proximately caused by the defendants' alleged RICO violations.
II. SECTION 14(a) CLAIM
The plaintiffs charge the Directors with violating Section 14(a) of the Securities Exchange Act of 1934 and Rule 14a-9 promulgated thereunder by issuance of the 1988 Proxy Statement seeking approval of the Raincoat Provisions. According to the Complaint, "The 1988 Proxy Statement was materially false and misleading in that it failed to disclose material facts necessary to make the statements made not misleading, including facts, inter alia, regarding the Company's gross mismanagement, lack of internal controls, waste of assets, and potentially illegal conduct, and the directors' utter failure to fulfill their stewardship responsibilities regarding the wrongdoing described herein." Complaint at P 184. The Complaint also charges the Directors with failing "to disclose to shareholders that the officers and directors who unanimously recommended approval of the Raincoat Provisions were already subject to suit at the time they so recommended." Id. at P 183.
Section 14(a) provides that it is unlawful to solicit a proxy contrary to rules established by the Securities Exchange Commission, and has been interpreted to provide for a private right of action. General Time Corp. v. Talley Industries, Inc., 403 F.2d 159, 161 (2d Cir. 1968), cert. denied, 393 U.S. 1026, 21 L. Ed. 2d 570, 89 S. Ct. 631 (1969). Pursuant to Section 14(a), the Securities Exchange Commission has issued Rule 14a-9(a), 17 C.F.R. § 240.14a-9(a), which prohibits a solicitation of proxies that is, inter alia, "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." "An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote." TSC Indus. v. Northway, Inc., 426 U.S. 438, 449, 48 L. Ed. 2d 757, 96 S. Ct. 2126 (1976).
A. Statute of Limitations
The Directors contend that the plaintiffs' Section 14(a) claim is barred by the statute of limitations. Claims under Section 14(a) of the Securities Exchange Act must be brought within the earlier of (1) one year from discovery of the conduct constituting the violation, and (2) three years from the occurrence of such conduct. Ceres Partners v. Gel Assocs., 918 F.2d 349, 364 (2d Cir. 1990). The Directors concede that this action was brought within the three year period, but not that it was brought within the one year period. The Directors assert that the plaintiffs discovered the conduct in question no later than August 7, 1989 on which date plaintiffs' co-lead counsel wrote a demand letter to the Directors concerning the Safra affair. See Complaint at P 177.
The plaintiffs answer, inter alia, that New York law required them to make a demand upon the Directors before bringing the derivative action, see N.Y. Bus. Corp. Law § 626(c), and that the statute of limitations should run from the date that the Directors refused the plaintiffs' last demand. The Court agrees with the plaintiffs that the one year period of limitations should be extended where plaintiffs in a derivative action have made a demand upon a corporation's directors within this period. While there is apparently no case law on point, to permit the statute of limitations to run in these circumstances would clearly be inequitable.
The Directors counter that the instant action was brought more than one year after the plaintiffs' first demand upon the Directors, and that, though the litigation was commenced within one year of a second demand made by the plaintiffs, this second demand was not legally required. The Court is nonetheless unwilling to disregard the plaintiffs' second demand. The demand process plays an important role in corporate governance and the courts have every interest in encouraging this process. A second demand, even when not legally required, may be an appropriate means for shareholders to urge reconsideration upon a board of directors whose first refusal the shareholders believe was improvident. To ignore this second demand in calculating the statute of limitations would discourage this potentially useful dialogue. Moreover, corporate directors will not be significantly prejudiced by extending the one year period since such demands will clearly place the directors on notice that litigation is likely.
Accordingly, this Court holds that the one year statute of limitations period ran from the date the second demand was refused in October 1990. Since this action was initiated in January of 1991, it is not time barred.
B. Failure to Disclose Material Facts
The Defendant Directors contend the plaintiffs have failed to state a claim upon which relief can be granted because the Complaint does not allege that they failed to disclose any facts they were required to disclose under Section 14(a) and Rule 14a-9.
In Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 51 L. Ed. 2d 480, 97 S. Ct. 1292 (1977) the Supreme Court declared itself unwilling to interpret Section 10(b) of the Securities Exchange Act of 1934 and Rule (10)(b)(5) promulgated thereunder so as to "federalize the substantial portion of the law of corporations that deals with transactions in securities." Id. at 479. Accordingly, the Court held that Section 10(b) does not prohibit "instances of corporate mismanagement . . . in which the essence of the complaint is that shareholders were treated unfairly by a fiduciary." Id. at 477.
This unwillingness to federalize corporate law has also shaped decisions concerning the scope of Section 14(a). In Field v. Trump, 850 F.2d 938 (2d Cir. 1988) the Second Circuit dismissed a claim under Section 14(a), reasoning as follows:
Allegations that a defendant failed to disclose facts material only to support an action for breach of state-law fiduciary duties ordinarily do not state a claim under the federal securities laws. Certainly this is true of allegations of garden-variety mismanagement, such as [of] managers failing to "maximize value for . . . shareholders," . . . of directors failing "to adequately inform themselves", . . . or of managers acting in a generally self-entrenching fashion.
Id. at 948. Thus, the Second Circuit has consistently rejected attempts to "dress up" mismanagement and breach of fiduciary duty claims "in a § 14(a) suit of clothes." Maldonado v. Flynn, 597 F.2d 789, 796 (2d Cir. 1979).
However, this does not mean that facts can never be both a basis for state law fiduciary duty claims and also subject to disclosure under Section 14(a). In Maldonado, the Second Circuit held that when votes for the election of corporate directors are sought, Section 14(a) requires the disclosure of "the circumstances surrounding corporate transactions in which directors have a personal interest" since this information is "directly relevant to a determination of whether they are qualified to exercise stewardship of the company." Id. at 796. In applying this rule, the Court found that the defendants might have violated Section 14(a) by failing to disclose certain information regarding their ownership of options on the corporation's stock. Id. at 798.
Whether a claim under Section 14(a) is proper or merely a "dressed-up" breach of fiduciary duty claim depends in large measure upon whether deciding the claim will require the Court "to distinguish between conduct that is "'reasonable' and 'unreasonable,' or 'informed' and 'uninformed,' distinctions that are the hallmark of state fiduciary law." Field at 948.
In the instant case, the Directors contend that the plaintiffs' allegations are of precisely the type found inadequate in Field. This position is certainly supported by the language of the Complaint, which alleges that the Directors failed to disclose information "regarding the Company's gross mismanagement, lack of internal controls, waste of assets, and potentially illegal conduct, and the directors' utter failure to fulfill their stewardship responsibilities regarding the wrongdoing described herein." Complaint at P 184. Plainly, this is the type of nondisclosure concerning "garden variety mismanagement" that Field held did not give rise to a claim under Section 14(a). See Field, 850 F.2d at 948. Nor are these allegations saved by inclusion of the charge that the Directors failed to disclose "potentially illegal conduct" for "the 'proxy rules simply do not require management to accuse itself of antisocial or illegal policies.'" GAF Corp. v. Heyman, 724 F.2d 727, 740 (2d Cir. 1983) (quoting Amalgamated Clothing & Textile Workers Union v. J.P. Stevens & Co., 475 F. Supp. 328, 331-32 (S.D.N.Y. 1979), vacated as moot, 638 F.2d 7 (2d Cir. 1980) (per curiam).
The Complaint also charges the Directors with failing "to disclose to shareholders that the officers and directors who unaniinously recommended approval of the Raincoat Provisions were already subject to suit at the time they so recommended." Complaint at P 183. Pending litigation has been held to be subject to disclosure in some instances. See, e.g., Goldsmith v. Rawl, 755 F. Supp. 96, 97-98 (S.D.N.Y. 1991). However, neither in paragraph 183 nor elsewhere in the Complaint is it alleged that a suit had been initiated or even threatened regarding the Safra matter as of the date the Raincoat Provisions were adopted.
Rather, the meaning of paragraph 183, upon close scrutiny, is merely that the directors had breached their fiduciary duties and, as a consequence, were therefore allegedly subject to suit. This paragraph, then, is no more than an alternative means of phrasing the allegations made in Paragraph 184 and cannot mend the inadequacy of those allegations. Section 14(a) does not require that such uncharged, unadjudicated charges of mismanagement be disclosed. Ciresi v. Citicorp, 782 F. Supp. 819, 823 (S.D.N.Y. 1991), aff'd, 956 F.2d 1161 (2d Cir. 1992).
Concededly, this case is distinguishable in one respect from those that have hitherto been considered by the courts of this Circuit. In the instant case, plaintiffs' Section 14(a) claim relates to provisions limiting the liability of the Directors for breaches of their fiduciary duties. Section 14(a) could be found to require the disclosure of information regarding mismanagement in this context, though such information need not be disclosed in other contexts. Cf. Goldsmith, 755 F. Supp. at 97 ("the Court must take into account the context in which the alleged nondisclosures occurred.") Disclosure of information regarding a breach of fiduciary duties could be held material to a vote concerning raincoat provisions since the very subject of such a vote is the limitation of liability for such breaches.
This issue was addressed by the Court of Appeals for the Third Circuit in General Elec. Co. v. Cathcart, 980 F.2d 927 (3d Cir. 1992). In that derivative action, the plaintiff sought to invalidate two raincoat provisions, the latter of which was adopted in the same year that an employee of General Electric was indicted for defrauding the United States Government on a computer contract. General Electric was subsequently fined over $ 1 million for the fraud. Id. at 929. The plaintiff claimed that at the time of the proxy statements the directors should have known that the fraud might give rise to legal claims against them and that Section 14(a) required the disclosure of this potential litigation. Id. at 935. The Third Circuit upheld the district court's dismissal of the claim pursuant to Fed. R. Civ. P. 12(b)(6) finding that the "mere possibility of litigation" against the directors was not a material fact. Id. at 935, 937. The Court held that "such speculative disclosure is not required under Section 14(a)," though the Court implied that the directors would have been required to disclose actual or threatened litigation. Id. at 935-37.
This Court agrees with the conclusions of the Third Circuit. Concededly, information that directors may have breached their fiduciary duties is of some relevance when shareholders are asked to consider raincoat provisions that would indemnify these directors or limit their liability. However, information regarding a breach of fiduciary duty is no less relevant to shareholders when called upon to elect corporate directors, but the failure to disclose such information in that context does not give rise to a claim under Section 14(a). See United States v. Matthews, 787 F.2d 38, 48 (2d Cir. 1986); Amalgamated Clothing v. J.P. Stevens & Co., 475 F. Supp. 328, 331-32 (S.D.N.Y. 1979), vacated as moot, 638 F.2d 7 (2d Cir. 1980); Limmer v. General Tele. and Elec. Corp., 1978Fed. Sec. L. Rep. (CCH) P 96,110 (S.D.N.Y. July 7, 1977). This unwillingness to impose liability in these circumstances reflects the counsel of the Second Circuit in Field that courts should not entertain Section 14(a) claims that in the final analysis turn upon "distinguishing between conduct that is 'reasonable' and 'unreasonable,' or 'informed' and 'uninformed,' distinctions that are the hallmark of state fiduciary law." Field, 850 F.2d at 948.
This Court might escape the necessity of making these distinctions in the instant case if this suit concerned a failure to disclose actual or threatened litigation. However, the plaintiffs have not alleged that any undisclosed litigation was threatened or commenced as of the time of the 1988 Proxy Statement. Consequently, in order to determine whether the Directors violated Section 14(a) by failing to disclose the possibility of litigation, this Court would first be required to determine whether the conduct at issue should have been viewed by them as giving rise to a claim for breach of state law fiduciary duties. This is precisely the type of case turning upon determinations of fiduciary duties that the Second Circuit warned against entertaining as a Section 14(a) suit. See Field, 850 F.2d at 948.
Accordingly, this Court holds that the plaintiffs allegations do not state a claim under Section 14(a).
III. JURISDICTION OVER THE PENDANT STATE LAW CLAIMS
The sole basis for this Court's jurisdiction over plaintiffs' breach of fiduciary duty claims against the defendants is this Court's supplemental jurisdiction under 28 U.S.C. § 1367(a). A court may decline to exercise such jurisdiction when the court has dismissed all claims over which it has original jurisdiction. See 28 U.S.C. § 1367(c)(3) (Supp. I 1990) (enacted December 1, 1990). Moreover, dismissal of pendant state law claims is particularly appropriate where all federal claims have been eliminated before trial. Carnegie-Mellon Univ. v. Cohill, 484 U.S. 343, 350, 98 L. Ed. 2d 720, 108 S. Ct. 614 (1988); DiLaura v. Power Authority, 982 F.2d 73, 80 (2d Cir. 1992).
The Court has dismissed both the RICO and Section 14(a) claims in this case over which it has federal subject matter jurisdiction. Accordingly, this Court dismisses the pendant state law claims pursuant to Fed. R. Civ. P. 12(b)(1) and 28 U.S.C. 1367 (c).
For the reasons stated above, the Court hereby grants the defendants' motions to dismiss the RICO and Section 14(a) claims pursuant to Fed. R. Civ. P. 12(b)(6) and to dismiss the pendant state law claims pursuant to Fed. R. Civ. P. 12(b)(1). Accordingly, this case is hereby dismissed.
Dated: December 22, 1993
New York, New York
Peter K. Leisure