The opinion of the court was delivered by: RUBIN
The parties to these consolidated class actions have agreed to settle the claims of those who were formerly preferred stockholders of Brown Company ("Brown") arising out of an exchange of their stock for debentures and warrants on June 9, 1970. Notice of the proposed settlement was given to all members of the class. Judicial approval of the settlement is now sought, in accordance with the requirements of Rule 23(e), F.R.C.P.
The original class consisted of the holders of 597,913 shares. The holders of 15,018 shares exercised their option not to be included in this action. One of these, Belsky & Co., Inc., ("Belsky") the holder of 2500 shares, requested the opportunity to revoke this "option out" so it could oppose the proposed settlement. Only Belsky appeared at the hearing held to determine whether the settlement would be approved.
In addition, the holders of 826 other shares filed written oppositions.
The duties of the court with respect to a proposed settlement require it first to reach "an intelligent and objective opinion of the probabilities of ultimate success should the claim be litigated" and "form an educated estimate of the complexity, expense, and likely duration of such litigation . . . and all other factors relevant to a full and fair assessment of the wisdom of the proposed compromise." Protective Committee v. Anderson, 1968, 390 U.S. 414, 424-425, 88 S. Ct. 1157, 20 L. Ed. 2d 1. Accordingly, we first consider the nature of the action and the potential evidence that has been developed in order to determine the likelihood of success by the plaintiffs and the likely quantum of damages in the event of recovery.
SUMMARY OF ACTION AND PROPOSED SETTLEMENT
Brown is, and has been for many years, a manufacturer of a variety of forest and paper products. Brown's common stock is listed on the New York Stock Exchange as was its preferred stock prior to the recapitalization. At all relevant times the majority shareholder of Brown was defendant Gulf & Western Industries, Inc. ("G&W"), a diversified company, commonly called a conglomerate, based in New York. The individual defendants were officers or directors of Brown.
The essence of plaintiffs' case is that Brown and its controlling shareholder, G&W, effected the recapitalization for the benefit of G&W and to the detriment of the minority Brown preferred shareholders in violation of the federal securities laws and the common law, in breach of the directors' fiduciary obligations, and as a tortious interference with the contractual relationship between Brown and the preferred shareholders.
The proposed settlement seeks to readjust the package given to these minority shareholders by awarding them a gross additional consideration of $1,600,000, amounting to $2.75 per share, payable in the same warrants they were given as part of the original package. If defendants fail to comply with certain conditions, the additional consideration will be paid in cash. It is proposed that attorneys' fees be allowed in the amount of $400,000, or 69 cents per share, making the net recovery $2.06 per share.
This is a consolidation of three class actions, J. Wolfe Golden et al. v. Gulf & Western Industries, Inc., et al. (S.D.N.Y.); Raymond W. Cromer & Marybelle K. Cromer v. Gulf & Western Industries, Inc., et al. (W.D. Pa.), and Michael Shapiro, etc. v. Gulf & Western Industries, Inc., et al. (E.D. Pa.).
Shortly after the commencement of these three actions, defendants moved, pursuant to 28 U.S.C. § 1407, for the transfer of these actions to the Southern District of New York, and for coordinated and consolidated pre-trial proceedings including these suits and an individual action entitled Henry Folger v. Brown Company. That motion was granted by the Judicial Panel on Multidistrict Litigation on April 6, 1971, 325 F. Supp. 307, and these actions were accordingly transferred to the United States District Court for the Southern District of New York and assigned to Judge Alvin B. Rubin, of the Eastern District of Louisiana. Subsequently, an order was entered pursuant to 28 U.S.C. § 1404 and F.R.C.P. 42 transferring these actions to the United States District Court for the Southern District of New York for all purposes and consolidating them for all purposes. All proceedings have been held in the Southern District of New York except a conference to review the notice of the proposed settlement and to set a date for hearing on it, which was held in New Orleans, Louisiana. There have also been conferences among all counsel and the court by telephone, with the judge participating from his chambers in New Orleans, Louisiana.
By order dated June 4, 1971 this Court, pursuant to F.R.C.P. 23, determined that these actions were maintainable as class actions on behalf of all persons who were holders of Brown preferred stock on May 1, 1970 and their successors in interest, i.e., executor, administrator, trustee, heir, beneficiary or assignee, except defendants, and on October 5, 1971 notice of this determination was given to members of the class by mailing it to all preferred shareholders of record as of May 1, 1970.
The Transactions Under Attack
Pursuant to stipulation, plaintiffs were permitted to file a joint amended complaint superseding the individual complaints previously filed. After the conclusion of plaintiffs' discovery a second amended complaint was filed.
The Joint Second Amended Complaint is primarily concerned with the Brown Proxy Statement dated May 8, 1970 (the "Proxy Statement") which was sent to the members of the Class in connection with a special meeting of Brown stockholders held on June 9, 1970. At that special meeting, stockholders of Brown (including, by a two-thirds class vote, the preferred stockholders) approved a reorganization of Brown that served to convert the preferred stock into debentures and warrants. The reorganization was accomplished by means of a merger of Brown and a wholly owned subsidiary created for that purpose (the "Merger"). Pursuant to the Merger, each share of preferred stock was converted into a $19 face amount subordinated debenture with interest at the rate of 9% per annum
and 1 1/4 warrants, each warrant for the purchase of one share of Brown common stock at a price of $16.50 per share. In addition, the stockholders of Brown at this meeting approved the acquisition by Brown of approximately 82% of the Class A common stock and all of the preferred stock of Livingston Rock & Gravel Co., Inc. ("Livingston").
The major allegations of the complaint, as it was finally put to the court, after amendment to delete claims found during discovery to lack merit, and to add claims learned of through discovery, can be briefly summarized as follows:
Since August 1968 when G&W completed a successful tender offer for the common and preferred stock of Brown, G&W and the individual defendants controlled Brown and operated it for their own benefit and to the detriment of the preferred stockholders. For some time the defendants fraudulently schemed to destroy the preferences and rights of the Brown preferred stockholders and embarked upon a course of conduct designed to carry this scheme into effect. Plaintiffs claim that this scheme was ultimately effectuated by means of an unfair merger and a false proxy statement.
In addition to their charge of a fraudulent scheme, plaintiffs make numerous allegations claiming that the Proxy Statement was false and misleading in several material respects. These allegations are discussed in more detail below.
Plaintiffs also claim that the Merger was unfair to members of the Class and that the acquisition of Livingston was detrimental to the members of the Class. The Joint Second Amended Complaint asserts that the actions of the defendants constituted violations of §§ 12(2) and 17(a) of the Securities Act of 1933 and §§ 10(b) and 14(a) of the Securities Exchange Act of 1934 and the rules and regulations promulgated thereunder. In their prayer for relief, plaintiffs seek damages equal to the difference between the value of the Brown preferred stock and the value of the debentures and warrants issued in exchange therefor and claim that the value of such preferred stock was equal to its redemption price as of June 9, 1970 plus accrued dividend arrearages.
As of June 9, 1970, Brown preferred stock had an alleged estimated liquidation value of $33 per share and a redemption price of $34.65 per share. Both liquidation and redemption were solely at the option of Brown and could not be compelled by the preferred shareholders. In addition, as of that time, there were accumulated dividend arrearages of $2.25 per share on the preferred stock representing six quarters of nonpayment. On that date, however, the preferred stock traded on the New York Stock Exchange at $11.50 per share. During 1970 it had traded at prices ranging from a high of $17.63 to a low of $9.50. In 1969 it had traded at prices ranging from a high of $21.75 to a low of $13.
Commencing almost immediately after the transfer and consolidation of these actions, and continuing for almost nine months, plaintiffs served and obtained responses to extensive written interrogatories and requests for admissions. In addition, in response to requests for the production of documents, defendants produced vast quantities of documents (of which approximately 10,000 were copied by plaintiffs).
The court required a deposition schedule to be proposed that would enable the trial of the matter to be reached as soon as reasonably possible. The pre-trial orders contemplated discovery of writings followed by an intensive period of oral depositions.
After the completion of the "first wave" written discovery, plaintiffs served approximately 75 "second wave" interrogatories and document requests to which defendants again responded.
Plaintiffs then deposed twelve of the individual defendants or employees of the corporate defendants plus fourteen separate third-party witnesses.
These depositions took place at an average rate of two per week for four months and resulted in approximately 5,000 pages of transcript.
At the conclusion of the discovery proceedings, plaintiffs and defendants entered into protracted and arm's length settlement negotiations, which have resulted in the present proposed settlement. Defendants contend that they would prevail in this action and demonstrate that the charges made by plaintiffs are without merit; that they have agreed to pay the compromise sum solely to have peace from the risks inherent in litigation and from the cost of a trial that would likely be extended and expensive.
Further Factual Background
In 1966, Brown merged with KVP Sutherland, a Michigan based paper manufacturing company. As a result of the merger, each share of KVP stock was converted into one share of Brown preferred stock. This was the genesis of the preferred stock here in issue.
In early 1968 G&W decided to invest in Brown. Through a private transaction, it acquired 23% of Brown's common stock from Brown's principal shareholder. A few months later, after investigation, G&W concluded that it would like to own all of Brown's stock and, accordingly, made a public offer to exchange certain G&W securities for Brown's common and preferred stock. On August 1, 1968, at the close of the G&W tender offer and as a result thereof, G&W acquired 40% of Brown's preferred stock and an additional 45% of Brown's common stock, giving it a total of 68% of the outstanding Brown common and, therefore, effective control of Brown.
From the time of G&W's first investment in Brown, its nominees served on the Brown Board of Directors and, at the times of the acts complained of, the majority of Brown's directors were either senior executives of G&W or had other close ties to G&W. Also, during 1968 and the first half of 1969, various G&W executives from time to time assisted in the day to day operations of Brown, including taking a leading role in the relations between Brown and its lenders.
Brown was a relatively small manufacturer in the highly competitive and cyclical paper industry with rather poor historical earnings. It compared unfavorably with other companies that G&W had acquired at or prior to that time, but it was acquired with the hope that G&W management could render Brown's operations profitable.
After the acquisition, representatives of G&W investigated further the business and operations of Brown in detail. Brown was saddled with a high debt burden arising out of exceptional capital expenditures incurred in an effort to improve and modify Brown's most important facilities, its paper mills in Espanola, Canada and Berlin, New Hampshire. However, still optimistic, G&W decided to increase its holdings in Brown and in July, 1968 made an exchange offer to Brown's common and preferred stockholders. That exchange offer was successful and G&W became the owner of 68% of Brown common stock and 40% of its preferred stock.
In early 1968 the Brown Board of Directors voted to discontinue dividends on the Brown common stock; in late 1968 it voted to discontinue dividends on the Brown preferred stock. The major facilities at Espanola and Berlin continued to be unprofitable and inefficient. Despite the efforts of G&W to aid Brown management, including the assignment of a regular G&W employee to duties as a full-time consultant, losses continued. As a result, it became clear by the fall of 1968 that Brown would be unable to meet its obligations under its loan agreements and was threatened with imminent default. In short, Brown was at the verge of bankruptcy.
In an effort to remedy the situation, Brown sold some of its most unprofitable operations, including in particular the Canadian division. This resulted in a loss of $20,000,000 but generated cash that could be used to pay Brown's lenders.
In the fall of 1968 negotiations were opened to avert default under the Brown loan agreements. If the loan agreements could not be amended in a way satisfactory to the Brown lenders, it was likely that Brown would be placed in receivership. These negotiations continued through the middle of 1969, until, finally, acceptable amendments were agreed upon.
Brown's operations continued to be unprofitable. This was particularly true of the Berlin plant, Brown's most important division. In June, 1969, G&W assigned a new management team to Brown, headed by Merrill Nash who had established a reputation for successfully rehabilitating ailing companies as their chief executive officer.
After assuming the presidency of Brown, Mr. Nash acted in three major areas to improve Brown's condition. First, he investigated whether the more unprofitable operations of Brown, including the Berlin facility and surrounding lands, could be disposed of, both to improve Brown's profit picture and to yield the cash necessary to meet loan obligations and to support the other aspects of Brown's business. He was unable to accomplish this. Second, he determined to expand Brown's operations into other areas of endeavor that were less cyclical than the paper industry, and could yield better earnings. Of particular interest in this regard was the construction industry. Finally, he examined Brown's capital structure to see what had to be done to make Brown a more viable company.
It became clear to Mr. Nash and the other members of Brown management that the existence of the Brown preferred stock with its dividend arrearages, which had no prospect of being paid in the foreseeable future, was a detriment not only to Brown's general standing in the business and financial community, but to its ability to diversify. Therefore, by the summer of 1969, Mr. Nash, in conjunction with the other members of Brown management, determined that it was necessary to find a formula by which the preferred stock could be exchanged for some other form of security.
For several months Brown management considered what form of security could provide fixed payments to the preferred stockholders. After deciding on a debenture with interest payable in cash or stock, management considered possible terms, evaluated their fairness to preferred and common stockholders, and studied the effects of such terms on the future financial condition of Brown. Prior to a final formulation, Brown consulted Goldman, Sachs & Co. and Lehman Brothers, whose proposals it considered to be too generous to preferred stockholders and thus unfair to the common stockholders.
Finally, the terms proposed by Brown management were evaluated by Bear, Stearns & Co. Bear, Stearns & Co. refused to approve the terms unless changes were made in favor of the preferred stockholders. These changes included increasing the face amount of the debenture, lowering the exercise price of the warrants, permitting the use of the debentures at face for the exercise of the warrants, and increasing anti-dilution protection of the warrants. Some of these changes were made, but Brown refused to make others and Bear Stearns agreed to approve the proposal as thus altered.
Based on the foregoing, the basic issues in the lawsuits may be summarized as follows:
1. Did G & W and the Brown Board of Directors (i.e. the individual defendants) embark upon and effect the elimination of Brown's preferred stock by means of fraud?
2. Was the June 9, 1970 shareholder approval obtained by means of a proxy statement that was materially false and misleading?
3. To what extent, if any, was each class member damaged?
The Allegations Weighed Against The Evidence Now Available
The complaint herein alleges the charges by which plaintiffs intend to prove liability and it assesses the damages at the absolute maximum, i.e. the redemption value of the preferred less the minimum value of the package given in exchange. The charges, of course, were made at a time when plaintiffs necessarily lacked the detailed evidence by which they could be proved. In the circumstances of this case, such evidence could only come from the files and the testimony of defendants and other persons involved with defendants.
In summary, after detailed discovery and investigation, although there is considerable doubt (and vigorous disagreement on the part of defendants), plaintiffs' lead counsel asserts that, on balance, he believes that plaintiffs would prevail at trial on the liability issues noted above. Plaintiffs' lead counsel is mature, able, and experienced in this type of litigation. He has had the assistance of other able and resourceful counsel. When pressed by the court to estimate the probability of a judgment for plaintiffs, he fixed this as somewhere between 51-49 and 60-40. But plaintiffs' counsel also asserts that, having learned something about the defense evidence, there is little likelihood of plaintiffs being able to prove damages near the amount sought in the complaint, or indeed at an amount much in excess of the value of the consideration that defendants have now agreed to pay.
Although there are facts that, on first impression, might lead to the conclusion that G & W, from the inception of its interest in Brown, deliberately embarked on a course of conduct to depress the value of the Preferred Stock and then eliminate it for an unfairly low consideration, exploration of such ...