The opinion of the court was delivered by: WEINFELD
WEINFELD, District Judge:
This litigation revolves about a contract for the sale of a block of unregistered stock of Dilbert's Quality Supermarkets, Inc., a corporation which had been engaged in the supermarket and food store business in the Metropolitan New York area. The litigants are (1) Arthur and Samuel Dilbert, the sellers of the stock; (2) Abraham Dilbert, their cousin, the purchaser of the stock; and (3) the partners of an investment and underwriting concern, S. D. Fuller & Co.,
who jointly and severally guaranteed the performance by Abraham Dilbert of the purchase contract.
Under the terms of the contract entered into on March 10, 1961, Abraham Dilbert agreed to purchase from his cousins, Arthur and Samuel, 164,540 shares of common stock, including the common stock to be obtained on conversion of preferred shares, at a price of $6 per share, for a total of $987,240. Upon execution of the contract $210,000 was paid for 35,000 shares, which were delivered on May 9, 1961. The balance of the shares as they came into the sellers' possession were to be deposited in escrow, and the purchaser was obligated to draw these down in five equal annual installments beginning on March 10, 1962, delivery to be made upon payment at the agreed price per share.
No registration statement was in effect as to the 164,540 shares, which represented approximately twenty-seven per cent of the then outstanding stock. However, "Abraham Dilbert and his designees" agreed that the purchased shares were being acquired for investment so that the transaction would come within the exemption provision of Section 4(1) of the Securities Act of 1933.
The Fullers, upon execution of the contract and as required by its terms, signed the following guaranty: "Performance of the foregoing agreement by Abraham Dilbert is hereby guaranteed." Simultaneously, the Fullers entered into a separate agreement (referred to as the designation agreement) with the purchaser under which (as permitted by the stock purchase agreement) they, the Fullers, purchased 8,500 shares of Abraham Dilbert's initial acquisition of 35,000 shares, for which they paid $51,000; in addition, they agreed to purchase fifty-five per cent of the balance of the shares that Abraham was to take down in installments.
In March 1962 the sellers, upon the failure of the purchaser or the guarantors to take down and pay for the first installment, declared a default; in April 1962, by reason thereof, they claimed the entire purchase price and gave notice they intended to sue. But before the sellers instituted any action, the guarantors commenced this suit for a declaratory judgment that the contract for the sale of the stock was void and unenforceable on the grounds that the sale was not for investment, but was a public distribution in violation of Section 5 of the Securities Act of 1933,
and that the sellers did not own all of the stock contracted to be sold, a violation of Section 16(c) of the Securities Exchange Act of 1934.
The initial pleading asserted no charge of fraud or conspiracy on the part of Abraham, Arthur and Samuel Dilbert.
The role in which the litigants were eventually cast in consequence of successive amended pleadings has some significance. The purchaser, Abraham Dilbert, in answer to the guarantors' first amended complaint, cross-claimed against the sellers, Arthur and Samuel Dilbert, for rescission of the contract, asserting it had been induced by fraudulent representations and concealments on the part of the sellers as to the financial condition of the company. In response the sellers moved to dismiss the cross-claim and for summary judgment, contending that since Abraham was executive vice president of the company and chargeable with knowledge of its affairs and condition, the claim of fraud was sheer pretense. This motion was denied, as was a motion for summary judgment against the guarantors.
Thereafter, the guarantors, in a second amended complaint, adopted the purchaser's allegations of fraud and sought to void the contract on this additional ground.
The sellers then counterclaimed against the guarantors for breach of their guaranty and sought recovery of the balance due; they also sought recovery from the purchaser for his breach of the contract.
As the pretrial procedure moved forward, the Fullers served a fourth pleading (a third amended complaint) in which they charged, as they had not previously, that Abraham, the purchaser, had conspired with his cousins, the sellers, to defraud them, the guarantors. This fourth and final pleading by the plaintiffs in substance sets up two separate causes of action: (1) that the purchaser and sellers had conspired to induce them to execute the guaranty and designation agreements by means of fraudulent representations and concealments involving common law fraud and a failure to comply with the stricter requirements of fair dealing imposed by the Securities Exchange Act of 1934, and (2) that the purchase agreement and their guaranty of its performance are void and unenforceable as in violation of Section 5 of the Securities Act of 1933, Sections 16(c) (1) and 16(c) (2) of the Securities Exchange Act of 1934, and Section 664(7) of the New York Penal Law. The plaintiffs further, in defense to the sellers' counterclaim for the contract price, allege nonperformance by the sellers.
The issues were sharply contested in an extensive trial, during which almost 2,000 pages of testimony were taken and scores of exhibits running into hundreds of pages received in evidence. The principal litigants were witnesses upon the trial; another important witness was an attorney who had participated in the negotiations and the contract closing. Whether he represented the Fullers or Abraham Dilbert, the purchaser, or both, was a sharply controverted issue - one of some significance, since if the attorney acted for the Fuller interests, his knowledge of certain matters touching upon the fraud charges was attributable to them.
The determination of the fact issues has not been without its difficulties, principally because of the generally unsatisfactory nature of much of the testimony of the interested parties. The testimony of the guarantors with respect to a number of material matters abounded in self-contradictions and, in some respects, was in conflict with the testimony of one another. The purchaser, eventually charged by the guarantors as a conspirator together with the sellers, had himself, as already noted, sought to void the purchase agreement upon allegations of misrepresentation. Thus, to an extent, and at a time when the guarantors had leveled no fraud or conspiracy charges against him, his interests were in large measure allied with theirs - voiding of the contract would release both from their commitments. This identity of interest was abundantly manifested; it was revealed by ready and acquiescent answers to leading questions at once redounding to his as well as to the guarantors' advantage. Then, too, there were instances where the purchaser admitted the falsity of his testimony, both upon his pretrial deposition and at this trial. Finally, one of the sellers, with respect to one matter which the guarantors advance in seeking to void the agreement, had given false testimony in a bankruptcy proceeding and upon his pretrial deposition, which he acknowledged and had corrected prior to the trial.
Out of the welter of this type of testimony the Court has had to sift fact from fiction, truth from untruth. In the situation here presented, events, when viewed in proper perspective against the background of time, setting and circumstance, may be more revealing and shed greater light upon what actually transpired than what the witnesses say,
or they may give support to a witness' testimony as credible or require its rejection as unworthy of belief. The ultimate test in passing upon the credibility of the witnesses after taking into account, among other matters, the inconsistencies whether inadvertent or deliberate, the contradictions, the admitted prior falsities, is, did the witness tell the truth before this Court at the current trial?
Based upon the Court's trial notes, which include its contemporaneous appraisal of each witness, a word by word reading and study of the stenographic transcript of the trial, the demeanor of the witnesses, an evaluation of their credibility and the reasonable inferences to be drawn from established facts and surrounding circumstances, this Court concludes that the plaintiffs have failed to establish either common law fraud or other fraudulent conduct under the Securities Exchange Act or their claim that the sellers and the purchaser engaged in a conspiracy as charged.
To set matters in proper perspective, events preceding the signing of the contract must be considered.
Dilbert's was founded in 1914 by three brothers: Louis, the father of Arthur and Samuel, the sellers; Harry, the father of Abraham, the purchaser; and Charles, a third brother. The business was originally conducted as a partnership, but was incorporated in 1925. By 1957 the enterprise consisted of a retail chain of seventeen supermarkets and twenty-two food stores in Brooklyn, Queens and Nassau County, all operated under the Dilbert name. The stock of the corporation was then held principally by Louis Dilbert, its president, who owned forty per cent; Abraham Dilbert, its executive vice president, who owned ten per cent, and one S. Solon Cohen, a son-in-law of Louis and a brother-in-law of the sellers. Cohen, in March 1956, had acquired a forty-five per cent stock interest (that of founder Charles, then deceased).
In 1957, to raise funds for a continued expansion program, the company "went public" to the extent of 180,000 shares of common stock (in units). The Fuller organization was the underwriter of this public distribution, and its senior partner, Stephen Fuller, was elected a director of Dilbert's pursuant to the terms of the underwriting agreement. In May 1960 Louis Dilbert, the last of the founders, died. Under his will, which was duly probated, he made a specific bequest to each of his sons, Arthur and Samuel, of 48,827 shares of Dilbert stock. These shares, together with others which they had acquired during their father's lifetime, are those sold under the contract here at issue.
For some time prior to the signing of the contract on March 10, 1961, the chief and dominant figure in the company was S. Solon Cohen who, in addition to being the largest single stockholder, was chairman of the board and president. Abraham Dilbert was executive vice president and a director; his cousins, Arthur and Samuel, were respectively vice president and secretary, and each was also a director. Cohen, his wife (sister of the sellers), his son and a business associate also were directors. Counsel to the corporation and Stephen Fuller completed the board.
It certainly is not open to serious challenge on this record that Cohen ran the affairs of the company, determined its policies and ruled with an iron hand. He acted as though Dilbert's were his private preserve, ignoring the other directors and executives, and withholding information from them. All were subordinate to him or acquiesced in his judgment after the event. Although there was an executive committee of three, consisting of Cohen, Abraham and Arthur Dilbert, it did not function. Cohen was abusive in his dealings with subordinates, store managers, executives and fellow directors, particularly those related to him by marriage, the sellers herein, who were cowed by him. Despite their titles as officers and directors, in fact their roles in the corporate hierarchy were not major and they functioned principally as employees.
In June and July 1960, at a board meeting and in press announcements, Cohen had painted a rosy picture of the company's prospects for that year. As it turned out, the company sustained a loss of $263,000 for the first six months, which did not come to the attention of the Fullers and other directors until October of 1960, when it was announced in a financial journal. The Fullers' requests for details as to the unanticipated loss were ignored by Cohen, notwithstanding that apart from Stephen Fuller's right as a director to information, they were entitled to receive, under the underwriting agreement, complete certified annual audits, noncertified semi-annual earning statements, and advice as to monthly sales of groceries, meats and produce. This was a familiar pattern, since previous requests for reports and monthly figures had consistently been disregarded by Cohen as far back as 1958 - as Stephen Fuller himself phrased it, he got the "brushoff," and the little information which occasionally he received orally was "very unsatisfactory." The other directors were similarly treated.
Entirely apart from the first half 1960 loss, Cohen's actions and conduct had caused serious concern about the company's future. In 1959 and 1960, without consultation with fellow directors, he made a number of significant moves that were ill-timed and ill-advised. By the fall of 1960, the Fullers had given up asking Cohen for reports; they had not only become "disenchanted" with, but had developed a violent distaste for, him, both as an individual and as manager of the business. They were dissatisfied with the general state of the company and recognized its salvation was to get rid of Cohen. Abraham Dilbert was of similar mind and led the movement to oust Cohen. The Fullers cast their lot with Abraham soon after they learned of the first half loss. Abraham, with Fuller support, urged Arthur and Samuel to pool their stock to force the issue. They declined because of family relationship and because they had no stomach for a proxy fight, notwithstanding Cohen's browbeating and ill-mannered treatment of them. Nor, during this period, although solicited to do so, were Arthur and Samuel willing to sell their stock.
The breakthrough came late in February 1961, when Arthur and Samuel manifested readiness to sell the stock inherited under their father's will, motivated by the need for cash to pay their share of the estate taxes, the illness of one of them, and because they no longer could take Cohen's abuse. Abraham Dilbert acquainted the Fullers with the turn of events, and they agreed the acquisition of this large block of stock afforded a real opportunity to rid the company of Cohen. The sellers, from the start aware that Abraham himself lacked the means to pay for so large a block of stock, insisted that any purchase by him had to be underwritten by a responsible guarantor.
Negotiations commenced in earnest on March 1 with an initial session participated in by Martin Davis, a Fuller partner, Abraham, the purchaser, and Arthur, one of the sellers. Then followed conferences and telephone calls between and among interested parties. Late Friday evening, March 10, after an extended conference, the agreement now under attack with its appended guaranty was concluded and signed by all parties.
On Monday, March 13, Cohen announced at a special board meeting that the first half losses had grown to over $500,000 for the nine-month period of 1960, but assured the directors that the "preliminary indications were that the losses had been stopped as of the last quarter of the last fiscal year." This information did not deter the Fullers and Abraham Dilbert from their campaign to oust Cohen; rather, it intensified their efforts. They continued to marshal the stock of their friends and associates and purchased additional shares on their own account and for friendly interests.
On May 5 the Fullers learned that the loss for the entire fiscal year 1960 was over one million dollars. A special board meeting was held on May 8, which Cohen did not attend, at which the 1960 figures were officially announced. With the Fuller group seemingly in control, Abraham Dilbert was named as "acting Principal Executive Officer." The meeting was recessed to May 15, when the Cohen forces, then having a majority of the board, made a brief comeback and passed a series of resolutions aimed at entrenching themselves and solidifying their position for the prospective proxy showdown at the annual stockholders' meeting scheduled for June.
But Cohen soon gave up the ghost without a fight - after Stephen Fuller sent word to him that his group had the necessary votes to oust him. A special meeting was held on May 25, at which Cohen formally resigned as chairman of the board and president; his associates also resigned as directors and officers; Abraham Dilbert was elected to succeed Cohen; the resolutions of May 15 were rescinded and the annual meeting of stockholders was set for June. At that meeting the Fuller slate of directors, including two Fuller partners, was elected. Irrevocable proxies, which had been executed and delivered upon the contract closing by the sellers covering all the shares of stock owned by them beneficially and of record, were voted by the purchaser in favor of the slate.
Thus, the Fullers and Abraham Dilbert achieved their objective of ridding the company of Cohen and taking over its management. But the losses had continued, running to $448,000 for the first five months ending June 3, 1961, by which date the Fuller group was in control.
The record is silent until March 1962 when, upon the failure of the purchaser to take down and pay for the first installment of shares and the guarantors' failure to make good, the sellers declared a default.
The guarantors' charges of conspiratorial conduct by the purchaser and the sellers upon which they predicate their refusal to honor their guaranty fall into two broad categories: (1) affirmative misrepresentations, and (2) concealment of material facts. While the spread of plaintiffs' claims of affirmative misrepresentations was broad, their thrust centered about the financial condition of the company for the second half of 1960. Stephen Fuller testified that when, in November 1960, he learned of the first half loss of $263,000, he sought, but as in the past was unable to obtain, satisfactory information from Cohen; that he then directed his inquiry to Arthur Dilbert, who stated the losses were of a nonrecurring nature and there was nothing to worry about since the fourth quarter was the best; that again in January and February 1961 he called Arthur (after he was unable to contact Cohen), who assured him the company had "a wonderful fourth quarter," with profits sufficient to overcome the first half loss; that the company was "sound" and operating "in the black." These statements, it should be noted, allegedly were made not only prior to the contract negotiation period, but also before the plaintiffs knew of the Dilberts' willingness to sell their stock, which the plaintiffs fix as March 1.
Coming closer to the contract date, Martin Davis, a Fuller partner who at the initial conference on March 1 had negotiated the $6 per share price, testified that Arthur Dilbert made similar statements about the company operating in the black and also that the stock was worth more than $9, the then market price.
Stephen Fuller testified that the following day, March 2, Arthur said he knew the company was "sound," "in the black," and that the second half was "profitable." A third Fuller partner, Paul Fuller, claimed that on March 4 Arthur, and Samuel too, gave assurances that the first half loss was nonrecurring; that the company was in the black and making a profit for the second half, and that as soon as Cohen was out "the company could take off because they were in a good financial condition."
Yet there are patent ambiguities in their respective versions. Stephen Fuller also testified that Arthur said he "hoped" that the company had made a profit in the second half; that he "[believed]" it was sufficient to wipe out the first half loss; that it "might have" made a profit for the whole year; and also that he didn't know whether the company "would" make a profit sufficient to make up for the $263,000 ...