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January 20, 1976

REA Express, Inc., Plaintiff
Interway Corporation, et al., Defendants

Brieant, District Judge.

The opinion of the court was delivered by: BRIEANT

BRIEANT, District Judge

By its amended and supplemental complaint, plaintiff REA Express, Inc. ("REA") seeks to recover damages under three separate counts against defendants Interway Corporation *fn1" ("Interway") and its wholly-owned subsidiary, Integrated Container Service, Inc. ("ICS").

 This Court has subject matter jurisdiction pursuant to Section 27 of the Securities Exchange Act of 1934, 15 U.S.C. § 78aa and principles of pendent jurisdiction.

 Count I of the complaint relies upon § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78i(b) and Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder by the Securities and Exchange Commission ("SEC"). Plaintiff claims that in the Fall of 1968 ICS made fraudulent misrepresentations to REA, and falsely and fraudulently omitted to disclose material facts in connection with an offer, and also a subsequent agreement, to purchase the stock of REA Leasing Corporation ("Realco"), then a wholly-owned subsidiary of REA. *fn2"

 On October 11, 1968, REA and ICS entered into a written agreement (the "Purchase Agreement") for the sale to ICS of 51% of the stock of Realco for $30,000,000.00 and for the sale to ICS of $2,400,000.00 of 5 1/2% subordinated debentures at par value, representing money which Realco owed REA plus accrued interest from October 1, 1968. The interest amounted to $11,000.00. (Joint Exhibit No. 107).

 In a letter of the same date ("Letter Agreement"), REA received an option, good until July 11, 1969, to "put", or sell any or all of the remaining 49% of the Realco stock to Interway for a total consideration of 440,000 shares (or a proportionate amount thereof) of preference stock of Interway, which was to be convertible into Interway common on the basis of 1.5 shares of common stock for each share of preferred. The closing took place on November 1, 1968, at which time ICS purchased 51% of the stock of Realco and the subordinated debentures, and paid the cash consideration specified in the Purchase Agreement.

 Counts II and III, pleaded in the alternative, are based upon the alleged breach by Interway of an agreement with REA to register with the SEC common stock of Interway obtainable by REA upon the conversion by it of shares of Interway preference stock which REA received as part of the consideration for the sale of certain of its shares of Realco. These counts differ only as to the theory of damages claimed.

 Defendants counterclaimed for damages arising out of alleged breaches by REA of representations and warranties contained in the Purchase Agreement executed by REA and ICS on October 11, 1968.

 The action was tried before me without a jury on March 3, 4 and 5, 1975. Post trial briefs have been submitted and considered.

 REA is a Delaware corporation which, prior to June 1968, was known as Railway Express Agency, Incorporated, having its principal place of business in New York, New York. Since its incorporation in 1928 it has been engaged primarily in the business of providing expeditious door-to-door transportation, primarily for small shipments. Until 1969, all of the outstanding capital stock of REA was owned, directly or indirectly, by approximately 60 Class I railroads.

 Prior to November 1, 1968, REA owned all of the outstanding capital stock of Realco. Since that date Interway has acquired 100% of Realco. At all relevant times, Realco has been in the business of leasing trailers, primarily to railroads, for their "trailer-on-flat-car" service, commonly known as "piggybacking".

 Interway is a Delaware corporation which also has its principal place of business in New York, New York. It owns all of the stock of ICS, Realco, and certain other subsidiaries. It conducts no business of its own.

 Defendant ICS is also a Delaware corporation, and is the successor to Integrated Container Service, Inc., a Pennsylvania corporation, incorporated in 1962. In October 1968, this Pennsylvania corporation transferred its assets and business (subject to its liabilities) to ICS in return for all of the capital stock of ICS. The Pennsylvania corporation was then merged into Interway and in conjunction therewith its shareholders exchanged their shares for Interway shares. At all relevant times ICS and its predecessor, Integrated Container Service, Inc. in Pennsylvania, has been in the business of leasing to others (primarily ship owners) cargo containers and accessory equipment used by ocean carriers for the transportation of freight. *fn3"

 On January 15, 1969, REA exercised part of its option by electing to sell an additional 13% of the Realco stock to Interway. The preferred stock of Interway which REA received was converted into common stock and sold as part of a public offering of Interway common stock in March 1969. From this sale REA realized $7,865,316.00 after expenses.

 On June 23, 1969, after some negotiations leading to a slight modification of the original agreement, REA exercised the balance of its option, and Interway obtained the remaining 36% of the Realco stock in exchange for $4,714,290.00 in cash, and the issuance to REA of 143,673 shares of Interway convertible preferred stock. This latter stock was unregistered. REA subsequently received 21,552 additional shares of this unregistered convertible preference stock as stock dividends on the 143,673 shares.

 In June 1971, acting pursuant to the rights specifically granted to it at page 4 of the Letter Agreement of October 11, 1968 (Joint Exhibit No. 109), REA requested by letter that Interway register with the SEC the common stock of Interway which REA would receive upon the conversion by it of all the Interway preferred stock it then held. No such registration was ever made. However, in February 1974 Interway purchased REA's total holdings of 165,225 shares of convertible preferred for $2,726,212.00, with REA paying $25,000.00 to a third party for services rendered in arranging the sale.

 Count I -- the Rule 10b-5 claim.

 The plaintiff has shown that ICS's offer contained affirmative material misrepresentations, and that ICS's management was reckless in making these statements. However, there is no credible evidence that the plaintiff or its advisors relied on the misrepresentations in making the decision to accept ICS's offer over the competing bids.

 In relation to its Rule 10b-5 claim, it should be noted that REA can be considered either as a defrauded seller of Realco stock or as a defrauded purchaser of an option to buy shares of Interway convertible preferred. See Zeller v. Bogue Electric Manufacturing Corp., 346 F. Supp. 651, 654, n. 4 (S.D.N.Y. 1972), rev'd. on other grounds 476 F.2d 795 (2d Cir.), cert. denied 414 U.S. 908, 38 L. Ed. 2d 146, 94 S. Ct. 217 (1973). Since, under either view the misrepresentations were made in connection with the purchase or sale of a security, there can be no doubt that Rule 10b-5 is applicable to this transaction. Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 44 L. Ed. 2d 539, 95 S. Ct. 1917 (1975). For purposes of clarity and consistency, REA will be referred to as a "seller" who accepted ICS's offer to purchase the stock of Realco.

 On September 23, 1968 ICS submitted two offers in the alternative to purchase a controlling interest in Realco. In its letter to REA, which was hand delivered within New York State, transmitting the offers, ICS made the following statement (Joint Exhibit No. 78, p. 2): "Based upon the current demand for the Company's equipment and services, ICS anticipates that equipment in use in its pool will at least double in 1969." At page 7 of the same letter, in connection with the preparation of an exhibit showing the effect of combining the earnings of ICS and Realco, ICS stated: "Based on its forecasts, its experience and evaluation of the market available to it, ICS anticipates net earnings after taxes in excess of $2,000,000 for the current calendar year and in excess of $4,000,000 in 1969."

 In fact, as events later showed, the value or amount of the equipment in use did not come near doubling in 1969, and the historic growth pattern of ICS came to an abrupt halt. Furthermore, after-tax earnings for 1969 were only $1,793,000.00, of which all but $324,100.00 was attributable to the earnings of Realco.

 I find and conclude that these are serious discrepancies and amount to affirmative material misrepresentations. While the mere fact that a forecast is inaccurate does not make it fraudulent, 1A Bromberg, Securities Law: Fraud, SEC Rule 10b-5, § 5.3 at p. 98 (1974), the evidence shows, and I find, that these particular forecasts were untrue statements of fact. These projections must be regarded and interpreted as a representation that in September, 1968, it was the informed, reasonable and sincere belief of ICS management that both equipment in use and earnings would double in 1969. Such a statement implies that ICS used a reasonable method of calculation and that the figures which were arrived at and furnished to REA had a valid basis. The making of such projections is a normal function of modern corporate management. The evidence shows that these forecasts were based on out-of-date computations.

 The latest projections for 1969 had been made in a five-year forecast drawn up in 1967, and there was sufficient information known to ICS to show that by the Fall of 1968 business conditions were beginning to change so as to make this 1967 forecast obsolete. Furthermore, there had been no recent analysis of ICS's business prospects. Mr. Needleman, the controller of ICS who was usually responsible for drawing up such forecasts, testified at his deposition that no new projections for 1969 were asked for from him by top management, in connection with the statements made in the offer to REA. Finally, from the absence of any workpapers in its files, it is reasonable to conclude that Price Waterhouse, ICS's accountants, did not participate in the preparation of these forecasts.

 The inference naturally follows, and the Court infers from the entire testimony that these figures were not arrived at in a rational fashion but were thrown in to make the ICS offer more attractive to REA than the competing offers.

 Absent a reasonable method of preparation or a valid basis, reckless and unfounded statements as to future earnings and future acquisitions of equipment are sufficiently misleading to be actionable under Rule 10b-5. Marx v. Computer Sciences Corp., 507 F.2d 485, 490 (9th Cir. 1974); Schuller v. The Slick Corporation, CCH SEC. LAW RPTR. P 95,065 at p. 97,739 (S.D.N.Y. April 3, 1975).

 While the plaintiff has alleged that ICS failed to disclose material facts concerning its business in its offering letter, based upon all of the evidence, the Court finds that there were no material omissions. The factors which led to a downturn of ICS's business in 1969 (the lengthy longshoremen's strike, the Army's cancellation of a big contract, and the increase in ...

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