Court Opinion

ID: 9462662
Source: CourtListenerOpinion
Date Created: 2023-08-04 22:46:41.841016+00
Date Added: 2024-06-11T17:37:42.337664
License: Public Domain

MANSFIELD, Circuit Judge
(concurring):
I concur in Judge Medina’s opinion holding that a short-form merger consummated without any legitimate corporate purpose and without any advance notice to the minority public stockholders, resulting in harm to the latter, violates Rule 10b-5. By using the short-form merger device in this fashion the majority commits a wrong that extends beyond mere mismanagement of corporate affairs; the majority also breaches its duty as a fiduciary to deal fairly with the public investors, and, by acting unilaterally and without any advance notice, deprives them of the opportunity to seek relief based on the absence of any legitimate corporate purpose. The resulting merger amounts to a “manipulative or deceptive device or contrivance” which operates as a fraud on public stockholders of the type intended to be proscribed by § 10(b) of the Securities Exchange Act and Rule 10b-5 promulgated thereunder. Upon a showing that the merger had no legitimate corporate purpose, the district court should, if feasible, set it aside or, if the merger cannot effectively be voided,1 award damages representing the difference between the fair buy-out price and the unfair, unilateral buy-out price set by the corporate insiders.2 Such relief is not barred by the co-availability of state law remedies. Superintendent *1295of Insurance v. Bankers Life & Cas. Co., 404 U.S. 6,12, 92 S.Ct. 165, 168, 30 L.Ed.2d 128, 134 (1971); Vine v. Beneficial Finance Co., 374 F.2d 627, 635-36 (2d Cir.), cert. denied, 389 U.S. 970, 88 S.Ct. 463, 19 L.Ed.2d 460 (1967); Popkin v. Bishop, 464 F.2d 714, 718 (2d Cir. 1972).
Inherent in the act of “going private” through a short-form merger is an enormous potential for abuse of the corporate insiders’ fiduciary position with respect to the “frozen out” public shareholders. Essentially, by “going public” when the stock market is flourishing and squeezing out the public shareholders when the market is depressed, the majority is able to manipulate the sale and purchase of stock to its benefit and to the detriment of the public shareholders, depriving the latter involuntarily of their investment in the corporation, see Vorenberg, Exclusiveness of the Dissenting Shareholder’s Appraisal Bight, 77 Harv.L. Rev. 1189 (1964), at a buy-out price unilaterally selected by the insiders, which they have every incentive to fix below the fair value of the public shareholders’ interest. Brudney and Chirelstein, Fair Shares in Corporate Mergers and Takeovers, 88 Harv. L.Rev. 297, 298 (1974).
The unfairness and conflicts of interests generated by “going-private” mergers have not been lost on the business community. For example, Dun’s Review, January, 1975, at 37, reports:
“However one looks at it ‘going private’ is most often a no-win situation for public shareholders. For the buy-out price is almost always a small fraction of what the investor paid for the stock. The price, moreover is determined by a consultant hired by the buyers. The investors have a choice of taking what is offered or holding a stock that is no longer readily marketable. And the insiders have formidable legal devices available to fight investors who refuse the company’s offer.
* * * * *
“Not only are the offering prices in buyouts far below what they paid, investors claim, they often do not reflect the current financial strength of the company any more than the market price does.” Id. at 38.
The Wall Street Journal, October 18, 1974, at 1 concurs, stating:
“[a] move to go private ordinarily creates a conflict of interest . . . [as] controlling shareholders who directly or indirectly finance the move often are buying back their interests at only a fraction of the price at which they originally were sold to the public. . . .”
And Barron’s, March 4, 1974, at 3, 13, warns:
“Generally, it is the low price of the stock, rather than declining earnings which sends firms private. . . . Admittedly, there are times when it appears that stockholders have been had. Indeed, figures indicate that the ones benefiting most from buying back the stock are the people who sold it to the public in the first place.”
In conclusion, Business Week, November 2, 1974, at 114, editorializes:
“[T]here is a distinctly bad smell about a deal that produces a substantial loss for the majority of the shareholders and a fat profit for a tiny minority.”
My purpose in referring to these current appraisals of the short-form merger device by those who have observed it in action is not to impugn the motives of the defendants in this case but to emphasize that the problem created by misuse of the short-form merger is not merely one of regulating “transactions which constitute no more than internal corporate mismanagement,” Superintendent of Insurance v. Bankers Life & Cas. Co., supra, 404 U.S. at 12, 92 S.Ct. at 169, 30 L.Ed.2d at 134, but one of protecting the public investor against manipulative devices used to deceive him, and the securities market from devices serving to discredit it, which together form the primary functions of the anti-fraud and anti-manipulation provisions of Rule 10b-5. The short-form merger, when used to squeeze out small public investors by forcing them to relinquish their corporate investments at low prices for no purpose oth*1296er than to benefit the insiders, can accurately be characterized as a “manipulative or deceptive device or contrivance,” id. at 10, 92 S.Ct. at 168, 30 L.Ed.2d at 133, which interferes with the interests of the public shareholders in the most fundamental of ways, by depriving the investor of his very interest in his corporate investment. It also undercuts the broader purpose of “preserving the integrity of the securities markets,” id. at 12, 92 S.Ct. at 169, 30 L.Ed.2d at 134, for a clearer instance of potential abuse of the market processes cannot be found. Commenting on the use of the short-form merger, SEC Commissioner Sommer has stated:
“What- is happening is, in my estimation, serious, unfair, and sometimes disgraceful, a perversion of the whole process of public financing, and a course that inevitably is going to make the individual shareholder even more hostile to the securities markets than he already is.” ([1974-75] Fed.Sec.L.Rep. K 80,010 at 84,695)
To immunize the short-form merger from the coverage of Rule 10b-5 merely because state law has authorized the device to be used for the purpose of squeezing out the public shareholders without giving them prior notice or an opportunity to obtain injunctive relief would be to ignore the central protective purposes underlying federal securities legislation and to countenance an anomalous result. Those who are most exposed and most vulnerable — the small outside public shareholders who are not privy to the inner workings of the corporate enterprise and who are forced to accept a unilaterally imposed result — would be the least protected. If they are to enjoy the protection intended to be furnished by 10b-5, that rule must not be interpreted in a technical or niggardly fashion.
When we were first called upon more than a decade ago to decide whether certain types of fraudulent corporate practices or devices fell within the proscriptions of Rule 10b-5, our initial tendency was to adhere rather closely to the elements of common law fraud (misrepresentation, reliance, scienter) in interpreting Rule 10b-5. See, e. g., O’Neill v. Maytag, 339 F.2d 764, 768 (2d Cir. 1964). Moreover we considered it essential that the fraud, to be actionable under the rule, must be intrinsic to the securities transaction itself. See, e. g., Superintendent of Insurance v. Bankers Life & Cas. Co., 430 F.2d 355 (2d Cir. 1970), aff’g, 300 F.Supp. 1083 (S.D.N.Y.), rev’d, 404 U.S. 6, 92 S.Ct. 165, 30 L.Ed.2d 128 (1971). Beginning in A. T. Brod & Co. v. Perlow, 375 F.2d 393 (2d Cir. 1967), and in Schoenbaum v. Firstbrook, 405 F.2d 215 (2d Cir. 1968) (en banc), cert. denied, 395 U.S. 906, 89 S.Ct. 1747, 23 L.Ed.2d 219 (1969), however, we recognized that the ambit of the term “fraud” as used in 10b-5 must be widened if Congress’ objective — protection of the public investor — was to be achieved. Furthermore, since only section (2) of 10b-5 deals with misrepresentation and non-disclosure, a broader definition of fraud would give effect to the prohibitions of sections (1) (employment of “any device, scheme or artifice”) and (3) (engaging in “any act, practice or course of business which operates as a fraud”), which disclose a broad intent to prohibit other forms of fraud. Accordingly in Schoenbaum we broke new ground to the extent of holding that where there was improper self-dealing and abuse of fiduciary responsibility by majority shareholders, disclosure of material facts to interested insiders would not preclude public stockholders, who were not privy to the scheme, from holding the controlling wrongdoers liable under 10b-5 for treating the public investors unfairly, even though the technical niceties of common law fraud had not been met. See Folk, Corporation Law Developments, 56 Va.L. Rev. 755, 806-07 (1970).
The recognition that “fraud” as that term is used in § 10(b) must be interpreted broadly was given further impetus by the Supreme Court’s decision in Superintendent of Insurance v. Bankers Life & Cas. Co., supra, where, in holding that fraud forming the basis of a 10b-5 suit need not be intrinsic to the securities transaction itself, the unanimous Court stated that “Section 10(b) must be read flexibly, not technically or *1297restrictively,” 404 U.S. at 12, 92 S.Ct. at 169, 30 L.Ed.2d at 134. In line with this philosophy we, in Drachman v. Harvey, 453 F.2d 722 (2d Cir. 1972) (en banc), reconfirmed the stand taken in Schoenbaum and, in a suit by public investors, held corporate directors liable under 10b-5 for their conduct in calling back their corporation’s convertible debentures at an excessive price in order to prevent conversion into common stock, which would have weakened the opportunity of a third party, with whom the directors were in conspiracy, to obtain control of the company. Judge Smith’s dissent, later accepted by the court sitting en banc, did not place reliance upon evidence of misrepresentation or non-disclosure, but instead emphasized “that here the directors of Harvey, influenced by a conflict of interest and acting to support Martin’s controlling interest,” caused “the corporation [to] sustain . . . damage. . . . ” This was considered sufficient to allege a Rule 10b-5 violation under the “broad and liberal reading” required by the rule. Id. at 735. More recently in Schlick v. Penn-Dixie Cement Corp., 507 F.2d 374, 381 (2d Cir. 1974), cert. denied, 421 U.S. 976, 95 S.Ct. 1976, 44 L.Ed.2d 467 (1975), in upholding 10b-5 liability we again de-emphasized the importance of alleged misrepresentations as “only one aspect” or “a part” of the illegal scheme that had at its core “market manipulation” and, as here, “a merger on preferential terms. . . .”
Defendants place heavy reliance upon Popkin v. Bishop, 464 F.2d 714 (2d Cir. 1972), as representing a departure from our steady trend toward an expansive view of the reach of the federal security laws. However, to the extent that Popkin is at all relevant to the short-form merger context, it impliedly supports the application of the Schoenbaum-Drachman rule to this case.3 In Popkin, unlike the present case, prior stockholder approval of the proposed merger was required. Full advance disclosure of the relevant facts regarding the merger exchange ratios to the minority stockholders was effective protection because it gave them the opportunity, as Judge Feinberg noted, to seek state court injunctive relief which was purportedly available under Delaware law. Id. at 720. Here, in contrast, disclosure after the merger has been consummated is virtually the equivalent of no disclosure at all, since it comes too late to enable the minority to invoke state law for protection against an unwarranted squeeze-out. Indeed, it is well recognized that the state post-merger appraisal procedure does not provide an alternative remedy comparable to federal relief.4 Only through liberal *1298interpretation of 10b-5 will the public investor gain the redress intended to be made available to him.
Our conclusion that where there has been self-dealing on the part of corporate insiders proof of misrepresentation or non-disclosure is not a sine qua non to the establishment of 10b-5 liability is shared by other Circuits. In Pappas v. Moss, 393 F.2d 865, 869 (3d Cir. 1968), Judge Seitz held “that where, as here, a board of directors is alleged to have caused their corporation to sell its stock to them and others at a fraudulently low price, a violation of Rule 10b-5 is asserted.” The only deception found in the case, two misstatements in the shareholder resolution authorizing the sale, was of no practical consequence to the wrongdoing since shareholder ratification was unnecessary under state law and, in any event, was sought only after the sale was consummated. Id. at 867, 869. Similarly, the Fifth Circuit has repeatedly held corporate insiders liable under Rule 10b-5 in the absence of misrepresentation. For example, in Reckant v. Desser, 425 F.2d 872, 882 (5th Cir. 1970) (Wisdom, J.), the court wrote:
“We conclude, therefore, that when officers and directors have defrauded a corporation by causing it to issues securities for grossly inadequate consideration to themselves or others in league with them or the one controlling them, the corporation has a federal cause of action under § 10(b) . . . . The essence of the transaction is not significantly different from fraudulent misrepresentation perpetrated by one individual or another.”
Similarly, in Shell v. Hensley, 430 F.2d 819, 826-27 (5th Cir. 1970) (Ainsworth, J.), citing Schoenbaum, the court held directors liable for scheming to sell control to another corporation. In response to the argument that there had been no deception of the corporation warranting 10b-5 liability, *1299since the controlling directors had all the relevant information, the court responded that to so construe 10b-5 would be to permit “the basest sort of chicanery” and remove the “protection of the section and the rule merely because of the ease with which defendants victimized [the corporation].” See also Bryan v. Brock & Blevins Co., 490 F.2d 563, 571 (5th Cir.), cert. denied, 419 U.S. 844, 95 S.Ct. 77, 42 L.Ed.2d 72 (1974); Travis v. Anthes Imperial Ltd., 473 F.2d 515, 527 (8th Cir. 1973) (Rule 10b-5 liability found even though “[t]he essence of the plaintiffs’ complaint ... is that the defendants violated § 10(b) and Rule 10b-5 by engaging in self dealing Here, as in Sup’t of Insurance, the defendants’ self dealing was a violation of a fiduciary obligation to minority shareholders . . ..”).
Defendants’ efforts to reconcile these decisions by searching for some misrepresentation or non-disclosure ignores the court’s plain language in each case and exalts form over substance. Such misrepresentations as may be found generally related to technical, trivial matters, having little or no relevance to the manipulative conduct giving rise to 10b-5 liability. Furthermore, in some of the cases the courts, in imposing § 10(b) liability, were quite explicit in acknowledging the absence of misrepresentation or openly minimizing its import to the illegal conduct under challenge.
Thus our decision today is not only consistent with the trend of our own case law on the subject of 10b-5 liability but with the line of authority developing in other Circuits. In holding that a short-form merger which lacks any legitimate corporate purpose may violate 10b-5 we of course do not foreclose use of the device for legitimate corporate purposes. Such a merger, for instance, might lawfully provide an acceptable method of enabling a corporation to achieve substantial savings in operating expenses or to dispose of an unprofitable business at a favorable price. However, where a short-form merger involving use of a dummy corporation appears to be used for no purpose other than to squeeze out minority public shareholders, as is alleged in this case, the burden is upon the corporate insiders to demonstrate the existence of a legitimate compelling corporate purpose.

. Ordinarily in providing relief a court faces difficulties in setting aside a consummated merger. However, in the case of a short-form merger, the sole functional difference between the pre- and post-merged entities is the absence of the “frozen-out” public shareholders from the latter. Therefore, unless the parties materially and in good faith had relied upon the merger, the court in equity should be able to undo the unlawful effects of the short-form device by restoring the public shareholders to their prorata share of ownership.

. As Judge Medina notes, for purposes of this appeal we are to assume that the $150 per share offered by Kirby to the public shareholders is inadequate and that the correct buy-out price equals $772 per share, a sum derived by a pro-rata division of Kirby’s appraised assets. Should the district court decide that legal and not equitable relief is appropriate here, it, of course, would be required to determine a fair buy-out price, cf. Knauff v. Utah Construction & Mining Co., 408 F.2d 958 (10th Cir.), cert. denied, 396 U.S. 831, 90 S.Ct. 83, 24 L.Ed.2d 81 (1969); Levin v. Great Western Sugar Co., 406 F.2d 1112 (3d Cir.), cert. denied, 396 U.S. 848, 90 S.Ct. 56, 24 L.Ed.2d 97 (1969), in the same manner as damages ordinarily are ascertained in a Rule 10b-5 action.

. For support of this proposition in the literature, see Comment, Schlick v. Penn-Dixie Cement Corp.: Fraudulent Mismanagement Independent of Misrepresentation or Nondisclosure Violates Rule 1 Ob-5, 63 Calif.L.Rev. 563, 570 (1975); Note, The Controlling Influence Standard in Rule 10b-5 Corporate Management Cases, 86 Harv.L.Rev. 1007, 1044 (1973); 47 N.Y.U.L.Rev. 1229, 1230 (1972).

. Under state law the only recourse available to the aggrieved shareholders is to initiate an appraisal proceeding, thereby hoping to be awarded the full value of their lost shares. In light of a variety of factors common to state appraisal laws, it is generally agreed that they provide an unrealistic remedy. See generally, Brudney, A Note on “Going Private," 61 Va.L. Rev. 1019, 1023-25 (1975); Brudney & Chirelstein, Fair Shares in Corporate Mergers and Take Overs, 88 Harv.L.Rev. 297, 304-07 (1974); Eisenberg, The Legal Roles of Shareholders and Management in Modern Corporate Decision Making, 57 Calif.L.Rev. 1, 85 (1969); Manning, The Shareholder’s Appraisal Remedy: An Essay for Frank Coker, 72 Yale L.J. 223 (1962).
The Delaware statute is typical. The public shareholders are afforded no right to equitable relief under the statute and therefore are totally dependent upon the valuation figure settled upon by the appraiser. Stauffer v. Standard Brands Inc., 41 Del.Ch. 202, 187 A.2d 78 (1962). Yet in determining the value of the “frozen out” shares, the appraiser may not award the public shareholders any gain resulting from the merger itself or the expectation thereof. Under the terms of the statute, any payment must be “exclusive of any element of value arising from the expectation or accomplishment of the merger or consolidation.” Del.Code Ann. tit. 8, § 262(b). This measuring criterion has been interpreted very stringently. For example, an appraiser may not award “an aliquot share in the value of the assets of the merged corporation.” Application of Delaware Racing Assoc., Del., 213 A.2d 203, 209 (1965). The appraiser’s focus must be entirely retrospective: “The determination must be based upon historical earnings rather than on the basis of prospective earnings.” Francis du Pont v. Universal City Studios, 312 A.2d 344, 348 (Del.Ch. 1973). *1298In short, the controlling shareholders have every incentive to “freeze out” the outsiders since, even if the appraisal procedure functions perfectly, by the terms of the statute the insiders alone capture all of the prospective gains associated with the merger.
In addition, procedurally the Delaware appraisal route is far inferior to a federal cause of action in terms of protection for the minority shareholders. For example, unlike a federal class action Delaware explicitly bars those who actually initiate an appraisal from receiving compensation from non-active members of the class of displaced shareholders, even if the latter have expressed their disagreement with the merger terms and have asked to be included in the final recovery. Raynor v. LTV Aerospace Co., 317 A.2d 43, 46 (Del.Ch. 1974); Levin v. Midland-Ross Co., 194 A.2d 853, 854 (Del.Ch. 1963). The Delaware courts acknowledge that this inevitably creates a free-rider problem, see 317 A.2d at 46, which in turn insures that only a minority shareholder with a large bloc of shares will find it beneficial to seek an appraisal in the first instance. As Dun’s Review, January 1975, at 64, notes: The proceeding takes years . . and the investors do not even collect dividends while the appraisal is in the courts. Unless a shareholder has at least 20,-000 shares, most attorneys believe it rarely pays off financially. . . Furthermore the statute expressly excludes the costs of attorneys or expert fees from the appraisal recovery. Tit. 8, § 262(h).
Finally, the extent of discovery rights available to displaced investors remains unclear. The statute provides that the appraiser “may” examine any books and records of the corporation in question, § 262(e), but says nothing about the minority shareholders other than to insure them “a reasonable opportunity . . to submit to him pertinent evidence on the value of the shares,” § 262(e). In the past, when “frozen out” shareholders have attempted “to complicate the issue raised” by demanding “proceedings of an adversary nature,” they have been repudiated. Lichtman v. Recognition Equipment Inc., 295 A.2d 771, 772 (Del.Ch. 1972) (claimant cannot introduce evidence of the value of stock options lost due to the merger). And while the outside shareholders therefore remain heavily dependent upon the corporation for information, Delaware law does not require disclosure of such information to shareholders even after the fact except for notice of the completed merger and a statement of the buy-out price. Tit. 8, § 253(d). As one commentator notes, “[t]he crucial valuation evidence — estimates of future earnings or of salable value of assets — is available to management but rarely to outsiders. Hence, these evidentiary problems which beset an outsider seeking appraisal or challenging for unfairness a merger which was timed by insiders make it a rare case in which he will succeed in establishing a value higher than was offered in the merger, in view of the leeway which courts allow to management’s judgment." Brudney, supra, at 1024 n. 21.