The opinion of the court was delivered by: NEAHER
This is an action by Pittsburgh Coke & Chemical Company ("PCC")
to recover from the defendant Louis J. Bollo ("Bollo") damages in the amount of $3,100,000, representing the larger portion of the consideration paid by PCC to him and other stockholders of Standard Aircraft Equipment Company ("Standard") to complete PCC's acquisition of a 97% controlling interest in Standard in 1969 and 1970. The asserted grounds of liability are § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b)(1970), SEC Rule 10b-5, 17 C.F.R. § 240.10b-5, and diversity claims of breach of express warranty and common law fraud. The case was tried to the court without a jury and the following constitute the court's findings of fact and conclusions of law. Rule 52(a), F.R.Civ.P.
Plaintiff PCC, prior to the time of the Standard acquisition, was a substantial diversified management investment company registered under the Investment Company Act of 1940. Commencing in 1964 it began an active program of conglomerate acquisitions, acquiring four wholly owned operating companies and significant stock holdings in several other affiliated and unaffiliated companies. As of December 3, 1968 PCC's net equity in operating companies and investments exceeded $56,000,000. DX A.
Standard began business life in 1933 at Roosevelt (Aviation) Field, Long Island, as a sole proprietorship of defendant Bollo. Its business then was primarily that of a repair facility for private aircraft, although it also served as a local distributor of aviation instruments and parts manufactured by pioneer aviation divisions of Bendix Corporation. After its first growth in distributor sales to the military during World War II, Standard was incorporated in 1947 with Bollo as 90% stockholder and began a postwar growth coinciding with the expansion of commercial and general aviation. At the end of 1966 Standard's annual total sales had climbed to $6,597,000, of which only 10% was attributable to repair services.
Although Standard had acquired some 100 distributorships by the 1960's, each representing distinct product lines, the bulk of its sales and profits were derived from selling the products of a group of manufacturer-suppliers to major airline customers (45%), fixed base operators and repair centers (40%), corporate aircraft operators (14%) and the military (1%). Those manufacturers were Bendix Aviation Corporation (through separate divisions), Whittaker Corporation, Goodyear Tire & Rubber Company, Champion Spark Plug, Sonotone and Pesco Products Division of Borg-Warner Corporation. For example, in 1966 their products accounted for approximately 5 million of Standard's 6.6 million sales in that year. And two of them, the Bendix group and Whittaker, accounted for 3.8 million of that total. All of Standard's distributorship agreements permitted the manufacturer to unilaterally alter the discount rate at any time and generally were terminable on as little as 30 days' notice. Additionally, the manufacturers often sold their products directly to the airline industry, thereby competing directly with distributors such as Standard.
Standard's business hinged on the willingness of manufacturers to continue to sell their products to Standard at a sufficient discount to allow it to earn a profit after operating expenses. Standard attempted to provide incentive for them to do so in several ways. The manufacturers were, obviously, interested in selling as much of their products as possible. The airline customers, in turn, were desirous of having a wide variety of parts immediately available for use at major points on their routes. The manufacturers, however, were either unwilling or unable to invest the additional capital needed to maintain large inventories at diverse geographic locations. Standard filled this gap by establishing distribution facilities, stocked with ample quantities of numerous items, at key points around the country, e.g., Garden City, New York (Pan Am overhaul base), Los Angeles, California and Kansas City, Missouri (TWA overhaul bases), Miami, Florida (Eastern Airlines overhaul base), and Atlanta, Georgia (Delta overhaul base). By continuously maintaining large inventories around the country, Standard not only satisfied its suppliers,
but also sustained good relations with its airline customers, who wanted their orders filled rapidly and who could obtain the same goods at the same price from either Standard's many competitors
or the manufacturers directly. The essence of Standard's business was aptly characterized by Bollo as having "the right part, in the right place, at the right time."
By the late 1960's, Standard's inventory consisted of some 50,000-60,000 different items, ranging in unit price from a nickel to $20,000, with most items (over 99%) costing under $500, and accounted for approximately 60% of its total assets. Each inventory item was maintained on a separate card, with sales and purchases manually posted to those cards on a daily basis. The sales history of any particular product could thus be readily gleaned from the inventory card. The 50,000-60,000 inventory cards were kept in open racks at Standard's headquarters in Garden City. By the end of 1968, the manual inventory system had been approximately 50% computerized (IBM punch-cards) in order to tie in with the inventory system adopted by the airlines.
Standard sold both units and piece parts. Units, which comprised about 5% of Standard's total sales, are complete parts, e.g., generators, ready to go on an engine or airplane. Piece parts, which comprised the balance of Standard's sales, are essentially replacement or spare parts, such as brushes in the generators.
Standard's total annual sales for the years 1965-1967 were as follows:
1965 $5.9 million
1966 $6.6 million
1967 $7.8 million
Between 1961 and 1967, Standard's gross profit margin was steadily between 20% and 23%.
PCC's 1967 Investment in Standard
PCC's original interest in Standard in 1967 appears to have coincided with PCC's acquisition in that year of a controlling interest in a supplemental airline. On July 31, 1967 PCC's wholly owned subsidiary, First Grant Corporation ("First Grant"), acquired American Flyers Airline Corporation as a 90% owned subsidiary. American Flyers, an air carrier certificated by the Civil Aeronautics Board, was authorized to operate charter passenger and cargo flights throughout the United States and to Canada, Mexico and the Caribbean and also charter passenger flights to Europe, Asia and Africa. In addition to turbo prop and jet aircraft it owned or intended to acquire, American Flyers, also leased Boeing jets from another First Grant subsidiary, Grant Aviation Leasing Corporation (87% owned). It would appear to have been PCC's intention, through American Flyers, to promote and develop a commercial airline business including transatlantic passenger charter flights using long-range jet aircraft. These, of course, would require aircraft maintenance and repair and the availability of repair parts.
In June 1967, shortly before concluding the American Flyers acquisition, PCC, through its same subsidiary First Grant, made its first investment in Standard. By agreement dated June 8, 1967, between Standard and Bollo, as sellers, and First Grant, as purchaser, PCC acquired a total of 84,000 shares of Standard common stock for $588,000 ($7 per share). DX V. Prior to the June 8 agreement, PCC had already purchased 23,000 shares of Standard on the open market3a at a cost of $147,432 (approximately 6-3/8 a share). As a result of these purchases and a year-end stock dividend of 5,349 shares, PCC at the beginning of 1968 held 25% of the outstanding shares of Standard.
Although PCC declined Bollo's invitation to be represented on Standard's board of directors, it appears to have been fully cognizant of Standard's basic financial data over a considerable time period as well as its position in the field. The June 8, 1967 agreement recites (and no one has questioned) that PCC, prior to making its initial investment was supplied with financial statements (balance sheets, income statements and related notes) for each year dating back to December 31, 1961.
Moreover, Richard M. Johnston, then assistant to the president of PCC, who was involved in the investigation and negotiations for the 1967 agreement, made a comparison of Standard with other companies in the field, see n. 3 supra, and personally discussed its business with Bollo at Standard's headquarters in Garden City, Long Island.
Indeed, as the calendar rolled into 1968 -- the boom year for conglomerate acquisitions -- it is quite apparent that Johnston had already made a further analysis of Standard's operations for the first eight months of the year in comparison with its prior seven years' earnings when, on September 27, 1968, he confirmed to PCC the news that another company had held discussions with Bollo regarding a takeover. PX 10, DX F.
We now turn to the events, transactions and claims which gave rise to this action.
PCC's Acquisition of Standard
There can be little question that the event which triggered PCC's virtually total acquisition of Standard was Johnston's news that Premier Industries of Cleveland had made a formal offer to Bollo to acquire his remaining 55% of Standard's shares in contemplation of making a tender offer to the minority stockholders, including PCC. As reported by Johnston, PX 10, Premier had retained White, Weld & Company to study the aviation market for possible acquisitions and Standard had been chosen. Premier's offer for Bollo's stock was in the form of 4-1/2% convertible preferred stock having an equivalent value of $12.50 a share. Public holders of Standard shares and PCC were to be offered a choice of cash or convertible preferred at an equivalent price of $15 a share. According to Johnston, Bollo was interested in knowing "if we would be interested in buying Standard and supplying the necessary aid." PX 10. The latter reference was to Bollo's fear that Premier would not be in a position to supply sufficient help to Standard because another recent major acquisition of Premier's was having difficulties.
PCC's reaction to the Premier offer was prompt. In October 1968 discussions were held between Bollo and PCC's chairman and president, Henry L. Hillman. Also in attendance were Putnam B. McDowell, a vice-president and director of PCC, and Johnston. Bollo offered to sell his stock for $16 a share, its then market quotation price. Hillman sought a lower price by 10-20%, based on what he considered an appropriate price-earnings ratio. Bollo rejected that offer and left the meeting believing that was the end of the matter. A few days later Johnston called and said PCC was willing to pay $16 and ready to go ahead with the deal.5a
The deal between PCC and Bollo was embodied in a written agreement executed December 20, 1968, PX 2, which was identical in substantial part to the June 1967 agreement, DX V, with respect to the warranties and representations of Bollo upon which this action is based. The 1968 agreement provided in substance that PCC would first make a tender offer for the stock of Standard's public shareholders at $16 per share and thereafter Bollo would sell to PCC, at $16 per share, so much of his stock as was required to make PCC the owner of 80% of Standard's shares. PCC also agreed to employ Bollo as president of Standard for five years at a salary of $65,000 per annum and, at his option, to purchase his remaining shares at a price formula which guaranteed him at least $12 per share. PCC also had the prior option to purchase such shares at the same price or terms offered to Bollo by third parties.
PCC's obligations under the agreement were conditioned upon its obtaining an exemption from the Securities and Exchange Commission (because of its investment company status) and either exemption or approval from the Civil Aeronautics Board (because of its American Flyers acquisition). To allow time for this, the closing date was originally set for no later than June 30, 1969. On December 31, 1968, pursuant to the agreement, PCC nonetheless went forward with a tender offer to stockholders other than Bollo. A total of 71,309 shares were tendered for which PCC eventually paid $1,140,944.
Due to delays in obtaining SEC and CAB clearances, the closing specified in the agreement did not take place until September 18, 1969. At that time PCC paid Bollo $2,740,832 for 171,302 additional shares needed to increase PCC's holdings in Standard to 80%. Bollo, for his part, delivered the certificate required by paragraph 6(d) of the agreement, which provided:
"(d) The representations and warranties contained in Paragraph 2 of this Agreement shall be true and correct as of the Closing Date, with the same force and effect as though they had been made at the Closing Date, and there shall have been delivered to Purchaser the certificate of Bollo, President of Standard, dated the Closing Date to such effect, . . ." PX 2.
In that certificate Bollo again warranted and represented that all financial statements furnished to PCC through September 30, 1968,
". . . have been prepared in accordance with generally accepted accounting principles applied on a consistent basis throughout the period involved. All such statements fairly present the financial position of Standard as of the dates thereof and the results of operations for the periods indicated.
(f) Since December 31, 1967, there has been no material adverse change in the financial condition of the company as evidenced by most recent balance sheet information except that, as you know, earnings in 1969 have been reduced due primarily to the investment in start up expenses of our Kansas City operation." PX 3.
It would appear that coincidental with the closing, a meeting of Standard's board of directors was held at which McDowell of PCC was elected chairman, Bollo was continued as president, and other PCC representatives were appointed vice-president and secretary. See DX D. In October 1970 Bollo resigned at PCC's request, his salary being paid until February 1971.
For the year 1968 Standard's sales were 9.1 million, an increase of 17% over 1967 sales of 7.8 million, but net profits declined by $39,125. This decline was in substantial part attributable to a federal income tax surcharge. DX KK. In 1969 annual sales increased again to 9.27 million. PX 1. In 1970 -- characterized as the year of the "aviation recession" -- sales dropped to 8.7 million, followed by a further drop in 1971 to 7.9 million. Id. In 1972, however, sales rose to 10.8 million, the highest in Standard's 39 year history. Id.
The relative profitability of these fluctuating sales figures was not disclosed in the evidence. Plaintiff's primary claim is that Standard's future profitability and growth had suffered severe setbacks because of material changes in major distributor relationships which Bollo had failed to disclose during the 1968 takeover negotiations and prior to the September 1969 closing. Had this information been made known, it is claimed, it "might well have discouraged" PCC from going forward with the deal, at least at the prices paid for the stock acquired under the 1968 agreement. To the specifics of PCC's claims we now turn.
Events Before the 1968 Agreement
Essentially PCC claims that contrary to facts known to him, Bollo led it to believe that Standard was in a strong position to gain substantial new business selling parts for the so-called "second generation" or wide-bodied jet airliners, the Boeing 747, Lockheed 1011 and Douglas DC-10, when they came into use. Standard's largest suppliers of such parts were Whittaker Corporation and two divisions of Bendix Corporation, Navigation & Control Division ("Bendix N & C") and Energy Controls Division ("Bendix E & C"), which, as previously noted, collectively accounted for more than half Standard's distributor sales. Standard's sales margin and profits depended, of course, upon the discounts available from its suppliers. Whittaker extended Standard a discount which varied from 15% to 22% depending on the size of Standard's monthly orders. Bendix N & C had traditionally extended standard a 50% discount from list on items which Standard resold at a 40% discount from list, thereby realizing a gross profit of 16.7%. Bendix E & C's traditional discount to Standard was 60% from list on products which Standard resold at a 45% discount, thereby realizing a gross profit of 27.3%.
PCC charges that Bollo was aware as early as 1967 that his Whittaker distributorship was in jeopardy and that Whittaker management was being urged to divert the business handled by Standard to Whittaker's own Aircraft Components Division ("ACD"), which sold Whittaker products directly to users such as the airlines. In support of its charge, PCC points to two internal memoranda of Whittaker surreptitiously obtained by Standard's Los Angeles branch representative. PX 12 and 13. Both were written by one Danks, an obviously ambitious subordinate desirous of increasing the importance of ACD but lacking the authority to effectuate his proposals. The earlier was dated January 6, 1967, months before PCC appeared on the scene, and the later memorandum, dated July 8, 1967, PX 13, appears to be only a rough draft of a proposal to his superior.
Bollo acknowledged he had seen and discussed these memoranda about the time they were obtained but had concluded there was nothing Standard could do about Danks' hostile views. In view of Whittaker's uninterrupted relationship with Standard during 1967,
1968 and 1969, and the ambiguous import of the memoranda, they cannot fairly be regarded as "facts" which ought to have been brought to PCC's attention in 1968 or clear notice to Bollo that he could not expect to supply parts when the air busses began operating.
On the contrary, Bollo's expectations were not without basis. In between the two Whittaker memoranda, Standard had received a letter dated March 15, 1967 from Bendix N & C. DX BB. The letter pointed out that Bendix, despite "very stiff competition", had succeeded in getting "about 50%" of its instrumentation on the Boeing 747 and estimated "our package is in excess of $60,000 per airplane." More importantly, the letter declared Bendix's "intention to have our distributors participate with Navigation & Control Division on ...