Before MOORE, FRIENDLY and KAUFMAN, Circuit Judges.
For some ten years, the subject matter of the lawsuit now on appeal has been before the New York State and federal courts. The particular aspect now presented is an appeal from a judgment in an action in the district court wherein plaintiff (appellant), Alleghany Corporation, sought to set aside, as obtained by fraud, a settlement of stockholders' derivative actions. Alleghany Corp. v. Kirby, 218 F.Supp. 164 (S.D.N.Y.1963). This appeal is further limited to the claim that the settlement was obtained by defendant (appellee) Allan P. Kirby, as a result of his failure voluntarily to disclose upon the settlement certain facts, essential to a proper adjudication of the fairness and adequacy thereof, alleged to have been known to him at that time. The district court found adversely to appellant.
The transaction giving rise to the many suits originated on December 6, 1949. On that date four officers and directors, including defendant Kirby, voted illegally (so alleges plaintiff) to give themselves an opportunity to exchange Alleghany preferred stock held by them for Alleghany's entire portfolio holdings of 48,225.61 shares of Class A stock of Investors Diversified Services, Inc. (IDS). Pursuant to a December 6, 1949 resolution authorizing an exchange, Kirby tendered his Alleghany preferred stock to Alleghany and Alleghany, in turn, transferred 24,062 shares of IDS stock to Kirby at a price of $8.1453 per share.
By 1954 the price of the IDS stock had advanced to some $200 a share. At such a price Kirby alone had profited at the expense of Alleghany in an amount in excess of $4,500,000. Champions on behalf of Alleghany did not long remain on the sidelines and soon (1954-55) many derivative suits were commenced in both state and federal courts. Other similar suits were brought in the federal court. In accordance with a practice which had developed in the State court to avoid complete chaos amongst the many wouldbe champions, under the caption of Zenn et al. v. Anzalone et al., Sup.Ct., N.Y.Co., 17 Misc.2d 897, 191 N.Y.S.2d 840 (referred to as the Zenn suits), the ten suits were consolidated and a general counsel (Abraham L. Pomerantz of the firm of Pomerantz, Levy & Haudek) was designated for the plaintiffs in the state and federal suits. Such counsel and his firm were most skilled and experienced (at least for over twenty years) in ferreting out fraud on the part of directors alleged to have been more mindful of serving their own interests than those of the corporations whose interests they should have been serving*fn1 Naturally the complainants in the various suits turned their spotlights on the IDS stock exchange and the fact that the beneficiaries thereof knew of, or were in a position to know of, the enormous prospective increase in earnings of IDS.
More specifically, the consolidated amended complaint (First Cause of Action) alleged that Kirby, Robert P. Young and other named co-defendants were engaged in a conspiracy "to enable defendants Young and Kirby to enrich themselves at the expense of Alleghany"; that the IDS stock exchange was to be made at Alleghany's cost or the market price determined as of the final exchange date whichever was higher and "was to be conditional upon ratification by Alleghany's common stockholders at their annual meeting on May 3, 1950"; that the proxy statement was "false and misleading with respect to material facts and omitted to state material facts necessary to make the statements therein not false or misleading," in part, including a failure to reveal not only an actual increase in earnings for the first three months of 1950 (i.e., $2.17 per IDS share, projected as $8.68 on an annual basis) but also a trend to further improvements "foreseeable to and foreseen by the individual defendants"; that 1950 earnings amounted to $20.76 a share; that the earnings trend was reflected in a spectacular increase in market value (also "foreseeable to and foreseen by") to $28, $37.75, $89.50, $100 at the end of the respective years 1950-53 and about $200 at the date of the complaint; that even at the date of the exchange (May 15, 1950) Kirby failed to pay the required consideration in that he paid $148,273.79 less than called for by the respective market prices of Alleghany preferred Series A and IDS stock; and that as a result of such fraud both the exchange and the purported stockholder ratification were void*fn2 Recision or the difference in value between the price paid and the real worth of the IDS stock was demanded. Kirby, although named as a defendant in the state court suits, actually was not served with process therein.
As not unusual in this type of suit, settlement negotiations soon began and in July 1955 a settlement stipulation in the Zenn suits was drafted. Alleghany thereupon moved in the New York Supreme Court for approval of the settlement. A Referee was appointed by the court to inquire on the merits into the fairness and adequacy thereof. Under New York practice, notice of the terms of the proposed settlement was sent to all stockholders and hearings commencing in September 1955 were held before the Referee.
In February 1955 a suit had been brought in the federal court in New York by another group of stockholders entitled Breswick v. Briggs, S.D.N.Y., 135 F.Supp. 397.Although some of the charges made were similar to those in the Zenn suits, the 1950 IDS stock exchange was not placed in issue.
The Breswick plaintiffs had not been participants in the Zenn settlement negotiations. For this reason and lest they be bound by any settlement therein, they sought and obtained in October 1955 a federal court injunction against the interposition of any defense based upon any settlement agreement not negotiated with them.
Returning to the hearings before the Referee in the Zenn action, there was vigorous opposition to the settlement. Many of the arguments now advanced were urged as reasons for rejecting the settlement. Counsel (Seymour Graubard of Graubard & Moskovitz) for one objectant (Rosen) in particular worked in close association with counsel in Breswick. The statistics as to the nature and duration of the hearing are revealing. Eighteen witnesses were called, some 480 exhibits introduced, over 4,600 pages of testimony were taken and twenty-two law firms and attorneys appeared. The hearing on the merits of the settlement was, in effect, a hearing on the merits of the suits.
The primary issue in the first cause of action in the Zenn suits was whether Kirby knew or should have known that the IDS stock, which he obviously had acquired from Alleghany in a self-dealing transaction, was worth far more than he paid for it. Counsel for Alleghany, to establish such knowledge and a logical imputation thereof, sought to and did by pre-trial procedures delve into the files of Alleghany and IDS for proof.
The Referee characterized the hearings as "truly an adversary proceeding, more nearly resembling a trial on the merits than a hearing on a proposed settlement * * *" He accurately perceived the principal issue, namely, Alleghany's claim that the defendants had failed adequately to reveal to the stockholders "the alleged sharp upward turn in the profits of IDS and the further improvement of future earnings which it is claimed was foreseen by Young, Kirby and Purcell."
Before considering the facts which appellant claims were not before the Referee, the alleged concealment of which forms the basis of its argument that the settlement was tainted with fraud, it would be well to review briefly certain items of proof before the Referee which bore upon Kirby's then (December 1949 through May 1950) knowledge or which might reasonably have put him on notice of substantially increasing earnings.
In February 1950, Robert W. Purcell had written Young and Kirby advising them of a net income before home office expenses forecast for the IDS mortgage department alone of $5,720,000 for 1950 in contrast with $2,277,000 for 1949. Kirby was told that this estimate was said to be "very conservative" and that mortgage department "operations promise to show continued substantial earnings." Had Kirby inquired at the end of the first quarter of 1950 as to net income, he would have learned of an income figure of $639,040 instead of a corresponding 1949 first quarter loss of $1,298. Purcell's optimism for 1950 was justified by a net income for 1950 of $6,454,411 instead of $1,365,485 for 1949. In addition, the Referee had the actual net income figures for the years 1949-1953 as contained in the IDS annual reports which showed a steady increase from $374,355 in 1948 to $13,229,310 in 1953.
During the trial in the district court, Alleghany caused to be produced certain documents which were not before the Referee and claimed that Kirby's failure to adduce them on the settlement hearings prevented the Referee from properly evaluating the fairness and adequacy of the proposed settlement under consideration. Of the "non-disclosed" documents which Alleghany claims were of critical significance, it stresses the following:
A. The Froggatt Report of April 29, 1949 .
This report was addressed to the IDS Board of Directors and was primarily concerned with a valuation of IDS certificates in force as of December 31, 1948. In addition, a prognostication was made for the years 1949-53 of net income available for improving certificate reserves before profit or loss on sale of investments or income taxes.Kirby apparently had received this report in August 1949. It was mentioned in an exhibit introduced before the Referee and was later found in Alleghany and IDS files.
B. An IDS Projection of Net Income for the Years 1949-53 Before Profit or Loss From Sales of Investments and Income Taxes .
There was no evidence that Kirby had received these figures.
C. An IDS Projection of Net Income for 1950 Through 1954 and a Projection for 1950 by Months .
These projections produced from the IDS files in discovery proceedings were not admitted in evidence by the district court because there was no evidence that Kirby had ever had them in his possession or that he knew of them. Nor was there any showing that counsel in Zenn had been in any way precluded either in pre-trial or in the settlement hearings from seeking any and all papers in the possession of IDS. To the contrary, there was proof ...