1st Cir.), cert. denied, 382 U.S. 879, 86 S.Ct. 163, 15 L.Ed.2d 120 (1965), is the appropriate measure of damages in this matter. Janigan held a shareholder induced by fraud into selling his shares for less than fair consideration may recover future accretions in value of the stock, even if those damages are not foreseeable. Id. at 786-87; see also Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128, 155, 92 S.Ct. 1456, 1473, 31 L.Ed.2d 741 (1972) (where defendant receives more than seller's actual loss, damages are the amount of defendant's profit). This rule applies to mergers involving fraudulent proxies as well as to face-to-face transactions under § 10(b). See Osofsky v. Zipf, 645 F.2d 107, 114 (2d Cir.1981). The goal of preventing the speculative fraud resulting when damages are awarded only for the difference in the values of the exchanged stocks, see id. (citing Restatement (Second) of Torts § 549(2), cmts. g, i (1977)), applies with as much force when appraisal rights are fraudulently forfeited as it does when a merger is fraudulently effected. 33 But to place plaintiffs in substantially the same position they would have occupied absent the fraud, they should be entitled to the profits attributable to the extra stock they would have received had the proxy provided a fair exchange ratio. Although the fraud may not be the proximate cause of the merger, it did cause the forfeiture of appraisal rights, which in turn prevented plaintiffs from realizing a fair exchange ratio. Thus the injury caused by the fraud cannot be measured by the shares that were exchanged, rather by the value of the additional shares that should have been exchanged but because of the fraud were not. The benefit of the bargain rule in the context of lost state appraisal rights would apply only to the stock never received, and not to the shares actually received. Cf. Gerstle v. Gamble-Skogmo, Inc., 478 F.2d 1281, 1307 (2d Cir.1973). This statement of how the benefit of the bargain rule is applied when state appraisal rights are fraudulently lost is not inconsistent with our instructions in Wilson II. 34 Defendants next declare the trial court's calculation of damages is not supported by sufficient evidence in the record. They insist that though properly discounting the 1984 value of Chenango to 1979 dollars, the trial court erred in deciding that an accurate appraisal must also account for the value of Chenango's projected earnings during the five-year period from 1979 to 1984. Careful review of the record convinces us the trial court's computation of damages is fully supported by the testimony of the experts, and should be affirmed if liability is imposed, except with regard to the correction made to the Gordon model by adding Chenango's projected earnings for the period between 1979-1984. We agree the measure of damages should be the difference between what the minority shareholders actually received and what they would have received had Chenango and Great American been properly valued. The trial court properly selected the Gordon method for appraising the value of Chenango and we find no fault with its determination that plaintiffs' last expert at trial, Mr. Higgins, provided the most credible method for calculating damages. 35 Nor was it error to employ different appraisal methods for ascertaining the worth of the two differently situated corporations. Although the capitalization of earnings method for appraising Chenango required consideration of the corporation's potential growth--a factor not expressly considered in valuing Great American--the market valuation method of the latter, using its price per share on the American Stock Exchange on the date immediately prior to the merger, adequately approximates a market value suitable for comparison purposes. Appraisal and valuation methods for differently situated corporations require resort to technical economic concepts that quite often fall outside the realm of judicial expertise and require reliance on expert testimony. We know of no reason why different but perfectly credible valuation methods may not be used to appraise different corporations. Defendants fail to explain why the market value of Great American on the day before the merger would not have taken into account the corporation's future growth potential or future dividend prospects, factors we would anticipate to be of primary interest to the typical investor. Cf. Mills v. Electric Auto-Lite Co., 552 F.2d 1239, 1247-48 (7th Cir.), cert. denied, 434 U.S. 922, 98 S.Ct. 398, 54 L.Ed.2d 279 (1977). 36 Nevertheless, defendants correctly contend the correction in the Gordon Model was not supported by the record. The district court determined the Gordon Model as implemented by Higgins computed the future earning power of Chenango for the period after 1984 in 1984 dollars. It discounted the value of the corporation to 1979 dollars and then added the projected earnings of Chenango for the five year period between 1979-1984. With respect to the correction, it stated that, [w]ithout the use of this additional calculation, the earnings for the years 1979-84 would have remained uncounted. Wilson IV, 763 F.Supp. at 691. But, in calculating what the district court considered only to be Chenango's base earning power as of 1984, Wilson III, 746 F.Supp. at 265, Higgins used a variable that actually accounted for the projected earnings of Chenango during the earlier five-year period--the Growth rate in earnings years 1-5 (18%). See id. 37 The district court properly discounted the Gordon computation from 1984 to 1979 dollars pursuant to the cross examination testimony of Higgins elicited by defendants. Yet, when it added to this discounted figure the 1979 value of Chenango's projected earnings from 1979 to 1984, it acted without any apparent support in the record. Calculations of damages not finding adequate support in the record may not be affirmed on appeal. See, e.g., In re Wolverton Assocs., 909 F.2d 1286, 1296 (9th Cir.1990); Alvary v. United States, 302 F.2d 790, 794-96 (2d Cir.1962). 38 Hence, if on remand liability is imposed, a hearing must be held on the limited issue of how to use the Gordon method properly. We do not intend the trial court should reopen for contest the valuation of Great American or the selection of a proper method for appraising Chenango, or even the selection of variables for use in the Gordon model. We leave to the district court's discretion the extent of the hearing it allows, directing only that all steps in the calculation of damages should find support in the record. Given the trial court's experience with the incredible and manipulative testimony proffered by both parties' experts, it might consider appointing its own expert as an aid in making its determination. See, e.g., Klurfeld v. Equity Enters., Inc., 79 A.D.2d 124, 138-39, 436 N.Y.S.2d 303 (1981). 39 Both parties contest the award of 9 percent compounded prejudgment interest. Defendants say it is excessive, inappropriate and punitive in effect. Plaintiffs, on the other hand, assert it insufficiently disgorges from defendants profits they realized as a proximate consequence of their fraud and is too low when compared to the profits actually realized and the market rates of return experienced during the 1980's. We affirm the district court's interest award. It acted within its discretion when it ruled any award of accretions in value of Great American stock would be unduely speculative. The award does not strike us as punitive under the circumstances; rather it accords with fundamental considerations of fairness and reasonably reflects what plaintiffs should have received absent the fraud. 40 We have carefully considered the remaining arguments of the parties on this appeal and cross-appeal and find them without sufficient merit to warrant discussion.