The opinion of the court was delivered by: MACMAHON
MacMAHON, District Judge.
Plaintiff Kennecott Copper Corporation ("Kennecott") brought this action on March 22, 1978 alleging multiple violations of the securities and antitrust laws by defendant Curtiss-Wright Corporation ("Curtiss-Wright"). Kennecott seeks a permanent injunction: (1) prohibiting the further solicitation of proxies and the voting of Kennecott shares and proxies now held by Curtiss-Wright at the Kennecott annual meeting set for May 2, 1978; and (2) directing Curtiss-Wright to divest itself of its holdings of Kennecott stock. Curtiss-Wright denies Kennecott's allegations and counterclaims for permanent injunctive relief prohibiting further solicitation by Kennecott and the voting of shares and proxies held by Kennecott at the May 2 meeting.
Time is of the essence due to the imminence of Kennecott's annual meeting. We, therefore, on motion of Kennecott, ordered the trial of the action on the merits to be advanced and consolidated with the hearing of the application for a preliminary injunction. Rule 65(a), Fed.R.Civ.P. The trial was held on April 24 through April 27; 17 witnesses testified and 59 exhibits were received in evidence.
This litigation is the fall-out of an ongoing proxy contest launched by Curtiss-Wright for control of Kennecott. Between November 23, 1977 and March 10, 1978, Curtiss-Wright quietly purchased some 9.9% of Kennecott's outstanding shares in transactions both on and off the national securities exchanges. Curtiss-Wright filed its Schedule 13D with the Securities and Exchange Commission ("SEC") on March 13. The schedule stated, in part, that Curtiss-Wright was "considering soliciting proxies from [Kennecott's] shareholders . . . looking to the election of directors" to Kennecott's board. Four days later, Kennecott management distributed its proxy materials, soliciting shareholders to return a proxy empowering the holder to vote the shares in favor of incumbent management.
On March 23, the battle lines were formally drawn when the Curtiss-Wright board authorized its management to wage a proxy contest to elect its own slate of directors to the Kennecott board. On April 4, Curtiss-Wright's proxy materials were mailed to Kennecott shareholders. Since that date, both sides have sent several additional communications to Kennecott shareholders. With this background, we turn now to the parties' contentions.
Kennecott contends that Curtiss-Wright's proxy materials are false and misleading in several respects, in violation of Section 14(a) of the Securities Exchange Act of 1934 (the "Act") and Rule 14a-9(a) thereunder. Section 14(a) provides:
"It shall be unlawful for any person, by the use of the mails or by any means or instrumentality of interstate commerce or of any facility of a national securities exchange or otherwise, in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors, to solicit or to permit the use of his name to solicit any proxy or consent or authorization in respect of any security (other than an exempted security) registered pursuant to section 12 of this title."
Rule 14a-9(a), in turn, provides:
"No solicitation subject to this regulation shall be made by means of any proxy statement, form of proxy, notice of meeting or other communication, written or oral, containing any statement which, at the time and in the light of the circumstances under which it is made, is false or misleading with respect to any material fact, or which omits to state any material fact necessary in order to make the statements therein not false or misleading or necessary to correct any statement in any earlier communication with respect to the solicitation of a proxy for the same meeting or subject matter which has become false or misleading."
The elements of a private cause of action for a violation of Rule 14a-9(a) are well-established. The plaintiff must demonstrate: (1) that the proxy materials contain a false or misleading statement of a material fact or omit to state a material fact necessary in order to make the statement made not false or misleading; (2) that the misstatement or omission of a material fact was the result of knowing, reckless or negligent conduct; and (3) that the proxy solicitation was an essential step in effecting the proposed corporate action. TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 48 L. Ed. 2d 757, 96 S. Ct. 2126 (1976); Mills v. Electric Auto-Lite Co., 396 U.S. 375, 24 L. Ed. 2d 593, 90 S. Ct. 616 (1970); Schlick v. Penn-Dixie Cement Corp., 507 F.2d 374, 381-84 (2d Cir. 1974), cert. denied, 421 U.S. 976, 44 L. Ed. 2d 467, 95 S. Ct. 1976 (1975); Gerstle v. Gamble-Skogmo, Inc., 478 F.2d 1281, 1291-1303 (2d Cir. 1973).
A. Omissions Respecting the Curtiss-Wright Plan
Kennecott's principal contention is that Curtiss-Wright's proxy materials were misleading due to Curtiss-Wright's knowing or negligent omission of material facts showing Curtiss-Wright's lack of due diligence in investigating the feasibility of its plan before presenting it to the shareholders as a workable program. In pertinent part, Curtiss-Wright's April 4 proxy statement explains the plan as follows:
"The [Curtiss-Wright] nominees have committed, if elected as the Board of Directors of Kennecott, to pursue a program seeking to sell its wholly-owned subsidiary, The Carborundum Company ("Carborundum") at an advantageous price and to make the proceeds available to the shareholders in the manner which, in the judgment of the Board of Directors at the time, would be most favorable to all shareholders.
The nominees believe that a sale at or above the $567 million which Kennecott paid for Carborundum only a few months ago would be advantageous from the point of view of the Kennecott shareholders. * * * They also believe that additional funds could be provided from Kennecott's cash and marketable securities and from borrowings against the $400,000,000 principal amount of 30-year subordinated income notes received by Kennecott on the sale of its subsidiary, Peabody Coal Company ("Peabody"), which notes are valued by Kennecott on its December 31, 1977 balance sheet at over $171,000,000. * * *
The nominees believe, accordingly, that it will be possible to make available sufficient funds for Kennecott either to make a pro rata distribution of approximately $20 with respect to each Kennecott share or to make a tender offer to its shareholders for 50% of the outstanding shares at a price of approximately $40 per share. Curtiss-Wright's present intention is to seek to have 50% of its shares (having an average cost of $23.42 per share) purchased in such a tender offer."
The evidence shows that T. Roland Berner, Curtiss-Wright's chairman and president, generally familiarized himself with Kennecott and other copper companies before proposing his plan to the shareholders on April 4. Berner studied the annual reports of Kennecott and its competitors and reviewed several other financial and copper industry publications. Curtiss-Wright's principal research, however, consisted of an inquiry by Charles Ehinger, Curtiss-Wright's executive vice president. So far as appears in the record, Ehinger analyzed Kennecott's balance sheets, with particular emphasis on Kennecott's cash position, and proposed to Berner several methods by which to improve it. Among other things, Ehinger suggested the sale of additional debt securities, the reduction of inventory, and the cutting of capital expenditures. As an accounting matter, Ehinger showed that Kennecott's negative cash flow would be improved in 1978 by the profits and depreciation generated by Carborundum and by Kennecott's existing carryover tax losses. Ehinger also reported that the Curtiss-Wright plan would not breach certain negative covenants in Kennecott's credit agreements if Kennecott adopted certain unspecified accounting techniques, which would maintain minimum levels of net tangible assets and stay within the maximum debt-asset ratios.
Kennecott maintains that this research is manifestly inadequate to determine whether the Curtiss-Wright plan is feasible. Kennecott points to its own in-depth research, which showed that depressed copper prices have and would continue to yield a drop in Kennecott's earnings. These lagging earnings, coupled with necessary substantial capital expenditures for the existing copper properties, will result in a severely negative cash flow for the foreseeable future. This cash position, Kennecott contends, renders a substantial cash distribution impossible, or, at least, highly perilous.
Kennecott's research further demonstrated that the Carborundum sale would not bring a price sufficient to permit a cash distribution of the magnitude proposed by Curtiss-Wright. Additional funds would have to be obtained for this purpose, and, Kennecott contends, such funds would not be readily available from banks or other conventional credit sources, or from internal economies. Finally, Kennecott notes that the proposed cash distribution would result in a default under existing credit agreements, since it would leave the company with a debt-asset ratio exceeding that permitted by the credit agreements, and with total net tangible assets falling below the minimum levels required by the agreements.
Of course, it is not for us to credit the research of one contestant over that of the other. The ultimate question of the feasibility of the Curtiss-Wright plan is beyond our province and is a decision to be made by the shareholders. Allen v. Penn Central Co., 350 F. Supp. 697, 702 (E.D. Pa. 1972). The significant questions for our determination are whether Curtiss-Wright used due diligence in investigating the feasibility of its plan, and whether Curtiss-Wright knowingly or negligently failed to make adequate disclosures in this regard in its proxy materials. Allen v. Penn Central Co., supra, 350 F. Supp. at 702; Gerstle v. Gamble Skogmo, Inc., supra, 478 F.2d at 1303. On the evidence before us, we must answer "no" to the first question, and "yes" to the second, and we conclude that Curtiss-Wright violated Rule 14a-9(a).
The inadequacy of Curtiss-Wright's research is striking. Curtiss-Wright conducted no bona fide internal study of the feasibility of its program, nor did it retain any outside expert to do so. It would have the Kennecott shareholders pass on the feasibility of its cash distribution on the basis of the superficial research conducted by Ehinger and Berner. Yet, Ehinger's shallow research was never committed to writing. He produced no notes, calculations or memoranda in reporting to Berner. Ehinger's work was in no way subjected to further scrutiny by other Curtiss-Wright personnel.
The extent of Ehinger's research, moreover, was hardly exhaustive. The feasibility of the plan was treated rather like an academic exercise involving an analysis of balance sheet data, wholly removed from the reality of Kennecott's day-to-day problems in the copper industry. We must conclude that Curtiss-Wright proceeded in an extremely cavalier manner in investigating the feasibility of its plan. Given the millions of dollars at stake, we conclude that reasonable men in the position of Berner and Ehinger would have done more to assure themselves of the feasibility of the plan. We, therefore, hold that Curtiss-Wright failed to exercise due diligence before suggesting its plan in the proxy materials.
In light of this finding, we turn to the disclosures in the proxy materials and we find them inadequate. The proxy materials failed to appraise the shareholders of the superficial nature of the investigation behind the Curtiss-Wright plan. To be sure, the proxy materials hedged with the disclaimer that "Curtiss-Wright has not made a detailed study of the consequences to Kennecott of the program described above." Under the circumstances, however, such limited disclosure is misleading because it omits to reveal the shallow and limited inquiry actually made. Clearly, the depth or shallowness of the investigation was highly material to a shareholder's decision of whether to grant or to withhold his proxy.
Quite simply, the shareholders needed more information in order to judge intelligently the question of feasibility. The Curtiss-Wright plan is reminiscent of the pot of gold at the end of the rainbow; it promises a $20 per share payment while allowing the shareholders to keep half their shares which would sell around $25. As noted above, we do not necessarily conclude that the pot of gold is illusory. We do conclude, however, that Curtiss-Wright failed to inform the shareholders that the path along the rainbow rests upon a weak foundation hurriedly pasted together by Berner and Ehinger.
Given the very shallow nature of Curtiss-Wright's feasibility studies, as well as the highly superficial appeal of the Curtiss-Wright plan, we must conclude that Curtiss-Wright omitted material facts from its proxy materials by failing to outline for the shareholders the limited extent and paucity of its feasibility investigation. There is no evidence that the omitted information was knowingly concealed, but given the magnitude of the proposal, due care required a full disclosure of the fact that the feasibility of the program had not been thoroughly investigated and was not supported by any objective research or study whatever. The omissions were thus due to negligence bordering on recklessness. As a result, the proxy materials misled shareholders to believe that the feasibility of the plan had been thoroughly studied, and the deception was aggravated by the fact that it appeared to have the imprimatur of Curtiss-Wright's proposed slate of directors, all of whom were recognized leaders in the financial community. Yet, there is no evidence that even they were aware of the shallowness of Curtiss-Wright's investigation.
There can be no doubt that the remaining elements of a Rule 14a-9(a) violation are also present. The omitted facts, going as they do to the very feasibility of the proposed corporate action, would certainly affect the judgment of a reasonable shareholder in determining how to vote. TSC Industries, Inc. v. Northway, Inc., supra, 426 U.S. at 449. Since Curtiss-Wright could not elect its own slate of directors or implement its plan without soliciting proxies, the solicitation is an essential link in effecting the corporate action. Mills v. Electric Auto-Lite Co., supra, 396 U.S. at 385; Schlick v. Penn-Dixie Cement Corp., supra, 507 F.2d at 381-84. All the elements of a Rule 14a-9(a) violation being present, we hold that Curtiss-Wright violated the proxy rules in this respect.
B. The Teledyne Connection
Kennecott further contends that Curtiss-Wright is controlled by Teledyne, Inc. ("Teledyne") and that Curtiss-Wright's failure to disclose that it was so controlled, in either its Schedule 13D or in its proxy materials, violates Section 13(d)(1) of the Act and Rule 14a-9(a), respectively.
The applicable definition* of "control" is set forth in Rule 12b-2, which provides:
"The term 'control' (including the terms 'controlling,' 'controlled by' and 'under common control with') means the possession, directly, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise."
Under Rule 12b-22, however, control need not be disclosed:
"If the existence of control is open to reasonable doubt in any instance, the registrant may disclaim the existence of control and any admission thereof; in such case, however, the registrant shall state the material facts pertinent to the possible existence of control."
Thus, the question for us is whether, at the time Curtiss-Wright mailed its proxy materials to the Kennecott shareholders, "the existence of control" was "open to reasonable doubt" about Teledyne's control of Curtiss-Wright, and, if so, whether Curtiss-Wright sufficiently disclosed the underlying facts.
We find as a fact that at the relevant time Teledyne's control of Curtiss-Wright was open to "reasonable doubt." It is undisputed that subsidiaries of Teledyne owned, and still own, approximately 30% of Curtiss-Wright's outstanding shares. Nevertheless, the evidence here shows that over the years there has been very little contact between the sachems of Teledyne and Curtiss-Wright. Indeed, Berner testified that he and Harvey Singleton, Teledyne's top executive, have never met and have spoken to each other on the telephone only six or seven times. Further, it is clear that Teledyne has been in no way involved in Curtiss-Wright's attempt to gain control of Kennecott. Most significantly, Teledyne and Curtiss-Wright have no directors in common, and there is no evidence of any specific instances in which Teledyne or any of its subsidiaries has sought to exert influence over the actions of Curtiss-Wright. In these circumstances, we fail to see how Teledyne or its subsidiaries presently possess the power to control or direct the management or policies of Curtiss-Wright. Certainly, the existence of such power does not appear with certainty from the naked fact that Teledyne's subsidiaries own approximately 30% of Curtiss-Wright's stock. The existence of control is, therefore, open to reasonable doubt.
Thus, the question is reduced to whether Curtiss-Wright made a sufficient disclosure of the underlying facts. Curtiss-Wright's Schedule 13D disclosed that Teledyne's subsidiaries owned 30% of Curtiss-Wright's outstanding shares, and that the shares were held for investment. The schedule further stated that neither Teledyne nor any Teledyne subsidiary had sought or received representation on Curtiss-Wright's board. From these facts, a shareholder might infer that Teledyne controls Curtiss-Wright. Apparently, Kennecott has drawn such an inference. The inference, however, is by no means inescapable and, therefore, Rule 12b-22 does not mandate its disclosure. We find, ...