Before Friendly, Chief Judge, Oakes, Circuit Judge, and Davis,*fn* Judge.
This appeal and cross-appeal in a class action by minority stockholders of General Outdoor Advertising Co. (GOA), attacking its merger into defendant Gamble-Skogmo, Inc. (Skogmo), raise a variety of new and difficult questions with respect to the SEC's Proxy Rules, adopted under § 14(a) of the Securities Exchange Act, and the remedy for their violation. Three comprehensive opinions by Judge Bartels, 298 F. Supp. 66 (E.D.N.Y.1969), 332 F. Supp. 644 (E.D.N.Y.1971), and 348 F. Supp. 979 (E.D.N.Y.1972), along with two elaborate reports by the special master, Arthur H. Schwartz, Esq., on the amount of damages, attest to the problems which the recognition of a private right of action for violation of § 14(a) in J. I. Case Co. v. Borak, 377 U.S. 426, 84 S. Ct. 1555, 12 L. Ed. 2d 423 (1964), have thrust upon the federal courts, and also the assiduity with which the judge and the special master tackled them.
The facts are stated in such detail in Judge Bartels' first opinion, 298 F. Supp. at 74-89, that we can limit ourselves to those that are vital for understanding the issues on appeal. In order to make the following summary more enlightening, it will be well to state at the outset that the gravamen of plaintiffs' complaint concerning the Proxy Statement sent to GOA's stockholders was that its disclosure that Skogmo expected to realize large profits from the disposition of such of GOA's advertising plants as had not been sold at the date of the merger was inadequate.
GOA had been the largest company in the outdoor advertising business in the United States. It had also acquired over 96% of the stock of Claude Neon Advertising, Limited, the largest outdoor advertising company in Canada, and all the stock of Vendor, S.A., the largest such company in Mexico. Skogmo was a company engaged in wholesale and retail merchandising of durable and soft goods through subsidiaries, franchised dealers, and discount centers in the United States and Canada, and related activities.
Between April, 1961 and March, 1962, Skogmo acquired 50.12% of GOA's common stock. Bertin C. Gamble, chairman of the board of directors and controlling stockholder of Skogmo, was elected to GOA's board in October, 1961. He was followed by Roy N. Gesme, a former consultant to Skogmo, who was to act as liaison between the two companies. Two Skogmo vice presidents were added to the GOA board in April, 1962. In the same month Gamble engaged Donald E. Ryan, who had no previous experience in the outdoor advertising business, as an officer of GOA, primarily in charge of the sale of plants, and had him elected as a member of the board and executive vice president of GOA; the district court found, 298 F. Supp. at 75, that "Ryan was indisputably Skogmo's man at General and was expected to evaluate General's prospects and make recommendations to Skogmo for the future." There were seven other directors. Four, including Burr L. Robbins, the president of GOA, had been associated with GOA before Skogmo's acquisition of control; three were outsiders. Despite the fact that only five of the twelve directors were Skogmo men, Skogmo does not dispute that it had effective control of GOA.
Beginning in 1961 the outdoor advertising business began to encounter serious difficulties. Disappointing reports, indicating that income from advertising plants had fallen off substantially during 1961 and that the expected rate of return in the business was declining, were made to Gesme by the management in the early months of 1962. Upon assuming his duties in May 1962, Ryan, after an intensive study, reported to Gamble that GOA's advertising plants could not be operated profitably and should be sold. A strong impulse in that direction had been furnished by the sale, in January 1962, of GOA's St. Louis plant to a competitor at a price described as "fantastic".*fn1 After this sale, Gesme had prepared a detailed report on the property and earnings of each of GOA's plants, referred to as the "Green Book", which listed sales prices for the plants, apparently calculated on the basis of the St. Louis sale, that were generally well in excess of their book values.
In July 1962, Gamble publicly announced GOA's intention to sell its "less profitable" and "competing plants," and expounded at a meeting of GOA executives his policy of "corporate mobility" and diversification, to be accomplished by selling the less profitable plants and investing the proceeds in new projects. Robbins had at this time prepared a list of what he considered GOA's most profitable plants, and urged that they be retained to form the nucleus of a profitable outdoor advertising operation. Nevertheless, Ryan continued to solicit offers for the sales of all the plants. He made available to prospective purchasers five-year operating statements, supplemented, in September 1962, by eight-year earnings projections for each plant. These indicated that, if 29% of the asking price were paid in cash, the balance could be paid out of eight-year earnings.*fn2 Through October 1, 1962, GOA had sold 13 of its 36 plants, including two of those on Robbins' list, and had almost fully negotiated several more sales. All this represented somewhat of a victory for Ryan over Robbins.
The sales program was temporarily interrupted in October 1962, when counsel raised a question whether the receipt of the large volume of purchasers' notes and a substantial investment by GOA in the stock of Allegheny Corporation might not have caused GOA to become an investment company within the purview of the Investment Company Act of 1940. Gamble took two important steps designed to avoid this result. First, he and Walter Davies, Skogmo's treasurer, negotiated an agreement with The First National Bank of Chicago and three other banks for the sale of $14,000,000 of the 6% purchasers' notes then held by GOA, at their face value, with the banks to collect the interest, retain 5%, and hold the additional 1% in escrow to be paid to GOA upon full payment of the notes. With the proceeds of the sales of the plants and notes, Gamble then caused GOA to invest $22,459,391 in the purchase of approximately 98% of the stock of Stedman Brothers, Limited, a Canadian corporation operating a chain of small wares stores.
Accordingly, in the latter part of December, Ryan and others announced that plant sales were being resumed and that all plants save that at Minneapolis were available for sale. Many more plants were sold in that month. The result was that by the end of 1962, GOA had sold 23 of its 36 plants, including 7 of the 11 listed by Robbins as the top earners, for a total price of $29,832,260, of which $5,247,506 was in cash and $24,584,754 was in notes. At the same time, preparations were made for future sales. Toward the end of December 1962, the agreement with the banks was revised so that the syndicate would buy up to $55,000,000 of purchasers' notes - a sum sufficient to take care of the sale of all GOA's remaining plants. A memorandum showing an up-to-date valuation of the remaining plants was prepared in late November by William H. Dolan, GOA's controller, on the basis of the prior sales and offers made by Curtis L. Carlson for eleven plants sold in December.
In December, 1962, the SEC instituted an investigation to determine whether Skogmo was an investment company. General's officers were subpoenaed, and extensive hearings were held in January. Apparently this led to a slowing up of the sales program. The sale of the Kansas City plant, which had been fully negotiated in October 1962, was closed in January 1963, but in the same month Ryan wrote prospective purchasers that all sales were being suspended. This did not mean, however, that GOA had altered its objective. On March 5, 1963, Allan Kander, a business broker, made an offer of $4,000,000 for the Philadelphia and Harrisburg plants on behalf of Wayne Rollins, president of Rollins Broadcasting Company, and advised Ryan that Rollins had authorized him to negotiate, on an all-cash basis, for all the unsold GOA plants except those in the greater New York City area. Ryan rejected the $4,000,000 bid as too low, but indicated a desire for a further meeting after March 21, which was never held. In March, also, Gesme prepared and submitted to Skogmo a report showing the "Green Book Value," "Probable Sales Value," "Cost on General's Books," and "Net Profit after Tax" for each of the unsold plants; the total "Net Profit after Tax" after projected sales of all plants was $19,925,000. Offers were received for small plants at Hartford, Connecticut, and Binghamton, New York, but were not accepted. During this period, John W. Kluge, president of Metromedia, Inc., continually made known to Ryan his company's interest in acquiring the large Chicago plant.
On April 11, 1963, GOA's Board of Directors adopted a resolution included in its quarterly report to stockholders, that for the present "GOA will continue to operate the plants operated by it excepting Oklahoma City where negotiations for sale are now pending." On May 31, 1963, the Oklahoma City plant was sold for $1,000,000, the price that had been offered before the temporary suspension of sales in October 1962. No other plant sales were made until late in 1963, after the merger.
In February and March, 1963, Skogmo began discussing with A. G. Becker & Co., an investment banking firm, the desirability of some form of consolidation of GOA and Skogmo. A prime motivating factor was the desirability of placing the management of GOA's newly acquired Stedman Canadian retail stores, a type of business with which GOA's officers had had no experience, under the direct control of Skogmo, which, in addition to its own operation, controlled McLeod's Limited, a retail chain specializing in the sale of hard goods in Canada. A preliminary Becker memorandum, dated March 11, 1963, mentioned as one attraction for Skogmo in a proposed offer to GOA stockholders on a share for share basis - a slight premium over the then market price of GOA shares - that Skogmo would pick up approximately $37 per share in book value,*fn3 "such book value being approximately $13 under estimated final liquidation value per share... providing steps with respect to the liquidation of GOA prove out as expected." The report also noted that a factor which a GOA stockholder might consider in evaluating such an offer was a "questionmark about 1963 activities of the Company; possible further enhancement of value of GOA shares through more sales of plants."
Instead of offering GOA stockholders a share-for-share exchange or, as Becker had recommended, one share of a new Skogmo $20 5% preferred convertible into a half share of Skogmo common plus a half share of the latter for each share of GOA common stock, Skogmo decided in May 1963 that the transaction should take the form of a statutory merger in which GOA stockholders would receive for each share of GOA stock a share of $40 par value preferred Skogmo stock paying dividends of $1.75 per annum and convertible into common on a share-for-share basis. Both boards informally agreed on this during June and formally approved it on July 2. Meanwhile, Becker had prepared, at the request of both companies, a detailed memorandum dated July 1, 1963, upon the "Fairness and Equitability of the Plan of Merger." Although putting primary weight on the market value of GOA stock, this recognized potential values arising out of further sales of GOA plants as a relevant factor. The report stated, however, that any GOA stockholder, either alone or with the aid of an investment adviser, could estimate the potential sale value of the plants and other assets retained by GOA and, indeed, that a judgment on this was already reflected in the market price of GOA stock.*fn4 The memorandum concluded that the plan of merger was "fair and equitable to the shareholders of General Outdoor."
A draft of a proxy statement to stockholders of both companies seeking approval of the merger was filed with the SEC on July 19, 1963.*fn5 On August 20, the Assistant Director of the SEC's Division of Corporate Finance sent a 15 page single-spaced letter of comment*fn6 and asked that a revised draft be submitted for SEC review. This was transmitted in late August and accepted by the SEC without further comment. The Proxy Statement was mailed to stockholders on September 11, 1963, along with Notice of a Special Meeting of Stockholders to be held on October 11.
For purposes of this case the most important parts of the Proxy Statement are those under the heading "History, Business and Property of General Outdoor." This sketched the growth of GOA's outdoor advertising business up to the point where, in the latter half of 1961, it was operating 36 branches. The Statement recited that "During 1960 and 1961 General Outdoor continued to entertain as it had theretofore proposals by persons desiring to purchase outdoor advertising plants from it," and that "Particularly serious attention was given to offers to purchase its plants located in major cities where there was direct local poster competition and resulting low profit margins." It instanced the acceptance of the offer for the St. Louis branch.
The Statement went on to say that at about the same time Skogmo's acquisition of a majority interest brought to GOA's board a number of men with experience in other fields, primarily merchandising and finance, thereby opening the possibility of profitable diversification. "In addition the price obtained for the St. Louis branch, as well as the prices at which other outdoor advertising operations were then being bought and sold, demonstrated that the market value of a substantial portion of the company's plants was considerably in excess of book value."
As a result of these factors and with a desire to diversify into other operating fields on a more profitable basis, General Outdoor sold a number of additional operating branches during the summer and early fall of 1962. These included a large number of competitive operations with relatively low profit margins. As it became clear that there were ready buyers for a large number of non-competitive plants, at attractive prices, sales of these also began to be made. As a result, by the end of 1962 General Outdoor had sold 23 of its 36 United States outdoor advertising branches, which accounted for approximately 36% of the total 1961 consolidated operating revenues of the Company. These branches were sold at individually negotiated prices aggregating $29,682,435, resulting in a profit of $14,184,368 after provision of $5,396,000 for federal and state taxes on income. The Company received $4,931,524 in cash down-payments and a total of $24,750,911 of notes receivable. The net proceeds were used to diversify the Company's operations as set forth in the following subsection headed "Diversification".
This was followed by a statement that in 1963 GOA had sold its Kansas City and Oklahoma City branches for $3,300,000 ($300,000 in cash and $3,000,000 in notes) for an after-tax profit of $1,523,015. The succeeding paragraph revealed that the plants sold on or before July 30, 1963, accounted for 35% of the outdoor advertising operating revenues and 37.9% of the profits in 1960, and 35.9% of the revenues and 40.6% of the profits in 1961. Then came a reference to the arrangements with the bank syndicate described above.
The fateful paragraph is this:
If the merger becomes effective, it is the intention of Gamble-Skogmo, as the surviving corporation, to continue the business of General Outdoor, including the policy of considering offers for the sale to acceptable prospective purchasers of outdoor advertising branches or subsidiaries of General Outdoor with the proceeds of any such sales, to the extent immediately available, being used to further expand and diversify operations now being conducted or which might be acquired and conducted by Gamble-Skogmo or its new, wholly-owned subsidiary, GOA, Inc. There have been expressions of interest in acquiring many of the remaining branches of General Outdoor and discussions have taken place in connection therewith, but at the present time there are no agreements, arrangements or understandings with respect to the sale of any branch and no negotiations are presently being conducted with respect to the sale of any branch.
After the Proxy Statement was disseminated, but before the stockholders' meeting, the SEC received a letter from Minis & Co., an Atlanta brokerage firm, objecting to the adequacy of the Proxy Statement. In response to this letter, Paul Judy, vice president of A. G. Becker & Co., Donald W. May, general counsel of GOA, and other representatives of Skogmo and GOA met in early October with Carl T. Bodolus, the SEC's branch chief responsible for evaluation of the Proxy Statement, and three representatives of Minis. The Minis representatives demonstrated by extrapolation from the information contained in the Proxy Statement regarding the profits obtained through previous plant sales that considerable profits might be realized on the sale of the remaining plants. They thought that this possibility should be highlighted in the Proxy Statement, which should include the fair market value of the remaining assets or projections of the anticipated profits on sales if there were to be sales. Mr. Bodolus replied, however, that such profits were subject to a variety of contingencies, that it was contrary to SEC policy to have that kind of prospective information in a Proxy Statement, and that he believed that under SEC regulations this was not permissible. In response to further questions raised by the Minis representatives, Bodolus inquired whether there had been discussions regarding future sales or whether any firm commitments had been made or were in the process of being made; the answer was that additional sales had been discussed, and that there might be future offers, but that no firm sales had been contracted or were in the process of being made.
One other meeting of significance which took place prior to the GOA stockholders' meeting should be noted. We have already referred to the interest displayed by John Kluge, president of Metromedia, in GOA's Chicago plant. On October 9, two days before the stockholders' meeting, GOA gave Metromedia updated six year statements of operations for both the profitable Chicago branch and the unprofitable New York branch. About the same time, Ryan and Kluge had a dinner meeting at which Kluge again indicated his interest in purchasing the Chicago plant. Ryan explained that he could not negotiate until "a meeting", obviously the GOA stockholders' meeting, had occurred, but that Kluge should be prepared to put up cash shortly thereafter. Ryan testified, but Kluge denied, that the discussion included the New York plant; the court credited Ryan, particularly because of other testimony that the treasurer of Metromedia had discussed with officials of the Bank of New York, on October 10, the possibility of obtaining funding for the contemplated purchase of the Chicago plant for $10,000,000 and the New York branch for $5,000,000.
The merger was approved at the October 11 stockholders' meeting and became effective on October 17. The next day, Kluge made a package offer for the New York and Chicago plants and by October 28 Skogmo had agreed to sell the Chicago and New York plants to Metromedia for $13,551,121 representing a pre-tax profit of $7,504,802. With the losing New York plant sold, there was no need to retain the other profitable plants as sweeteners, and sales proceeded apace. On December 2, Skogmo agreed to sell the Philadelphia and Washington plants to Rollins for $5,300,000, representing a pre-tax profit of $3,334,737. An agreement to sell the Mexican subsidiary to Rollins, on this occasion at a loss, was concluded in November. By July 13, 1964, GOA had contracted to sell all the United States plants which had remained at the date of the merger. Including the Mexican subsidiary, the sales prices amounted to $25,081,121 as against a book value of $10,576,418, representing a pre-tax profit of $14,504,703 and an after-tax profit of some $11,740,875 - more than a 25% addition to GOA's net worth as of May 31, 1963, as shown in the balance sheet attached to the Proxy Statement.
II. The Proceedings in the District Court
In his first opinion, 298 F. Supp. 66, Judge Bartels found that the Proxy Statement was materially false or misleading in violation of SEC Rule 14a-9(a), on grounds we shall discuss below, and therefore held the defendant liable under section 14(a) of the Securities Exchange Act. He also held that Skogmo had breached its fiduciary obligations to the minority shareholders of GOA under applicable New Jersey law by its inadequate disclosures in the Proxy Statement and by accomplishing the merger through a plan which was unfair to the minority. Since restoring the parties to the pre-merger status quowas obviously impossible, the district judge held that the plaintiffs were entitled to restitution and that Skogmo must account for the profits it received from the sale of GOA assets. He also prescribed that:
After proper deduction for Skogmo's proportionate interest in General's assets as of the date of the merger, plaintiffs are entitled to the highest value since the date of the merger of all the assets transferred to Skogmo by General including post-merger appreciation of said assets less (i) Skogmo's proportionate share thereof, and (ii) the value of Skogmo stock as of the date of the merger received by those ...