# Opposition Brief — Muscat v. Norte & Co. > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385604_1351%3A2 ## Record - **Collection:** Supreme Court brief - **Document type:** Opposition Brief - **Published:** January 1, 1970 - **Citation:** 397 U.S. 989 ## Text 7 INDEX Preliminary Statement ..................cccccece. RN II 4 oa day Ca Ons Vane gos Statement of the Case oo... oo. .scccccicccece.,.. Summary of the Argument ...................... | Pornt=I—The petition should be denied because the questions posed by petitioners do not arise out of the facts in the case or they involve issues of fact .. wae me TE se sc secc. cae The Third and Fourth Questions .............. The Fifth Question ..............0............. : CoNCLUSION ......... Ss REREN OED OEE AE bak Meat cue ‘ APPENDIX ..:..... Nis O46 Se wEW he Ree eee we dae here li be , TABLE oF AUTHORITIES ( Cases _~— , ’ Appalachian Power Co. v. American Institute of Certified Public Accountants, 361 U.S. 30, 4 L Ed 2d 30, 80 8; Ot. 16.(1950) oc svee sec ccce... Berenyi v. Immigration Service, 385 U.S. 630, 17 L _Ed 2d 656 ROMER eS vebeel 4s vane eye ee bee eee Comstock v. Group of Institutional Investors, 335 U.S. 211, 92'L Ed 1911 (1947) .................. Conway v. Adult Authority, US. ,24L Ed 245 (ARTO) BE Wh NO ae eee e de Haas v. Empire Petroleum Co., 300 F. Supp. 834, or: SO, SOE 055 55 cde sine ee ete. - Gallagher v. Perot, 112 Misc. 717,183 N.Y. Supp. 257 (Sup. Ct. 1918) aff’d 200A.D. 867, 191 N.Y. Supp 926 aff’d 234 N.Y. 516 (1922) ................... | Giannone v. United States Steel Corporation, 238 Home Fire Ins. Co. v. Barber, 67 Neb. 644, 93 Nw, ssciatath al fee SORT T EE Me ce oe Hooper v. Mountain States Securities Corp., 282 F., 2d 195 (5th Cir. 1960), cert. den. 365 U.S. 814,5 L te BR OO BIN) ods os beeen ee ee J. I. Case Co.-v. Borak, 377 U.S. 426, 12 L Ed 2d 423 Laird v. Carrier Engine Service Co., 263 F. 2d 948 ORE CUE SIO) sds cons cen sh see PAGE 18, 22 9, 26 7,11 14,17 ' ie “di i pes ' PAGE “Marin v. Kngland, 385 U.S. 99, 17 LEd 2d 197 (1966) 16 Mathews v. Heedley Chocolate Co., 130 Md. 523, 100 Atl, 645 (1917) .......... eee ee ee 16 May v. Midwest Refining Co., 121 F. 2d 431 (1st Cir. “ 1941}, cert. den. 314 U:S. 668, 86 LEd 534 (1941) 16 McCarthy. v. Brunner, 323 U.S. 673, 89 L Ed 547 » (SONS). sine oes vn bc dete es Op ee 10 Mills v. Electric Auto-Lite Co., 403 F. 2d 429 (2 Cir. 1968), judgment vacated, supra, U.S. , 24 " L Bd Sd 606 .... Sreryeresy Vee whee evieg we Cee 17, 25 Moor v. Texas & New Orleans R. Coz 297 U.S. i 5> 80 L Ed 509 (1935) ........ 5 as aa /..7, 11, 18 NLRB v. Pittsburgh S.S. Co., 340 U.S. 498, 95 L Ed 479 (1951) .. 1s Fe cesabes oP ¥EVER TART eeES fs veo SE 18 Perlman v. Feldman, 219 F. 2d 173 (2nd Cir. 1955) 16. ‘Potter v. Walker, 276 N.Y. 15 (19ST) oe. en en ees 19 ° Ross v. Bernhard, etal, US. ;.. Li Bd 2d (Feb. 2, 1970) n De sib.t vein est eo een Savvis pan ‘14, 18 Simon v. New Haven Board & Carton Co., 250 F. , Supp. 297 (D. Conn. 1966) ....., ‘eaee aay 13 Southern Pacific R:R:-v: Bogart; 250 US. 478 (1919) 16 3 1, Ed 2d 723, reh. den. 359 U.S. 993, 3 L Ed 2nd 986 $1900)... oo. cise ae re Tyrrell v. District of Columbia, 243 U.S. 1, 61 L Ed 507 (1916). sve ee ee eee eds 10 \ é iv. Statutes and Rules j | PAGE Federal ‘Rules of Civil Procedure: pm BUT) BOG IG(D) os. sooo hoo vende 2 ‘Rules of the Supreme Court of the United States: WR eee hen tera iksG coh oie ce ee 2 Securities Exchange Act of 1934: | | dF” Deo teh Er oem imine 3, 8, 23, 24 §§ 10b-5 and 14a-9 weeeeee o EAD Eia ee tes’ ay bace 8 a 8, 24° Miscellaneous 13 Fletcher, Cyclopedia of Corporations (1961, Rev. volume) BA: Gee, aoe elena neee 15 2 Hornstein, Corporation Law and Practice (1959) § 731, pp. 246- pe BERTIE Oe or noe eae ane 15 Henn on Corporations (1961) See. 375, p. Rs 15 Stern & Gressman, Sup. Ct. Prac (4th Ed. 1969), : S§ 6. a DO oS oh rsa ete e a tae Pe aubeaee 7,10 0 \ ‘Supreme Court of the United States October Term, 1969.. “N 7% ¥ Victor Muscat anv R. L. Hurrrinss, Jr., Petitioners, —against— Norte & Co. ' - ¢ ve Respondent. 7% ¥- BRIEF IN OPPOSITION TO PETITION FOR ) WRIT OF CERTIORARI ; Opinion Below Petitioners have: omitted citation of the opinion of the District Court rendered after trial, which is 304 F. Supp. 1096. Preliminary Statement Petitioners seek a writ of certiorari to review a judg- ment of the United States Court of Appeals for the Second’ Circuit, unanimously affirming a judgment of the United States District Court for the Southern District of New York after a trial on the merits. Petitioners pose five questions which they contend re- quire review by this Court (Pet. pp. 2-3). None of the questions raised presents a proper basis for certiorari be- cause it is demonstrable that either (1) the questions pre- sented are not involved’ in this case and are, therefore, en- tirely hypothetical, or (2) they involve contested issues of fact decided against petitioners by the District Court and affirmed by the Court of Appeals. 2- Additional Rules Involved In addition to the statutes and regulations set forth in the petition (A 72-76), the following rules are involved: Rule 19 of the Rules of the Supreme Court of the United States; and Rules 8(f) and 15(b) of the Federal Rules of - Civil Procedure. : fae : . f Statement of the Case The action is a derivative stockholder’s suit brought on behalf of Defiance Industries, Inc. (‘‘Defiance’’) against its | principal officers, directors and controlling stockholders. The amended complaint asserts three causes of action. The first, a common law cause of action, based on diversity of » citizenship, aHeges that petitioners, together with one Ed- ward Krock (named as a‘defendant, but not served), caused ° Defiance to issue a grossly excessive number of its shares in exchange for shares of Insurance and Industrial Iinter- prises, Inc. (‘‘ITK’’), a corporation 77% ‘owned by peti- tioners and Krock (R 6a-12a).* ate Liability on the second cause of action was conceded by petitioners and is,.therefore, not involved on this applica- tion.** ; * References designated by the letter “R” refer to petitioners’ . appendix on their appeal to the Court of Appeals, '** The second cause of action, likewise a common law claim based "on diversity of citizenship, alleges that petitioners and Krock . appropriated an opportunity belonging to Defiance to acquire - l 10% of the stock of IIE at $20.94 per share at the very time petitioners, and Krock were conspiring to sell these shares. to Defiance at $70.51 per share (R 12a-13a). Judgment in the sum of $206,357 was rendered against petitioners. on this cause . of action. On their: appeal to the Court of Appeals, petitioners conceded that they had appropriated this corporate opportunity and that they should have tendered the shares in question to Defiance at their cost. . fee . . The third cause of action alleges that petitioners’ secured ~ stockholder approval of the exchange transaction between Defiance and IIE on the basis of a false and misleading proxy statement in violation of §¢ 10 and 14 of the Seeuri- ties Exchange Act of 1934 (‘‘Act’’) and the: SEC rules adopted thereunder (R 14a-18a). The District Court awarded judgment with respect to the first cause of action upon the ground that. petitioners had violated ‘‘their state-law fiduciary obligation to’ Defi- ance (first cause of action) by causing it to acquire all of the stock of I1E, 77% owned by them and their associates, at an inflated price’’ (A 35).* In this connection the Dis- trict Court further held (A 32): ‘Plaintiff has established a clear case of gross and deliberate fraud on the part of defendants Huffines. and Muscat, knowingly participated in by Krock, in breach of their fiduciary duties to Defiance’s” stock- a , holders and with the purpose and effect of profiting _at the expense of its stockholders. It is difficult to conceive of more flagrant and callous breaches of trust on the part of corporate fiduciaries than those found here.’’ The District Court also awarded judgment with respect to the third cause of action upon the ground that the proxy Statement, on the basis-of which the Defiance-IIE exchange was approved by the shareholders of Defiance, was false and misleading in material respects (A 19-29). The Dis- trict. Court expressly held (A 34- 36) that petitioners had personal knowledge of the false representations made in the proxy statement (A 34- “Py. “ * Reference despise by ihe tétter “A” refer to petitioners’ ap- pendix annexed to their petition. ra . 4 Petitioners thereafter moved for a oe trial on the ground of alleged newly discovered evidence. On that mo- tion petitioners contended for the first time that the Court, in assessing damages, should have accepted the market price of the stock of Defiance as its fair value, rather than the fair value of $14.49 per share fixed by Hayden Stone & Co., petitioners’ own expert (A 44), ee In rejecting that contention, the District Court held (A 44): ‘‘Review of that record reveals that defendants’ present contention to the effect that Defiance stock _ was over-valued is not only belated, but contrary to, . and inconsistent with, the proof offered by the par- ties and the position taken by the defendants both’ at pretrial and trial.’’» The District Court, notwithstanding its view that peti, *. tioners’ contention that the market price of Defiance’s Stock should be equated to its fair value was belatedly made, nevertheless, carefully explored petitioners’ conten- tion and concluded that (A 20) ‘‘while market price is properly considered as one of-the factors in arriving ata value for Defiance stock, it is neither controlling nor con- clusive’’.* After considering all of the élements usually taken into account in arriving at fair value, the District Court held that,‘‘The result of this process of valuation was the determination of fair value of Defiance stock of $14.49 per share * * *’’, (A 56) * The District Court noted (A 63) “The unreliability of such - _ prices,/in view of the extreme thinness of the market in Defiance stock jand the fact that such lower prices may well have been attriutable in part to defendants’ own unconscionable con- aa 6 yap 45 ee } Petitsoners, on their motion for a new’trial, also con-’ tended for the first time that the award of damages should. have been made to the innocent shareholders of Defiance, © ‘rather than to Defiance, itself (A 58). The District Court _-rejected that contentiom,halding (A 58> that ‘‘The general rule in a derivative action is that recovery is awarded to the corporation on. behalf of which suit is brought * * *,”” In unanimously affirming the District Court, the Court of Appeals held that ‘‘A study of the record shows ample support of Judge Mansfield’s findings * * *’?, (A 3) The Court of Appeals concurred with the District Court that petitioners had ‘‘acted in violation of their fiduciary duties as controlling officers and directors of Defiance’? (A 3) and that their conduct was the result of ‘calculated fraud”’ (A 5). The,Court of Appeals also agreed that an award of damages to Defiance was the appropriate form of relief : (A 4). Petitioners thereafter moved for a rehearing limited to the question of prejudgment interest. The Court of Ap- - peals remanded thé matter to the District Court ‘‘for fur- ther consideration of prejudgment interest’? (A 7) but ‘affirmed in all other respects’? (A 8) the judgment of the Distriet Court. « The Court of Appeals directed the District Court to give ‘further consideration to whether the prejudgment interest awarded was ‘‘compensatory”’ and ‘‘in accord with ‘funda- mental fairness’ ’’.* (A 7) In that connection, the Court of Appeals, among other things, directed the District Court | to ‘‘make specific findings, first¥ on the personal wrong- doings of Huffines and: Muscat’’. (A 7 ) Clearly, the Court’s * The issue of prejudgment interest was settled by stipulation, ap- ' proved by the District Court (A 69-71). 6 direction did not, and was not intended to, as petitioners imply (Pet. fn. p. 12); negate its prior finding that petition- ers were guilty of.‘‘calculated fraud’’. (A 5) : Summary of the Argument None of the questions raised by ssllthonern present any | basis for certiorari. The first four questions posed by petitioners for review by this Court do not arise out of the facts of the case and are, therefore, entirely hypothetical. It is well settled that this Court will not render advisory opinions by reviewing issues which are not presented by ms dacts of the case .' béfore’ it. The fifth question posed by petitioners involves an issue of fact decided against the petitioners by the District Court and unanimously affirmed by the Court of Appeals. It is equally well settled that this Court will not review concur- rent findings of fact by’ two lower courts. Furthermore, since the judgment is also, based on common law diversity grounds, any decision by this Court on federal grounds would not disturb the judgment. f tf 1. The First Question: ‘Petitioners contend (Pet. p. 18) that in awarding judgment in favor of Defiance, rather than to its innocent stockholders, the éourts below were ‘‘strait- jacketed’’ by state law and further contend (Pet. pp. 21-22) ‘that there is a conflict among the Circuit Courts of Appeal over whether, in a diversity case, federal courts are bound to apply state court remedies.. These questions, advanced for the first time on this application for a writ of certiorari, do not arise from the actual facts of this case. Neither the District Court nor the Court of Appeals in awarding judgment eeu rather than to its share- ~ IE e eats . CO a ’ re ee ee ee ee ee ee ee , = . | ? : holders, was constrained to do so by ‘any requirement of state law. Neither court made any reference to state law relating to the appropriate remedy, or to any possible con- flict which. might exist among the Cireuit Courts of Appeal on this question. Both courts, in the exercise of their dis- cretion, in awarding judgment in favor of Defiance, followed the traditional and generally accepted equitable principle that in a derivative suit the award of damages goes to the wronged corporation, not to its shareholders.* Accordingly, since the question of state law versus federal law, ie., the application of the doctrine of Erie R. Co. v. Tompkins, 304 U.S. 64 (1938), was neither ‘raised nor involved in the case, the question of a conflict among the Courts of Appeal. on the question was likewise neVer an issue in the case. It may not, therefore, be raised now. (Stern & Gressman, Sup. Ct. Practice, 4th ed. (1969) § 6.37 at p. 297) The real complaint of petitioners is not based, as they contend (Pet. p. 20), on any alleged erroneous application of the Erie doctrine, or any conflict among the circuits, but rather, that.the’courts below refused to exercise discretion in petitioners’ favor and awarded judgment in favor of Defiance, itself. This Court does not review the exercise of discretion by, lower courts in the absence of a showing of a clear abuse. (Moor v. Texas &: New Orleans R. Co., 297 U.S. 101, 105, 80°L Ed 509, 511 (1935)) 2. The Second Question: Petitioners contend ( Pet.-p. 12) that the courts below, in fixing the fair value of Defiance at $14.49 per share, ignored a stipulation in the pre-trial order that the shares had a market value of $11.625 per * It would have been’ superfluous for the courts below to have distinguished between the applicability of state or .federal law, since the judgment was based on a violation of both state and federal law. - ; share. The District Court, however, did not ignore the stipulation. On the contrary, the District Court accepted the stipu- lated market price of Defiance’s shares as the fact (A 53), but held that ‘‘it is neither controlling nor conclusive’ (A 90) on the issue of the fair value of Defiance ’s shares. In view of the ‘‘thin’’ market prevailing, the Court accepted the report of Hayden Stone & Co., petitioners’ own expert, that the fair value of Defiance’s shares was $14.49 per share (A 44, 46-48, 54-55). The stipulation in the pre-trial order as to ‘‘market value’? was never intended to foreclose inquiry into the ‘fair value’’ of Defiance’s shares. By the terms of the pre-trial order, that issue was reserved for the trial (R 147a, 148a). Indeed, throughout the trial, both sides accepted Hayden Stone’s evaluation of Defiance at $14.49 per share, and the entire case was tried on that theory (A 44). Accordingly, petitioners’ contention that the courts below ignored the pre-trial stipulation does not accord with the— undisputed facts. 3. The Third and Fourth Questions: Petitioners contend (Pet. pp. 12-14) (a) that this Court should review the ques- tion of whether scienter must be proved to recover damages for violations of §§ 10 and 14 of the Act and Rule 10b-5 and 14a-9; and (b) the extent to which reliance on the ‘‘clear- ance”? by the SEC of a proxy statement negates fraud. Neither of these issues arises out of the facts of this case. The District Court expressly found that petitioners: had knowingly misrepresented material facts in the proxy state- ‘ment and that they had ‘‘misled”’ the SEC by withholding this information from it (A 34-35, 37). The Court of Appeals a & » 9 unanimously affirmed. Accordingly, the issues thus raised by petitioners are academic in this case and ought not be reviewed by this Court. \ 4. The Fifth Question: Petitioners contend (Pet. p. 3) - that this Court should review the fairness of the Defiance- IIE exchange transaction. The fairness of the exchange was the principal issue upon the trial. On that issue of fact, the District Court held that the ratio of exchange was grossly unfair to Defiance, and the Court of Appeals unanimously affirmed. This Court will not review an issue of fact de- termined by the District Court and unanimously concurred in by the Court of Appeals. (Berenyi v. I mmeagration Service, 385 U.S. 630, 635, 17 L Ed 2d 656, 661 (1966). Finally, it may be observed that review by this Court of the federal questions which petitioners purport to raise (Questions ‘‘2’’, ‘3’? and ‘‘4’’) cannot affect the judgment in this case. This is so because the judgment here is based on common law diversity claims (as well as on federal claims). The judgment against petitioners for breach of their common law fiduciary duties would be unaffected, even as- suming this Court believed that the courts below had er- roneously construed, or applied, federal law. : POINT I The petition should be denied because the questions posed by petitioners do not arise out of the facts in the case or they involve issues of fact. | This Court has consistently held that it will not grant cer- tiorari to review hypothetical questions which are not pre- sented by the facts of the particular case before it. As this Court stated in Conway v. Adult Authority, we...3 Bh L, Ed 245 (1970) at p. 298: ~.. aac RDS lek a Sic ae Te aaah a aa Se ec Se ee Z - ) : er Aa es a tht EL i 5 OL ae DOB AL MCI iba mht Micha sited od tS. ann te allie ot tet pA nw he. a eres 10 ‘“* * * Thus, it now appears the State has docu- mentary evidence that the actual facts simply do not present the issue for which certiorari was granted by us. “Tn this state of affairs we decline to adjudicate this case. Were we to pass upon the purely artificial and hypothetical issue tendered by the petition for certiorari we would not only in effect be rendering an gdvisory opinion but also lending ourselves to an unjustifiable intrusion upon the time of this Court. Accordingly, the writ of certiorari is dismissed as improvidently granted.’’ Accord: _ Stern & Gressman, Sup. Ct. Prac. (4th Ed. 1969), §6.37, p. 297; Tyrrell v. District of Columbia, 243 U.S. 1, 61 L Ed 557, 558, 559 (1916) ; S. 8. Monrosa v. Carbon Black Export, 359 U.S. 180, 184, 3 L Ed 2d 723, 726, reh. den. 359 U.S. 993, 3 L Ed 2nd 986 ( 1959) ; Dick v. New York Life Ins. Co., 359 U.S. 437, 444- 445, 3 L Ed 2d 935, 941 (1959) ; McCarthy v. Brunner, 323 US. 673, 89 L Ed 547 (1944). This well established rule applies to the first four ques- tions presented by petitioners, We shall discuss each of the questions raised by petitioners in the order presented in the petition. The First Question . Petitioners contend (Pet. p.‘18) that in awarding judgment to Defiance, rather than to its innocent shareholders, the courts below were in a ‘strait jacket’’; that ‘‘Federal remedies do not depend on State law even in diversity cases’? (Pet, p. 19); and that in this case, ‘‘State law was erroneously applied’’ soA a : ae (Pet. p. 20). Petitioners also suggest (Pet. pp. 21-22) that there is a conflict among the Courts of Appeal over whether the Erie doctrine is applicable and obligates federal courts in a diversity case to apply state court remedies, These conten- tions were not advanced in the courts below and are made for the first time on this application. This circumstance, alone, warrants denial of petitioners’ application for a writ, of cer- tiorari. (Moor v. Texas & New Orleans R. Co., 297 U.S. 101, 105, 80 L Ed 509, 511 (1935) ; NLRB v. Pittsburgh 8.8. Co., 340 U.S. 498, 503, 95 L Ed 479, 483 (1951) ). e It is clear, moreover, from the opinions below that neither the District Court, nor the Court of Appeals, in awarding “judgment to Defiance, rather than to its shareholders, was constrained to do so by ‘‘state law’’. Indeed, neither court made any mention of the requirements of state law, or of the question of a conflict among the circuits with respect to the applicability of state law. Petitioners did not raise, nor did the courts below discuss, the applicability of the Erie doc- trine. In awarding judgment in favor of Defiance, the courts below followed generally accepted equitable principles ap- plicable to derivative actions in both federal and state courts and were in no way ‘‘strait-jacketed’’ by requirements of state law.* Accordingly, petitioners’ reference (Pet. p. 20) to the court’s alleged erroneous application of Erie v. Tom p- kus, supra has no relation to the facts of this case. The District Court denied petitioners’ motion for a new trial upon the ground that (A 58 to A o9) : * Petitioners agree (Pet. fn. p. 22) that “neither the law of Ohio nor the law of New York would prohibit recovery directly to independent shareholders although the suit is brought deriva- tiyely on behalf of the corporation”. Accordingly, since state law permits the remedy petitioners now urge, the courts below were not “straitjacketed” by state law. . ! n eens 12 “The general ruletin a derivative action is that re- covery is awarded to the egrporation on behalf of which suit is brought, and that the corporation may not be ‘by-passed’ by an award to individual stock- holders on a pro rata basis, which would, in effect, © declare a dividend of the corporate recovery. See Liken v. Shaffer, 64 F. Supp. 432 (N.D. Iowa 1946, per Graven, J.); Keenan v. Eshleman,. 23 Del. 234, 2 A. 2d 904, 912-13 (1938); 13 Fletcher Cyclopedia of - Corporations (1961) 64]-47 § 6028. ~ This case does. not fall: within the exceptions to this rule which have occasionally been made to avoid uhnecessary litigation * * * ’? (Emphasis ours). In affirming, the Court of Appeals likew'se based its deci- sion on generally accepted principles of equity and made no distinction between state and federal court remedies in de- rivative suits. The Court of Appeals held (A 4): ‘‘The corporation by issuing shares to its control- ling officers and directors for less than their fair value was obviously damaged to the extent of the difference which was $2,992,940 because: it received ITE shares worth only $40.58 per share in return for its shares which were worth $70.51 per share. Under such circumstances those fiduciaries who caused the corporation to part with its assets for less than their fair value must make up the difference to the cor- poration.’’ (Emphasis ours) Thus, the courts below, in the exercise of their discretion, adopted the remedy they deemed most appropriate in the circumstances, with regard to state law. It is clear that peti- tioners seek review by this Court, of a principle not \pre- ’ sented by the facts.* Stebicnenits * Even in those cases cited by petitioners (Pet. pp. 21-22), where the issue of state law versus federal law is alleged to have been ~ involved, this Court never deemed the question of sufficient importance to grant certiorari. A fortiori, it should not be granted here, where the question does not arise. : 13 Nor can there be any doubt that the form of relief awarded was altogether appropriate. It would seem to he elementary that when a corporation issues shares to its controlling officers and directors for less than: their fair value, the corporation is damaged to the extent of the — difference. (Hieoper v. Mountain States Securities Corp., 282 F’, 2d 195, 203. (5th Cir. 1960), cert. den. 365 U.S. 814, 5 L.Ed. 2d 693 (1960) ; Simon v. New Haven Board & Carton Co., 250 F. Supp. 297 (D. Conn. 1966).) Obviously, if de- _fendants had paid fair value to-Defiance, it would have in its ‘treasury the amount which they pocketed. Therefore, it is a non sequitur for petitioners to compare (Pet. p. 5) De- fiance’s damage with its prior net worth, | Petitioners advance the novel contention (Pet. p. 15) that Defiance*s issue of an excessive number of ics shares to acquire ITE resulted only in giving ‘‘a disproportionate equity in Defiance’? to the IIE shareholders; and that ‘*Defiance, itself, lost nothing’’ because it ‘gave up nothing but pieces of paper’’ (Pet. p. 10). | \s the District Court found, and the Court of Appeals affirmed, the ‘‘pieces of paper”’’, which petitioners exacted from Defiance, had a value of $14.49 per suare (A 25, 2-3). It necessarily’ follows that Defiance was damaged when: petitioners grossly ‘underpaid it for the ‘pieces of paper’? which they received from it. As stated in Hooper v. Mountain States Securities Corp., — supra, (282 F. 2d at p. 203) : ‘*Kven in our remote position, we would be blind to all we hear and read about were we to succumb to the artificial contention that the issuance of this stock made the corporation no poorer so that the *. 14 4 only persons who suffered were the stockholders for _ whom the suit cannot be brought by the Trustee.”’ % 66% & & it would be unrealistic to say that a corporation having the capacity to acquire $700,000 worth of assets for its 700,000 shares of stock has suffered no loss if what it gave up was $700,000 bit what. it got was zero.”’ ; Petitioners argue .(Ret: p. 16) that “it is inequitable to take the rigid view that in every case where shares are issued by the corporation there is damage to the corpora- tion if the shares issued are excessive in number’’, The fact is that the courts below did not take a ‘rigid view’? of the relief to be awarded, but granted judgment in favor of Defiance after a careful feview of all the circumstances. We do not perceive how it is ‘‘unrealistie and unfair’’ (Pet. p. 17) to petitioners to require them to pay Defiance the full fair value of the shares they exacted from it. Upon defendants’ theory, the recovery in a derivative action would rarely, if ever, go to the corporation. But it is the award of damages directly to shareholders, which is - the rare exception. ; In J. I. Case Co. v. Borak, 377 U.S. 426, 432,.12 L Ed 2a 423, 427, this Court held: RAG ‘The injury which a stockholder suffers from cor- porate action pursuant to a deceptive proxy solicita- tion ordinarily flows from the damage. done to the corporation, rather than from the damage inflicted directly upon the stockholder.’’ (Emphasis ours) In Ross v. Bernhard, et al., US. eae L Ed 2d (Feb. 2, 1970), this Court again affirmed the principle that in a derivative suit _ 15 ‘*Although named a defendant, it [the corporation] is the real party in interest, the stockholders being at least the nominal plaintiff. The proceeds of the action belong to the corporation and it is bound by the result of the suit.” The consensus of the authorities is that: ‘‘Generally, where the action is a derivative one brought for the benefit of a going corporation, equitable principles demand that the theory of the action be recognized and that the whole recoverable amount be decreed to be paid to the corporation. ’’ (13 Fletcher, Cyclopedia of Corporations (1961, Rey, volume) § 6028, » 641) < Accord: 2 Hornstein, Corporation Law and Practice (1959) § 731, pp. 246-247 ; Henn on Corporations (1961) See. 375, p. 592. The District Court held (A 59), and the Court of ‘Appeals. affirmed (A 3-4), the instant case does not fall within the rare exceptions to the general rule that in a derivative suit the recovery belongs to the corporation on whose behalf the suit is brought. Accordingly, the District Court found - that the cases cited to it by petitioners (Ret. pp. 17-19) were iiapplicable. (A 60); and concluded that (A 60): ‘“ Accordingly, since none of the special cirecum- stances in Which pro rata recovery has been awarded exist here, the theory of the derivative action must be recognized and recovery awarded to the corpo- ration.’’ All of the cases cited by petitioners (Pet. pp. 17-20, 29- 23) are either cases where the corporation on whose behalf j | ie 16 the suit was brought was bankrupt and the shareholders, ' therefore, had no standing to sue (Marin v. England, 385 U.S. 99, 17.L:ed 2d 197. (1966) ; or where a closely held cor- ‘poration was involved and the action was essentially one rani galery (Gallagher v. Perot, 112. Mise. 717, 183 N.Y. Supp. 257 (Sup Ct. 1918) aff’d 200 A.D. 867, 191 N.Y. ‘Supp. 926, aff’d 234 N.Y. 516 (1922); or where the corpo-’° ration was extinguished upon a merger* (Southern Pacific R.R..v. Bogart, 250 U.S. 478 (1919); de Haas v. Empire Petroleum Co., 300 F. Supp. 834 (D. Colo. 1969)) ; or where _. the action was one for recovery by the suing stockholders - individually or was an alternative to valuation proceedings, when no damage to’ the corporation was charged (May v. Midwest Refining Co.; 121 F. 2d 431 (1st Cir, 1941) cert. den. 314 U.S. 668, 86 Led. 534. (1941); de Haas y. Empire Petroleum Co., 300 F. Supp. 834 (D. Colo. 1969) ; Perlman. v. Feldman, 219 F. 2d 173 (2nd Cir.. 1955), or where the suing stockholders were disqualified because they took their shares from the wrongdoers, or had ac- quired their stock after the date of the commission of the wrongs complained of (//ome. Fire Ins. Co. v. Barber, 67 Neb, 644, 93 N W, 1024 (1903); Mathews v. Heedley Choco- | Co., 130 eee Atl, 645 (1917)). late | Fata contention really is that in a derivative suit, inyolving the issue of corporate stock to fiduciaries for an iterate consideration, the award must be made to the innocent shareholders (Pet. pp. 17, 22). If sustained, such a holding would seriously undermine the therapeutic utility * Petitioners’ intimation \ (Pet. fn. ‘p. 19) that the merger of Defiayce into El Tronics Inc. has some bearing on this case is. ' incorrect. Defiance “was \merged into El Tronics long after the judgment was rendered ‘here. “17 of derivative suits, particularly as a means of enforcing the provisions of the Act.* This. Court recently stated in Mills v. Electric Auto-Lite Co, U.S. ,24 Lied. 2d 593, 609 (January 20, 1970), that ‘*private stockholders’ actions of this sort ‘involve corporate therapeutics’ and furnish a benefit to all shareholders by ‘providing jan important means of enforcement of thé proxy statute’’. Again, in J. J, Case Co. v. Borak, supra (377 US., p. 432) this Court held that ‘Private enforcement of the proxy rules provides a necessary supplement to Commission az action.”’ Petitioners’ reliance upon the decision of this: Court in Mills v. Electric Auto-Lite Company, supra, is misplaced. In that case, Electric Auto-Lite was acquired on terms which were inadequate and unfair to its shareholders. The corporate existence of Electric Auto-Lite was extinguished upon the merger. As this Court pointed out in Muls, *‘ Peti- tioners asserted the right to complain of this alleged vio- lation both derivatively, and as representatives of the class of all minority shareholders’’. (Emphasis ours) Plaintiffs - in Mills sought to either void the merger, or to recover the fair value of their shares. Even under those cirecum- ° stances, this Court did not determine the form of the relief, but left the selection of the proper remedy to ‘‘the sound * To “by-pass” the corporation would inevitably ledd to a hornet’s nest of future litigation. The Court would be called on to de- termine whether stockholders at the date the vote approving the exchange was adopted, or at the date when the, exchange was consummated, should share in the award. Also, the Court would be required to determine the amount of each- share- holder's damage and whether the right’ to participate in the award passed with a sale of the shares. Undoubtedly, it: would ° be also necessary for the Court to appoint a Master to‘adjudi- cate the claims and to supervise distribution. ; \S ° 18 discretion which guides the determination of courts of equity’’. ‘The instant ease represents the ‘reverse of the situation in Mills. Here, Defiance. paid excessive consideration to acquire the outstanding stock of IE, which was largely | owned by petitioners and Krock. fiance continued in existence thereafter. Obviously, Defiance itself could have maintained an action for damages against its faithless fiduciaries, and would have done so, were it not under their control. Had Defiance, itself, brought the action, any re- covery it obtained would, necessarily, have belonged to it. Apparently the real complaint of petitioners is that in “‘molding’’ the equitable remedy in this case, the courts below did not exercise their diseretion as petitioners would have liked. But it is well established that this Court will not review the manner in which the courts below have exercised their discretion. (Moor v. Texas & New Orleans - R. Co., 297 U.S. 101, 105,.89 L ed 909, 511 (1935) ; Appala- chian Power: Co. v. American Institute of Certified Public Accountants, 361 U.S. 30, 4 L ed 2d 30, 80S. Ct. 16 (1959) ; N.L.R.B. v. Pittsburgh S.S. Co., 340 US. 498, 502-503, 95 L ed 479, 482-483 (1950).) In any event, petitioners’ contention that equity should “‘mold its deeree’’ (Pet. p. 17) is beside: the point. In a derivative suit, the stockholder plaintiff ordinarily stands in the shoes of the corporation and can enforce against its fiduciaries only those claims which the corporation itself could have asserted. As this Court declared in Ross v. Bern. hard, supra, in sustaining the right of a derivative plaintiff to a jury trial: 19 ‘The heart of the action is the corporate claim. If it presents a legal issue, one entitling the corporation io a jury trial under the Seventh Amendment, the right td a jury‘is not forfeited merely because the stockholder’s right to sue must first be adjudicated as an equitable issue triable to the court.’’ In the case at bar, the cause of action against petitioners is essentially an action at law to recover money damages. This, in fact, was the only relief awarded by the District Court. There should be no doubt that, in the instant case, plaintiff is entitled to enforce the legal claim of Defiance to recover money damages, precisely as Defiance could have done, had it been in a position to sue in its own name,* q The Second Question Petitioners contend (Pet. p. 12) that ‘‘both the District Court and the Court of Appeals completely ignored a stipu- lation incorporated into the pre-trial order that the shares of Defiance had a market value of $11.625 per share on the date the proxy statement was issued’’. Petitioners sug- gest (Pet. p. 26) that this alleged violation of F.R.C.P. 16 ‘‘should be remedied by this Court in its supervisory ca- pacity’’. The fact-is that the courts below did not ignore the pre- trial order. The pre-trial order merely stipulated the market quotations of Defiance’s shares based on ‘the average between the bid and asked prices’’ on May 8, 1962 (R 139a). * The doctrine that a derivative suit, though equitable in form, is in fact legal, if the corporate claims which the suit seeks to enforce are legal in nature, is well established. (Potter v. Walker, 276 N.Y. 15 (1937); Dunlop's Sons, Inc. y. Spurr, 285 N.Y. * 333 (1941)). 20 There was no actual sale of any shares of Defiance on that date (R 122a). The District Court accepted the stipulated market price of Defiance’s shares ‘‘as one of the factors in arriving at a value for Defiance stock’’, but held that ‘‘it is neither con- trolling nor conelusive’’ (A 50). As petitioners would have it, the effect of the stipulation in the pre-trial order was to preclude the District Court from entertaining any other evidence of the fair value of the stock of Defiance. We sub- mit that the pre-trial order does not provide, and was never intended to accomplish, any such result, The purpose of a pre-trial order is to limit the issues and to avoid proof as to facts which can readily be proved. The market price of Defiance’ s shares was a fact that could readily have been established and was, therefore, stipulated. The materiality and relevance of this fact was expressly reserved for the trial (R 132a). It is absurd for petitioners to attempt to stretch this stipulated fact relating to market price into a concession, binding of the Court, that $11.625 was the fair value of Defiance’s shares and that no other evidence on this issue was admissible. Indeed, it is clear from the stipulation itself that the issue of the fair value of the Defiance stock was reserved for the trial. Thus, the stipulation provided that among ‘‘the issues to be tried’’ was whether the shares issued by Defiance on the exchange constituted ‘‘excessive and exorbitant consideration for the 999998 shares of the stock of ITE acquired in exchange’”’, (R 148a) Moreover, the pre-trial order seman’ noted that ‘*plaintiff claims that such excess is approximately in the sum of $3,335,000’? (R 147a), a figure which could not have been , remotely achieved if the market price of $11.625 were to be ~ deemed final and controlling. 21 Moreover, throughout the trial petitioners and respondent both accepted the finding of Hayden Stone & Co., petitioners’ own expert, that the fair value of Defiance’s shares at the time of the exchange was $14.49 per share. This valuation was not put in issue by petitioners.* It was not until after the District Court had rendered its opinion accepting the finding of Hayden Stone and holding petitioners liable that petitioners for the first time on their motion for a new trial contended that the District Court should have accepted the lower market price of the Defiance shares as conclusive evi- dence of value. In denying that motion, the District Court held (A 49): ‘Throughout the trial defendants accepted as au- thoritative the Hayden Stone report, including its valuation of the stock to be issued by Defiance at $14.49 per share and although they were given ample opportunity to challenge it or to offer any evidence tending to show a lower value for the Defiance stock, they chose not to do so. The report therefore con- stitutes probative and convincing evidence, partic- ularly since it represents the results of an indepen- dent appraisal by recognized experts in the evalu- ation of corporate properties, who were eminently well qualified. Repeatedly the defendants pointed to the fairness of the report, Muscat going so far as to testify that the effect of the report was to ren- der the Defiance transaction an arm’s-length one.’’ The District Court could have arrived at a value other than $14.49 for the shares of Defiance only by disregarding petitioners’ (and respondents’) consistent position through- * Upon the trial petitioners contended only that Hayden Stone’s evaiuation of ITE at $70.51 per share was also correct. This was disputed by respondent and was the central issue’ at the trial, “ORS ORR 22 out the trial, a position which petitioners abandoned only after the trial was concluded and judgment had been ren- dered against them. To belatedly give the pre-trial order the effect now contended for by’. petitioners would be to change ex post facto ‘‘the whole course of the trial, the whole tenor of it’’. (Laird y. Carrier Engine Service Co., 263 I’, 2d 948, 952 (5th Cir. 1959).) The language of Mr. Justice Brennan, in an opinion in Chambers, in the case of Appalachian Power/Co. v. Amer- ican Institute of Certified Public Paes f 361 U.S. 30, 4 L Kd 2d 30, 32 (1959), aptly applies to the ease at bar: ‘‘But ordinarily an application by a District Court of the Rules of Civil Procedure when affirmed by the Court of Appeals will not be reviewed by this Court. This is particularly true where, as here, the question is one that concerns the judgment of the District Judge in relation to a particular set of facts.”? We submit that the question here raised by the petition- ers has no application to the facts of the case, and the deci- sion of the District Court ‘‘made in relation to the particular set of facts’’ before it should not be reviewed by this Court. Petitioners further contend (Pet. p. 25) that the alle- . gation of the complaint that the Defiance’s stock had a fair — and reasonable value of $11.50 per share ‘‘should be bind< ing on the plaintiff’’.* FRCP, Rule 8(f) expressly declares that ‘‘all pleadings shall be so construed as to do substan- tia justice’. Rule 15(b) further provides that the allega- tions of a complaint do not preclude a court from rendering judgment in accgrdance with the facts as found by it after trial. This should be especially so in a derivative suit where * See: Giannone v. United States Steel Corporation, 238 F.2d 544, 547-548 (3rd Cir., 1956). 23 the rights of many absentee stockholders are involved, The District Court was fully justified in fixing the value of the Defiance stock at $14.49 per share, particularly since both sides accepted that vatnation throughout the trial. The Third and Fourth Questions Petitioners contend (Pet. p. 27) that ‘‘no Court of Ap- - peals has ruled on the requirement for scienter in an action for damages where §§ 10 and 14 overlap * * * ” and peti- tioners urge (Pet. p. 29) that this Court should grant re- were not disclosed in the proxy statement, on the Pasis of which the Defiance-I1E exchange of stock vas’ appipved. The issue raised by petitioners is irrelevant in the ‘case at bar. The District Court found as a fact that petitioners had personal knowledge of at least two materiaLfacts which were not disclosed in the proxy, on the basis of which the Defiance-IIE exchange of stock was approved. The principal issue on the trial was the fraud of peti- tioners in inflating the earnings of IIE’s principal sub- sidiary, Nablico, and thereby inflating the value ascribed . to ILE. The proxy statement represented the earnings of Nablico to be $2,098,013 for the period 1958-1961, inclusive. However, an audited report by the eminent accounting firm of Peat, Marwick, Mitchell & Co. certified Nablico’s earn- ings for the same years to be only $1,501,882.* The District Court found as a fact (A 34) ‘‘that Huffines and Muscat, ~~ two knowledgeable and experienced business executives in ' charge of Nablico’s affairs were aware of its true earnings’’, * In evaluating ITE, Hayden Stone had multiplied the inflated earnings of Nablico by 14 and 15 times and used the average of such multiplied earnings, plus a 25% premium for control, as the basis for its evaluation of Nablico. The impact of this method of evaluation upon the value of Nablico and. therefore, upon the ‘value of IIE, needs no elaboration. ‘ i / 24 Again, it is undisputed that prior to the circulation of the proxy statement, two of Nablico’s policy holders had instituted suit against it, claiming they were entitled to dividends equal to those paid to shareholders. Long be- fore the proxy statenyent was mailed to Defiance’s share- holders, those plaintiffs recovered judgment against Nablico in the sum of $5,500 on a motion for summary judgment (A 28). Petitioners knew of this judgment before the proxy state- ment was issued (A 35). Moreover, they were fully aware that this judgment, in favor of two, out of many, policy holders, was a portent of more claims to come. As the District Court found (A 35), petitioners “knew of the ad- verse judgment and of the probability of substantial addi- tional claims, facts which should have been disclosed in the . proxy statement’’.* We submit that since the courts below found on the facts that petitioners had personal knowledge of the falsity of the proxy statement, the issue of scienter as a condition precedent to recovery under $$ 10 and 14 of the Act and Rules 10b-5 and 14a-9 is not an issue in this case. Similarly, petitioners’ contention (Pet. p. 30) that the ‘‘elearance’’ of the proxy statement by the staff of the SEC ‘‘negates fraud and shows due diligence’’, does not relate to the circumstances of this case. Petitioners seek to create the impression that the finding of fraud against them was based merely on an ‘‘alleged misclassification of the figures’’ (Pet. p. 31) and an improper arrangement ‘of the disclosed figures’’ (Pet. p. 32). * Up to March 1965 the amount paid in settlement of these claims was $162,000 (A 28) and, as the District Court held, the amount of “additional claims remains undetermined”. (A 28)’ However, the finding below that the proxy statement was false and misleading was not based, as petitioners would have it, merely on the arrangement in the proxy statement of disclosed facts. As noted aboye, supra, pp. 23-24, the find- ing of fraud in the proxy statement was based, in large part, on undisclosed facts. As the Distrie¢ Court held, these facts were known. to the petitioners, but withheld from the SEC (A 37).* | Petitioners agree (Ret. p. 31) that ‘‘There may be cases of material omissions or misstatements, where scant com- fort can be found in the clearance by the SEC”. This ease is surely one of them. In the instant case, the District Court expressly found (A 37) that ‘here is no indica- tion that the SEC was aware, as were the defendants, of the inflation in the Nablico earnings figures used in the _ proxy solicitation material * * * .”’ This is, therefor, a clear case of knowingly withholding material information from the SEC. Again, it is clear from the record that the petitioners failed to disclose to the SEC the Judgment which had been rendered against Nablico in favor of two of many similarly situated policy holders (A 28). It is obvious that that information, too, was withheld from the SEC, since it is inconceivable that, had it been disclosed, the SEC would * It may be noted thai in Mills vy. Electric Auto-Lite Co., 403 F. 2d 429, 433 (2 Cir. .968), judgment vacated, supra, U.S. 24 L Ed 2d 593 the Court's finding that the proxy statement was misleading was »ased on the failure to give “the same em- phasis” to the recommendation of. the board of directors sup- porting the merger, as to the relationship of Electric Auto- Lite’s directors with the principal corporate