Opinion ID: 344913
Heading Depth: 3
Heading Rank: 1

Heading: The Objective Element

Text: 46 At the December 26 merger negotiation meeting, Meers agreed with Ethington that Ethington's earnings estimates for SKI of $1.16 per share in 1968 and $2.00 23 per share in 1969 were reasonable. Although there is conflicting evidence on whether Meers confirmed these earnings figures as reasonable, we cannot say that the trial court's credibility determination in Ethington's favor was clearly erroneous. 24 Since Sundstrand was primarily concerned that the proposed merger not result in an earnings dilution, the reliability of SKI's earnings projections was, of course, most important to Sundstrand and, as the district court realized (mem. op. 12), it stretches credulity to believe that SKI's earnings were not discussed. Given the importance of the earnings projection, the danger of misleading Sundstrand (as of December 26, 1968) was high when information the Burke and Ernst & Ernst reports that the earnings estimates might be significantly overstated due to accounting gimmickry was kept from Sunstrand's officers. 47 Meers denies actual knowledge of the danger, and the trial court made no determination that Meers possessed actual knowledge. However, a finding on the objective obviousness of the danger was made (mem. op. 32-34), which is sufficient for liability even absent an actual appreciation by Meers of the significance of the omitted material to Sundstrand. 48 The factual findings of the district court relevant to the obviousness of the danger, which upon our independent examination of the record we find amply supported, are most succinctly stated in the trial court's own words (mem. op. 32-34): 49 (Meers) failed to disclose to Sunstrand that James W. Burke, a director, officer and large shareholder of SKI had, in May, 1968, formally submitted to the board of directors of SKI questions as to the propriety of certain SKI accounting practices, including that of continuing to defer certain preproduction costs on the CPU-46 and other programs. The questions related principally to accounting practices as revealed in the 1967 annual report. Burke supported his questions in June with a report from Ernst & Ernst, an independent firm of certified public accountants which Burke had asked to consider the propriety of the practices he challenged. Ernst & Ernst, though declining to render a formal opinion because it had not conducted an examination in conformity with generally accepted auditing procedures, concluded that the practices addressed in the Burke Report seemed questionable. 50 These reports were considered serious enough by the SKI board of directors to be discussed at at least twenty-five board meetings during the spring and summer of 1968. The board directed the officers of SKI to prepare responses to Burke's questions, and at Meers' request, representatives of Price Waterhouse, the firm of certified public accountants which prepared the SKI 1967 annual report, appeared at several of these meetings to discuss Burke's questions. The board eventually decided that Burke's criticisms were without merit. However, as a result of Burke's questions, the board began, in April, 1968, to receive monthly financial reports. These reports revealed the continual increase of deferred preproduction costs on the CPU-46 and other programs throughout 1968. Meers was concerned enough to ask about the progress of each of the contracts on which costs were deferred, including the CPU-46, at every board meeting and asked particularly whether the CPU-46 had been qualified with the government a step which was essential to producing an acceptable product and obtaining follow-on contracts. In each such meeting he learned that no such qualification had been obtained. (In fact, qualification was not obtained until September, 1969.) 51 Dissatisfied with the board's action, Burke complained to the SEC. Ryan, Hart, acting as attorney for SKI, and H. Dudley Murphy, a partner of Price Waterhouse, met in Washington with Curtis A. Davies of the SEC to discuss Burke's charges. At that meeting it was concluded that the 1967 annual report did not reflect improper accounting practices. With respect to preproduction costs on the CPU-46, Murphy assured Davies that Price Waterhouse would re-evaluate the situation when they prepared the 1968 annual report. This assurance was reiterated in a letter from Murphy to Davies. Both Ryan and Meers saw copies of that letter. None of this was disclosed to Sundstrand. 52 Neither was it disclosed that, because of questions about the propriety of SKI's 1967 financial statements, two directors of SKI, Burke and Perry Addleman, refused to sign a registration statement filed by SKI with the Securities and Exchange Commission in March, 1968. Meers later suggested that the registration statement be withdrawn, which was done in August, 1968. In addition, defendants failed to disclose to Sundstrand that Addleman also raised questions about the financial accounting of SKI. 53 The trial court concluded that the materiality of the Burke and Ernst & Ernst reports is not open to serious question (mem. op. 36). 54 Meers places heavy reliance on the SEC meeting of August 1968 as dispelling the doubts the Burke and Ernst & Ernst reports had raised in his mind. However, the 1968 accounting practices were not passed on in the SEC meeting. The monthly financial reports which Meers requested as a result of Burke's initial complaints continued to show an increase in deferred preproduction costs. At every board meeting Meers asked about the preproduction costs. Indeed, Meers found out that the computer unit CPU-46 had still not been qualified with the government, a condition precedent for additional government contracts for that product. Thus the principal expected source of revenue against which to amortize the mounting preproduction costs remained indefinite and unreliable. Under these circumstances, any reasonable man would be bound to know that the danger posed to Sundstrand by the serious conflict on SKI's accounting policy among its board members and two public accounting firms as to deferred preproduction costs had not been vitiated by the inconclusive August 1968 SEC meeting.