The opinion of the court was delivered by: SOFAER
REVISED OPINION AND ORDER
Plaintiffs Data Probe Acquisition Corp., and its parent Data Probe, Inc., (collectively "Data Probe"), brought this action under the Williams Act, 15 U.S.C. §§ 78m(d)(e) and 78n(d)-(f) (1976), to enjoin a corporate merger between defendant corporations, Datatab, Inc. and CRC Acquisition Corp., a wholly-owned subsidiary of CRC Information Systems, Inc. ("CRC"), because defendants allegedly entered into unlawful option and indemnity agreements. Plaintiffs also claim that a letter written by Datatab to its shareholders on July 1, 1983 failed to satisfy the disclosure requirements of Section 14(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78 n(a) and Section 14(e) of the Williams Act, 15 U.S.C. § 78 n(e), which amended the 1934 Act, and violated Rules 143-2, 17 C.F.R. § 240.14e-2, and 14a-9, 17 C.F.R. § 240.14a-9.All three parties, Data Probe, Datatab and CRC, are engaged in the market research business. The complaint raises no state law claims, although it alleges at various points breaches of "fiduciary" duties by Datatab's officers and directors. See Complaint PP22, 23, 26.For the reasons that follow, plaintiffs' request for injunctive relief is granted, both because the July 1 letter omits material facts and because the option agreement is a manipulative device that interferes unlawfully with plaintiff's tender offers, in violation of Section 14(e).
This matter was brought on by Order to Show Cause before the undersigned in the emergency part for the Southern District of New York. The parties agreed that no discovery was necessary, and established an expedited schedule for briefing and argument. At oral argument on July 27, the parties conceded that the only disputed issues of fact in the litigation concerned statements allegedly made at a dinner meeting between the principal officers of Datatab and Data Probe. The parties agreed to proceed with a trial of those disputed issues, and thereafter to submit this case for judgment on the papers presented, conceding on the record that no further oral testimony or written exhibits would be necessary for a final disposition. These stipulations moot the pending motions for a preliminary injunction and for summary judgment and permit the court to enter final judgment. A tentative, expedited opinion was filed on August 4 to permit prompt appeal; this revised opinion represents the court's final findings and conclusions.
Datatab, a company with a recent history of losses, approached CRC in December 1982 to inquire whether CRC would be interested in acquiring the financially troubled corporation. Datatab is traded over the counter, and at the time had a book value of $2 per share and a net operating loss tax carry forward on December 31, 1982 in excess of $1,250,000. CRC is a privately held corporation having four director-shareholders, three of whom were formerly employed by Datatab. Negotiations followed, and on April 29, 1983 the companies entered into a proposed "merger" agreement under which CRC would create a subsidiary corporation, CRC Acquisition Corp., which would purchase all outstanding Datatab common stock for $1.00 per share and then merge into Datatab making Datatab a wholly-owned subsidiary of CRC. Pursuant to federal and state laws, on May 26, 1983 Datatab sent proxy materials to its shareholders providing information explaining the proposed sale of Datatab stock by "merger" and announcing a June 23 special meeting of shareholders to vote on the proposed sale. In these materials, Datatab's board of directors described CRC and stated that in its opinion, supported by the views of various purported experts, $1.00 was a fair price for each share of Datatab stock. In addition, these materials disclosed that,if the sale-by-merger plan were adopted, Datatab's principal officers, currently on month to month contracts, would receive three-year employment contracts with CRC which altered their salaries with Datatab as follows: Mr. Sanford Adams, President and board member at Datatab, would receive an increase in annual salary from $94,500 to $100,000 with a guaranteed bonus of at least $5,000 per year; Mr. Lee D. Gallagher, a member of Datatab's board of directors, would receive a reduction in salary from $80,000 to $70,000; and Mr. John L. Lobel, Vice-President, Treasurer and board member at Datatab, would receive an increase from $69,800 to $70,000.
On June 21, Data Probe, a relatively small but profitable company in a related line of market research activity, made a cash tender offer of $1.25 for all outstanding common stock of Datatab, conditioned on the rejection by Datatab shareholders of the proposed sale-by-merger agreement at $1.00 per share. Data Probe published all the information required by the Williams Act in connection with its tender offer, explaining its purposes, the source of its financing, and its intentions for the company. Datatab's management thereupon adjourned the scheduled June 23 meeting to July 12 and subsequently to Autust 8, and informed CRC management of Data Probe's tender offer. Datatab claims that, after considerable negotiation, CRC agreed to raise its offer to purchase through a merger all outstanding shares of Datatab stock from $1.00 to $1.40 per share, but only if Datatab management first granted CRC an irrevocable option, not subject to shareholder review and exercisable on demand for one year, whereby CRC could purchase 1,407,674 voting shares of Datatab authorized but unissued stock -- an amount equal to 200% of all presently outstanding voting shares -- at the same price of $1.40 per share.
Meanwhile, negotiations also occurred between the principals of Datatab and Data Probe. At the mini-trial held to resolve the only disputed issues of fact in this case, the evidence established that Yitzhak Bachana, President of Data Probe, called Sanford Adams of Datatab and arranged to meet and discuss Data Probe's interest in the company. They met on June 21, at a restaurant in New York City, and discussed a variety of issues, including Data Probe's intentions with respect to the continuation of the services and salaries of Datatab's officers. The versions of the dinner conversation offered by the parties were similar in most respects. Both Bachana and Adams agreed that the salary of the Datatab officers was discussed, and Adams conceded that he asked Bachana what salary arangements Bachana was willing to offer.He testified that Bachana indicated a probable willingness to go along with the annual salary amounts to which CRC had agreed, and Adams suggested in his testimony that Bachana did not view a three-year commitment as unacceptable. In this later respect, however, Adams' own notes undermine his testimony and support Bachana's claim that Bachana was unwilling to commit himself. The notes read at the relevant point: "will discuss -- premature." (D. Ex. 1). This effort by Adams to indicate that length of contract was not a problem, as well as his demeanor and that of Bachana, make it clear that the length-of-contract issue was in fact of major concern to Adams, and that, while Bachana might have been willing to go along with the salary amount agreed to by CRC, he was unwilling to commit Data Probe to either the amount or duration of the proposed employment contracts until he had examined the situation and satisfied himself that the salary arrangements (totalling $250,000 annually) were justified by the company's earnings. This explains why Adams stated to Bachana, as alleged in Bachana's affidavit: "This baby will never work for a dollar less." Affidavit, July 21, 1983, P4. Adams denies having made the quoted statement, but his subsequent arrangement with CRC -- which seeks to vest CRC with the power to override the Datatab shareholders -- indicates that he did respond in substance to Bachana when reminded of the need for shareholder approval: "I don't care about shareholders; we have to take care of ourselves and this baby is not going to work for a dollar less."
By July 1, Datatab management had agreed to accept CRC's commitment to offer to purchase Datatab's shares by merger at $1.40, and had granted in exchange for that commitment an irrevocable option that in effect guaranteed CRC the power to accomplish the proposed merger even if disapproved by Datatab's present shareholders. On that day, Datatab sent its shareholders a letter informing them of a new proposed "merger" agreement with CRC by which, if approved, CRC would pay $1.40 per share for all outstanding shares of Datatab stock. It also stated that Datatab had granted CRC an option to purchase 1,407,674 authorized but unissued shares at the $1.40 price. Finally, the letter notified shareholders that a meeting was scheduled in August to permit shareholders to vote on the amended "merger agreement," and that the shareholders would receive timely supplemental proxy materials relating to that meeting. The shareholders wre not expressly informed, however, that if the option agreement was valid a vote rejecting the "merger" would have been inconsequential, since the option would give CRC the power to buy the number of shares necessary to approve an identical merger proposal at a subsequent meeting; not were they advised that the option agreement, if valid, effectively capped any further bidding for their shares.
On July 14, Data Probe made a second tender offer for all outstanding Datatab shares, increasing its bid to $1.55; the offer was conditioned of course upon the invalidation by corporate or judicial action of the option agreement between Datatab and CRC.Simultaneously, Data Probe commenced this action, claiming that defendants, as principals or aiders and abettors, violated Section 14(e) of the Exchange Act by entering into the lockup agreement, which constitutes a manipulative act or practice in connection with the tender offer for shares of Datatab, Complaint P28.Data Probe further claimed that defendants violated Section 14(e)'s disclosure requirements by failing to disclose in its July 1, 1983 letter to Datatab shareholders that:
(a) the purposes of the Lockup Agreement are to preclude Data Probe from successfully bidding for Datatab Shares, deter a competitive offer from any third-party, insure the success of the CRC merger proposal, and perpetuate Datatab's management in office at the expense of Datatab's shareholders;
(b) the Lockup Agreement set an artificial ceiling of $1.40 per share on the price any bidder would offer, and consequently on what shareholders could expect to receive for Datatab's shares;
(c) no inquiry was made by Datatab to determine whether CRC had the unds to purchase Datatab's shares pursuant to the Lockup Agreement;
(d) by exercising the option CRC would control two-thirds of the voting shares of Datatab which would disenfranchise the shareholders of Datatab by making their vote on the Amended Merger Agreement meaningless;
(e) [an] Indemnification Agreement [existed between Datatab and CRC holding the former harmless for its acceptance of the option proposal;] and
(f) the Securities and Exchange Commission ("SEC") considers similar indemnification agreements to violate public policy.
This case presents the important question whether the Williams Act permits the management of a target company unilaterally to thwart an ongoing tender offer by granting to one contestant an option that effectively precludes further bids. Counsel for target companies in tender offer cases like to put the qustion differently. In some of the commentary recently produced in response to the Sixth Circuit's decision in Mobil Oil Corp. v. Marathon Oil Co., 669 F.2d 366 (6th Cir. 1981), the issue had been described as whether the Williams Act is anything more than a disclosure statute. All concede that those provisions of the Act that require disclosure of information by the participants in the tender offer process confer jurisdiction on the federal courts to enforce their compliance.But many contend that the enforcement jurisdiction conferred upon the federal courts by Section 14(e), which proscribes "fraudulent, deceptive and manipulative acts and practices . . . in connection with a tender offer," does not extend to tactics which fall short of fraud or classic market manipulation. The language of Section 14(e), it is argued, is virtually identical to that of Section 10(b) of the Securities Exchange Act of 1934, which the Supreme Court in Santa Fe Industries v. Green, 430 U.S. 462, 51 L. Ed. 2d 480, 97 S. Ct. 1292 (1977), construed as conferring jurisdiction to review whether the defendant had engaged in blatantly fraudulent practices or market manipulations, but did not provide a federal law basis for claims stemming from management's abuse of fiduciary duties. Santa Fe held that stockholders who complained of the unfairness of a short form merger must pursue their remedies in state not federal court and that if, in fact, management's action deprived stockholders of any part of the full and fair market value of their shares, those values could only be obtained in state court appraisal proceedings. Defendants here, and others who criticize Marathon, claim that construing the words used in the Williams Act proscribing "manipulative" practices literally would involve federal courts in reviewing whether defendants had violated fiduciary duties, and for the same reasons relied on by the Court in Sante Fe contend that such claims must be resolved in state court proceedings.They find further support for this position in the holding in Piper v. Chris-Craft Industries, Inc., 430 U.S. 1, 51 L. Ed. 2d 124, 97 S. Ct. 926 (1977), which describes the Williams Act as concerned with assuring disclosures of information for the protection of shareholders and holds that no cause of action for damages exists in federal court for competitors in tender-offer battles.
They argue that decisions such as Applied Digital Systems, Inc. v. Milgo, 425 F. Supp. 1145 (S.D.N.Y. 1977) assuming jurisdiction in Williams Act cases challenging defensive tactics, preceded the Supreme Court's decision in Sante Fe and are no longer good law.
The notion that Sante Fe is dispositive rests on the mistaken assumption that analysis of Section 10(b) of the 1934 Act applies with equal force to the Williams Act. Section 10(b) is directed at insuring informed investment decision through "regulating trading markets, requiring disclosure, and prohibiting deception and classic kinds of market manipulations." Weiss, Defensive Responses to Tender Offers and the Williams Acts' Prohibition Against Manipulations, 35 Vand. L. Rev. 1087, 1092 (1982). The Williams Act focuses on the narrower and more specific problem of "protection of investors who are confronted by a cash tender offer. Chris-Craft, 430 U.S. at 35. A different form of protection is necessary under the Williams Act than under the 1934 Act, because tender offer battles, even in a context of full disclosure, create extreme pressures and may involve tactics which distort or even abort the investment decision. Furthermore, whereas available state-court remedies might be sufficient to warrant refusing to recognize a federal claim for "unfairness" under Section 10(b), a federal, injunctive remedy is a necessary adjunct to the Williams Act goal of preventing abuses of the tender offer procedure before they damage shareholders by undermining or aborting the tender offer process. As Senator Williams said in describing the purposes of the Act:
If the stockholder sells and can establish at a later time that he fell victim to fraud or misstatements, he would obviously have recourse to the courts. But many stockholders are unwilling to go to court even though they believe they have a sound case. Litigation is expensive, time consuming, and lacks the advantages that result from advance filing of the facts for the public record.
113 Cong. Rec. 854 (daily Jan. 18, 1967) (Statement of Senator Williams). Finally, the Supreme Court has shown in Edgar v. Mite Corp., 457 U.S. 624, 102 S. Ct. 2629, 73 L. Ed. 2d 269 (1982), that standards do exist for determining when the Williams Act's protection of the tender offer process preempts state corporation law; by contrast, one of the considerations that led the Court in Sante Fe to refuse federal jurisdiction was the lack of federal standards by which to evaluate whether state fiduciary laws should be preempted. 430 U.S. at 478.
The view of the Williams Act as purely a disclosure law, conferring little other protection on shareholders or contestants in the market for corporate control, is in addition inconsistent with the Act's history and purposes, and with authoritative judicial constructions. State law principles, including those of fiduciary duty and appraisal value, are not directly related to the purposes of the Williams Act. The Williams Act was not written to insure that corporate managers perform their general duties faithfully, or that shareholders succeed in obtaining the full and fair value of their stocks in tender-offer sales. Rather, the Act was written to assure stockholders access to the information necessary to make informed judgments,which they would then in fact be allowed to exercise, however positive or detrimental the economic consequences. Congress therefore imposed in the Act not one, but two duties on tender-offer participants, including target corporations: first, to provide shareholders the required information; and second, to refrain from any conduct that unduly impedes the shareholders' exercise of the decision-making prerogative guaranteed to them by Congress.
A. Dual Purposes of the Williams Act
In Piper v. Chris-Craft Industries, Inc., 430 U.S. 1, 51 L. Ed. 2d 124, 97 S. Ct. 926 (1977), the Supreme Court reviewed much of the legislative history of the Williams Act, and demonstrated that its primary purpose was to provide for disclosure of information to shareholders. Chris-Craft dealt comprehensively, however, only wit those portions of the Act's history necessry to explain its holding that the Williams Act provides no remedy to contestants for damages caused by its violation. While the Supreme Court has never passed upon the extent to which the Williams Act was intended to prevent defensive tactics by target companies, its recent decision in Edgar v. Mite Corp., 457 U.S. 624, 102 S. Ct. 2629 91982, 73 L. Ed. 2d 269 ), reveals that important aspects of the legislative history of the Williams Act had not been fully examined in Chris-Craft, including, for example, Congress' recognition of the importance of preventing target companies from delaying the tender offer process. See discussion infra.
A review of the Act's legislative history with the legitimacy of defensive tactics in mind reveals that Congress indeed meant for the federal courts to prevent tender offer participants from interfering with the informed investor choice that the Act sought to assure.One can safely say that the Act underwent from its original introduction in 1965 to its ultimate passage in 1968 a steady transformation from legislation designed to prevent corporate takeovers by cash tenders, to a bill that studiously maintained neutrality between offerors and targets, but consciously protected the rights of shareholders to transfer managerial power by tendering their shares, with proper information and without undue interference.
Senator Williams' original bill was avowedly designed to protect "proud old companies" from "white collar pirates" who seized assets with funds from unknown sources and "split the loot." See 111 Cong. Rec. 5273 (Oct. 22, 1965) (statement of Sen. Williams). Broad disclosures by would-be offerors would have been required, and ample time for defensive measures would have been provided by a 20-day precommencement filing requirement, with SEC regulation of corporate defenses limited to purchases of substantial blocks of a company's own stock. See S. 2731, 89th Cong., 1st Sess. 28257-60 (1965). This bill was not considered when initially introduced, and as revised on reintroduction it increased the mechanisms for shareholder participation in the tender offer process and reduced the delay from filing to purchase from 20 to 5 days. See Cohen, A Note on Takeover Bids and Corporate Purchases of Stock, 2 Bus. Law 149 (1966). Continued hearings and discussion led to balanced disclosure provisions that comported with SEC Chairman Manuel Cohen's clear espousal of the bill's neutrality of purpose: "It is not intended to encourage or discourage such activity [acquisitions of control] or provide management or any other group with special privileges over any other." See Full Disclosure of Corporate Equity Ownership and in Corporate Takeover Bids, Hearings on S. 510 Before Subcomm. on Securities of Banking and Currency Committee, 90th Cong. 1st Sess. 16 (1967) (herinafter "Senate Hearings").Rather, the bill -- which by then expressly applied to a corporation's repurchases of its stock -- was repeatedly touted as a vehicle for permitting informed investment decisions. And in this connection, Chairman Cohen made explicit the obvious proposition that an effort to enable a stockholder to exercise an informed judgment necessarily implies the exercise of a judgment that is not unreasonably restricted by offers with unfair conditions on acceptance, or by management's misleading or manipulative efforts to prevent acceptance:
It would be naive to assume that tender offers are not, at times, opposed by management motivated by their own interests in staving off a change in control. It would however, be as much an overstatement to suggest that management, in opposing bids is motivated solely by self interest as it would be to suggest ...