The opinion of the court was delivered by: TYLER
The Securities and Exchange Commission ("plaintiff" or "SEC") filed its civil complaint for an injunction on December 2, 1970, alleging violations by defendants of Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. 240.10b-5. The case was tried before the undersigned, sitting without a jury, on April 30, May 1, 2, 3 and 9, 1973. Prior to that time, defendants Simon, Sit, Jundt, and Investors Diversified Services, Inc. ("IDS") entered into stipulations of settlement with the plaintiff; final judgments of permanent injunctions by consent were entered against them pursuant to such settlement. Thus, the only defendants remaining in the action are Lum's, Inc. ("Lum's"), Melvin Chasen, and Lehman Brothers ("Lehman").
The Pleadings and Parties
Defendant Lum's was at all material times a Florida corporation with its principal place of business in Miami, Florida. Originally a franchisor and operator of " fast food" restaurants, Lum's acquired on October 1, 1969 Caesar's Palace, a large hotel-casino in Las Vegas, Nevada. Shortly after the acquisition, in October, 1969, Lum's became listed on the New York Stock Exchange. In the summer of 1971, Lum's Restaurant Corporation, a subsidiary of Lum's, Inc., was sold, and in December of that year Lum's became Caesar's World, Inc. For purposes of continuity, references to Lum's as defendant will be understood to include its successor corporation.
Defendant Melvin Chasen was at all material times the chief operating officer and a director of Lum's; in February, 1970 Chasen also became president of the company, and remained such until his departure in August, 1972.
Defendant Lehman Brothers is a registered broker-dealer firm with its principal place of business in New York City; it is a member of the New York, American, and other major stock exchanges, and a member of the National Association of Securities Dealers, Inc. At the time of the transactions in question here, Lehman Brothers was a partnership; on or about October 27, 1970, however, the broker-dealer trading function was transferred to a corporation known as Lehman Brothers, Inc. Defendant Simon was a registered representative and institutional salesman for defendant Lehman Brothers' Chicago office at all relevant times.
One of Simon's institutional customers was defendant Investors Diversified Services, Inc., a Minnesota corporation registered with the plaintiff as a broker-dealer and whose business consists principally in the management of a number of open-end registered investment companies. Defendant Sit is a vice president and senior portfolio manager with IDS; in November, 1969 he became directly responsible for the IDS New Dimensions Fund, Inc., which held in its portfolio as of January 8, 1970, approximately 40,000 shares of Lum's common stock at a cost basis of about $730,000. Defendant Jundt is also an employee of IDS; towards the end of December, 1969, in addition to his responsibilities as analyst in the restaurant area, he became manager of a part of the IDS Investors Variable Payment Fund, Inc., which held in its portfolio as of January 8, 1970, approximately 43,000 shares of Lum's common stock at a cost basis of about $1,400,000.
The critical allegations of the complaint charge essentially that on or about January 5, 1970 Chasen received earnings projections for Lum's second quarter and for the fiscal year ending July 31, 1970, which indicated a sharp downward revision in prior projections publicly released to the investment community; that Chasen communicated this material, non-public information to Simon on or about January 8, 1970; that Simon in turn conveyed the information to Sit and Jundt later that day; that Sit and Jundt on January 9, 1970, acting on this information, sold out their entire positions in Lum's common stock. These actions, it is contended, constitute violations of Section 10(b) and Rule 10b-5 by the participants. In addition, the SEC at the close of its case moved to amend the pleadings to conform to the proof adduced, and asserted that defendant Lehman Brothers is liable as a participant under these provisions for its failure to supervise its employee Simon; the SEC also charges that Lehman Brothers is vicariously liable on the theory of respondeat superior.
With a price tag of sixty million dollars, Caesar's Palace was a most significant acquisition for Lum's, and was expected to contribute approximately fifty percent of the consolidated profits. Some curiosity and confusion in the investment community apparently accompanied the acquisition of Caesar's Palace, and the change in the nature of business which it represented. Record winnings at the casino for the month of October also added to speculation. On November 19 and 20, 1969, Lum's hosted a "seminar" at Caesar's Palace for some sixty or so analysts, brokers and other financial managers, for the stated purpose of introducing the investment community to the changes which had occurred.
At that meeting, in an apparent effort to counter what to him seemed excessively bullish expectations about Lum's earnings being expressed by analysts, Melvin Chasen declared orally that Lum's earnings per share for the fiscal year ending July 31, 1970 would be in the range of $1.00 to $1.10. Chasen testified that it was generally the company's policy not to disclose earnings projections, and that prior to the meeting he had no intention of making such a disclosure. Indeed, the oral earnings estimate was based on a draft projection for fiscal 1970 which Earl Powell, then vice president of finance for Lum's, had happened to bring with him to the seminar; Chasen testified that he had not had time to study the draft before the meeting or to review it with Powell. This projection, moreover, was substantially lower than two previous estimates prepared for internal use in May and September, 1969.
Some time between November 20 and mid-December, Chasen reviewed the final version of these November projections (dated November 26) with Powell. Despite the fact that the estimated earnings per share for fiscal 1970 was only $.96 and he had just predicted a range of $1.00-$1.10 at the seminar, Chasen was very concerned about the accuracy of the figures, particularly the profits from the restaurant company (which he considered excessively high), and felt that more work was needed. Accordingly, Chasen directed Powell to go over the figures again; just before the annual stockholders' meeting, on December 16 or 17, preliminary figures on this revision were submitted, but were again sent back for further scrutiny.
The task of revising the projections was substantially delegated to one Berton Perez, the Comptroller of Lum's. Perez finished the revisions on or about Monday, January 5, 1970; on Tuesday the sixth, Chasen received a schedule (SEC Exhibit 23-A) summarizing the results, and breaking down the discrepancies between this version and the original one dated November 26, 1969. The discrepancies reported in GX-23-A were significant: earnings per share for the year of $.76, down approximately 20% from the earlier $.96 per share estimate; net income for the second quarter $397,826, down $1,202,174 from the earlier projection of $1,640,000, resulting in an earnings per share for the quarter of $.06 vs. $.23 for the first quarter. Exhibit 23-A also reveals that the principal factors underlying the reduced projections were declines of almost $1.2 million in income from the restaurant company ("restaurant subs" on the exhibit), $450,185 in income from the casino at Caesar's Palace, and $479,869 in income from "rooms, food and beverages" at Caesar's Palace. It should be noted that these discrepancies refer to decreases in income; 23-A does not indicate any significant increase in expenses at Caesar's Palace (or elsewhere) as the cause of the reduced projections of earnings.
Chasen testified that the results summarized in Exhibit 23-A were worse than he had expected, even though earlier he had been concerned that the November projections might have been too high. The day following his receipt of Exhibit 23-A, Chasen placed a call to David Bernstein, counsel to Lum's and a partner in the firm of Royall, Koegel & Wells, to discuss the revised projections. Chasen asked Bernstein whether he thought a press release was necessary under the circumstances; Bernstein replied that it probably was. But, since Chasen had not yet received the back-up figures, and had only the summary sheet, it was agreed that a decision on the release would not be made until the estimates were checked and confirmed.
Chasen also informed Bernstein that he would be talking to Simon the next day, and asked for Bernstein's legal opinion as to whether he might warn Simon of the reduced projections, "in view of our relationship with Simon". Bernstein replied that Chasen could so inform Simon, if he specified that the information was confidential and could not be acted upon.
Simon's Relationship with Lum's
To appreciate the background of this rather remarkable exchange, it is necessary to pause here and trace out the relationship between Lum's and Ben Simon. As an institutional salesman, Simon's principal duties were to convey to his accounts (most of which were institutions such as IDS) the products of Lehman Brothers' research, their projections and analyses; to sell their underwritings; and to otherwise solicit business. In the period 1968-70, Simon was particularly interested in -- and familiar with -- Lum's, which he had recommended to his customers. Because of this interest, Simon communicated often with the management of Lum's, and met and became friendly with Chasen some time in the latter part of 1968. According to Chasen, Simon gave him valuable advice about rendering the company more attractive to the investment community, and helped in general to set up a dialogue between Lum's and that community. In addition, Simon had been particularly helpful in raising funds for the purchase of Caesar's Palace: he introduced Lum's to his clients, and in general "opened doors" for the company in this transaction. More specifically, Simon set up a meeting between Lum's and IDS, which eventuated in a purchase of $2.5 million of Lum's debentures by IDS.
Some time in the summer of 1969, furthermore, Simon was asked to become a director of Lum's; he was required to reject this request by his supervisor, Mr. Walter Scott, because of the potential conflict of interest such a situation might raise and because of a long-standing Lehman Brothers' policy not to become involved in gambling operations. Indeed, this latter policy also led Lehman to refuse to act as underwriter for the financing of the acquisition of Caesar's Palace.
Chasen testified that he thought of Simon as an institutional advisor to Lum's, even though Simon was neither an analyst nor an underwriter. Not surprisingly, Simon was afforded greater access to the company than most, and was in frequent contact with Chasen and others there. As part of what must be called the "accommodation" between Chasen and Simon, the latter had requested that he be informed in advance of changes confronting Lum's, for the stated purpose of avoiding the embarrassment of appearing to his clients to have failed to "do his homework" when such changes were made public. Simon had also stated that his customers owned 1 1/2 million shares of Lum's and that he would not be in any position to use such information for trading, but rather was concerned with being unexpectedly surprised by any news.
At least partly through Simon, then, IDS became a large stock and debenture holder in Lum's. When Jundt in late December, 1969, became manager of a part of the IDS Variable Payment Fund and expressed an interest in meeting with the management of Lum's to update his analysis, Simon was the one who arranged the meeting. Originally scheduled for sometime late in December, this appointment was postponed to Monday, January 12, 1970.
Chasen apparently became aware sometime the week of January 5 that he would be unable to attend this meeting, because of the need to be in Las Vegas for a hearing on the 12th. Accordingly, Chasen knew that he would have to call Simon to cancel the meeting with Jundt, since it was Simon who had originally set it up. And he knew that Simon would surely ask him if there were any changes at Lum's. Finally, Chasen intended that Simon would in turn call Jundt to inform the latter of the cancellation of the meeting.
The following day, Thursday, January 8, Chasen talked to Simon between three and four P.M., Miami time (just after the 3:30 P.M. closing of the New York Stock Exchange, according to Simon). During the course of the conversation, Chasen informed Simon that he had to be in Las Vegas the next Monday and would thus be unable to meet with Jundt. A Saturday alternative was proposed. Simon asked if there was anything he should know. Chasen's version of the dialogue follows:
"I said 'I have some information and it is of a confidential nature and if I give it to you you have to act accordingly and not put me or you in an embarrassing position. On that basis do you want it? '
"He says, 'I want it, give it to me.'
"I said 'Our earnings projections for the second quarter are not up to snuff.'
"He said 'What seems to be the general problem?'
"I said, 'I am primarily concerned about the franchise sales and the restaurant company.'
"He said, 'Well, are you going to have a loss?'
"I said, 'No, I don't think it will be that bad.'
"He said, 'Okay, you know I know. I can handle it and protect myself.'
"I said, 'Listen, Ben, I am telling you only -- I am keeping the faith you ...