Amicus Curiae Brief — Mills v. Electric Auto-Lite Co.

Page

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Introduction and summary of argument_-_-_------__----- g

Argument:

I. Fairness of the merger terms is not a defense to a

private action complaining of materially mis-

leading solicitation of proxies which authorized a

corporate merger, but is a relevant considera-

tion in determining appropriate relief _____-_-_- 11

II. Violation of the Commission’s proxy rules should

entitle the plaintiffs to an award of reasonable

litigation expenses, including attorneys’ fees,

both in establishing the violation and in attempt-

ing to show unfairness of the merger-_----_-_-_- 19

I intnn ins cuknenns ponies anekan basinal 25

CITATIONS

Cases:

Abrams v. Textile Realty Corp., 97 N.Y.S. 2d 492___- 23

Bakery and Confectionary International Union v. Ratner

TC .. ckcewa nna dchhhene aukao mn kee 22

Barnett v. Anaconda Company, 238 F. Supp. 766- --_- 14

Blau v. Rayette-Faberge, Inc., 389 F. 2d 469________- 23

J. I. Case Co. v. Borak, 377 U.S. 426___------ 10, 11, 20, 23

Consolidated Motor Parts, In re, Inc., 85 F. 2d 579_.-- 22

Dolgow v. Anderson, 43 F.R.D. 472____...---------- 21

Eastside Church of Christ v. National Plan, Inc., 391

CL Ee AGA Gat ion nokieeawas eames 14

Electronic Specialty Co. v. International Controls Corp.,

CCH Fed. Sec. L. Rep. ¢ 92,342 (C.A. 2, January

iS J nnhina ane nee hpaupnnen en dak pede 10

Gilson v. Chock Full O’ Nuts Corp., 331 F. ‘2d: ere 23

(rz)

361-667— 65——-1

eR SE ETE ADO

I

Cases—Continued Page

Greater Iowa Corp. v. McLendon, 378 F. 2d 783_-____. 16

Laurenzano v. Einbender, 264 F. Supp. 356_---..____ 14, 15

Maggiore v. Bradford, 310 F. 2d 519_....---...-___- 22

Midland United Co., In re, 64 F. Supp. 399, affirmed

on other grounds, 159 F. 2d 340____.-.._____.__- 23

Murphy v. North American Light and Power Co., 33

i EE no kactinhpaithepacdbmnnetiatosnmaian 21

Mutual Shares Corp. v. Genesco, Inc., 384 F. 2d 540__- 12

Robbins v. Banner Industries, Inc., CCH Fed. Sec. L.

Rep. { %’,861 (S.D. N.Y., December 21, 1966) - __- 15

Scribner & Miller v. Conway, 238 F. 2d 905____.___- 22

Smolowe v. Delendo Corp., 136 F. 2d 231, certiorari

Ged, 21, 22, 23, 24

Sprague v. Ticonic National Bank, 307 U.S. 161____- 22

Studebaker Corp. v. Gittlin, 360 F. 2d 692__..._____- 12

Trustees v. Greenough, 105 U.S. 527_.__..-.-.---___- 22

Willoughby v. Port, 182 F. Supp. 496, affirmed as

modified per curiam, 277 F. 2d 149____._________- 12

Statutes and rule:

Securities Exchange Act of 1934, 48 Stat. 881 et seq.,

as amended, 15 U.S.C. 78a et seq.:

Section 9(e), 15 U.S.C. 78i(e)....-.------_--___- 22

Section 14(a), 15 U.S.C. 78n(a)__......--_-_-_- 2,7

Section 16(b), 15 U.S.C. 78p(b)___.---__.--___- 21, 22

Section 18(a), 15 U.S.C. 78r(a)___....-_-_-__-- 22

Section 29(b), 15 U.S.C. 78ce(b)____-_-______- 3, 16, 17

Bankruptcy Act, Chapter X, 11 U.S.C. 501 et seq.:

Sections 241-246, 11 U.S.C. 641-646___________ 22

Section 248, 11 U.S.C. 648_............---_.-. 22

Section 249, 11 U.S.C. 649__.........____-___- 22

Rule under the Securities Exchange Act of 1934:

Rule 14a-9, 17 CFR 240.14a-9________________ 4,7,8

Miscellaneous:

6A Collier, Bankruptcy (14th ed. 1968)_____.._____- 22

Hornstein, The Counsel Fee in Stockholder’s Derivative

Suits, 39 Colum. L. Rev. 784___.__....-....-._-- 24

Hornstein, Legal Therapeutics: The ‘Salvage’ Factor

in Counsel Fee Awards, 69 Harv. L. Rev. 658__-___- 22, 24

Hornstein, New Aspects of Stockholders’ Derivative

ey FF GN: Bb. TR Biveiidincatiiniannacnusinn 22

4n the Supreme Court of the United States

OcToBER TERM, 1969

No. 64

Emer E. Mitts anp Louis SUSMAN, PETITIONERS

Vv.

THe Execrric Auto-LirE COMPANY, ET AL.

ON WRIT OF CERTIORARI TO THE UNITED STATES COURT OF

APPEALS FOR THE SEVENTH CIRCUIT

BRIEF FOR THE UNITED STATES AS AMICUS CURIAE

This brief is submitted in response to the Court’s

order of April 21, 1969, inviting the views of the

United States.

OPINIONS BELOW

The opinion of the district court (App. 675-684)’

is reported at 281 F. Supp. 826.’ The opinion of the

court of appeals (App. 1001-1014) is reported at 403

F. 2d 429.

1“A pp.” references are to the printed Appendix in this Court.

2The district court’s Findings of Fact and Conclusions of

Law upon which summary judgment was granted, its order ex-

punging one of the conclusions of law, and its earlier unre-

ported opinion specifying facts appearing without controversy

are set forth at App. 441-454, 684-691.

(1)

2

JURISDICTION

The judgment of the court of appeals was entered

on November 25, 1968 (App. 1015). On February 21,

1969, Mr. Justice Marshall extended the time for filing

a petition for a writ of certiorari to March 10, 1969,

The petition was filed on the latter date, and was

granted on April 21, 1969. 394 U.S. 971. The juris-

diction of this Court rests on 28 U.S.C. 1254(1).

QUESTIONS PRESENTED

This brief will discuss the following questions, which

it is believed are comprehended by the questions that

petitioners present:

1. Whether, in a suit challenging a corporate merger

on the ground that the proxies by which the stockhold-

ers consented thereto were obtained through materially

misleading statements, the fairness of the terms of the

merger is a defense to the action or merely bears on

the relief to be awarded.

2. Whether a determination that the federal securi-

ties laws have been violated by misleading solicita-

tion of proxies required to authorize a corporate

merger entitles solicited stockholders, suing as a class

and derivatively on behalf of their nonsurviving cor-

poration, to an award of reasonable litigation ex-

penses, past and prospective, irrespective of any other

relief that might subsequently be deemed appropriate.

STATUTE AND RULE INVOLVED

Section 14(a) of the Securities Exchange Act of

1934, 48 Stat. 895, as amended, 15 U.S.C. 78n(a),

provides:

—7~"

(a) It shall be unlawful for any person, by the

use of the mails or by any means or instru-

mentality of interstate commerce or of any fa-

cility of a national securities exchange or other-

wise, in contravention of such rules and regu-

lations 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 781 of this title.

Section 29(b) of the Securities Exchange Act of

1934, 48 Stat. 903, as amended, 15 U.S.C. 78¢e¢e(b), pro-

vides in pertinent part:

(b) Every contract made in violat« > any

provision of this chapter or of any rwe or

regulation thereunder, and every contract (in-

cluding any contract for listing a security on

an exchange) heretofore or hereafter made, the

performance of which involves the violation of,

or the continuance of any relationship or prac-

tice in violation of, any provision of this chap-

ter or any rule or regulation thereunder, shall

be void (1) as regards the rights of any person

who, in violation of any such provision, rule, or

regulation, shall have made or engaged in the

performance of any such contract, and (2) as

regards the rights of any person who, not being

a party to such contract, shall have acquired

any right thereunder with actual knowledge of

the facts by reason of which the making or per-

formance of such contract was in violation of

any such provision, rule or regulation * * *.

4

Rule 14a-9 of the Securities and Exchange Com-

mission Rules, 17 CFR 240.14a-9, provides in perti-

nent part:

(a) No solicitation subject to this regulation

shall be made by means of any proxy statement,

form of proxy, notice of meeting or other com-

munication, written or oral, containing any state-

ment 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 neces-

sary in order to make the statements therein

not false or misleading * * *.

STATEMENT

Petitioners are minority shareholders of respondent

Electric Auto-Lite Company (“Auto-Lite”). They in-

stituted this action in the United States District Court

for the Northern District of Illinois on June 26, 1963,

against Auto-Lite and two other corporations, Mer-

genthaler Linotype Company (“Mergenthaler”) and

American Manufacturing Company, Inc. (“Ameri-

can’’), on behalf of Auto-Lite, derivatively, and on be-

half of its minority shareholders as a class. The origi-

nal complaint sought, inter alia, to enjoin the voting

of all proxies obtained by the Auto-Lite management

in favor of a proposed merger of Auto-Lite and Mer-

genthaler on the ground that the solicitation of the

proxies was materially misleading, in violation of Sec-

tion 14(a) of the Securities Exchange Act of 1934

(“Act”) and the Securities and Exchange Commis-

sion’s Rule 14a-9 thereunder (App. 3-24). Subse-

quently, after the merger was authorized at a

——

5 ’

meeting of Auto-Lite stockholders an? became

effective, an amended complaint was filed in February

1964, seeking to have the merger set aside, on the

ground, in part, that the proxies solicited by the Auto-

Lite management and voted by it to authorize the

merger were void because of the violations charged.

The challenged proxy statement proposing the

merger of Auto-Lite and Mergenthaler was mailed to

the stockholders by the Auto-Lite management on

May 29, 1963 (App. 27-134). Before the merger, Mer-

genthaler owned 54 percent of the outstanding shares

of Auto-Lite common stock, and the remaining 46

percent was held by 8,987 other shareholders (App.

1004). Thus, in order to achieve the two-thirds vote

required to approve the merger, the votes of minority

shareholders holding approximately 13 percent of the

outstanding shares were needed. The merger was in

fact approved by votes representing 82 percent of

the common stock (App. 1005).

The proxy statement consisted of 108 pages. At

page 23, under the caption “Principal Holders of Se-

curities,”’ it contained a percentage breakdown of

the principal shareholders in the companies involved

in the merger. This showed that on May 1, 1963,

Gurdon W. Wattles, who was president and a direc-

tor of American Manufacturing Company, Ine.

(“American’’), as well as chairman of the board and

a director of Mergenthaler and chairman of the execu-

tive committee and a director of Auto-Lite, owned ap-

proximately 34 percent of the voting stock of Amer-

ican, that American and Mr. Wattles in the aggregate

owned approximately 33 percent of the stock of Mer-

es oy ee

6

genthaler, and that Mergenthaler owned approxi-

mately 54 percent of the outstanding common shares

of Auto-Lite (App. 51). It was further stated that

no other person owned of record, or was known to

own beneficially, more than 10 percent of the stock of

Mergenthaler or of the common stock of Auto-Lite

(App. 51).

On page two of the proxy statement in boldface

and larger type than was used generally in the text, was

the statement: “The Board of Directors has carefully

considered and approved the terms of the merger and

recommends that the shareholders vote to approve

the plan of merger’’ (App. 30). On the same page,

there appeared in regular type under the heading

“Reasons for Merger’’ the following statement: “After

a thorough review of all factors involved, both Boards

of Directors are of the opinion that the merger would

be mutually beneficial to the Constituent Corporations

and their respective shareholders’? (App. 30).° Mer-

genthaler’s ownership of 54 percent of the Auto-Lite

common stock was also mentioned on that page.

Count II of the complaint‘ charged that the sole

purpose of the merger was to effectuate a “fraudulent

plan”’ conceived by American and Mergenthaler to

*On page three of the proxy statement, the following expla-

nation appeared in regular type under the heading “Basis of

Merger”: “The Board of Directors of Electric Autolite be-

lieves the plan of merger to be fair and equitable to the share-

holders of Electric Autolite; the Board of Directors of Mergen-

thaler believes the plan of merger to be fair and equitable to

the shareholders of Mergenthaler” (App. 31).

*Count I of the three-count complaint alleged common law

fraud; Count ITI alleged that the merger was ultra vires under

Ohio law (App. 163-177, 180-183).

7

take over Auto-Lite’s business at a loss to Auto-Lite,

that no Auto-Lite director was independent and free

from the control and domination of Mergenthaler,

and that the proxy statement concealed this lack of

director independence from the Auto-Lite sharehold-

ers (App. 170, 173, 178).

The district court, in an unreported memorandum

opinion and order, held that the controlling issue was

whether as a matter of law “the proxy statement dis-

close[d] to the shareholders of Auto-Lite all of the

material facts with respect to the control of the Board

of Directors of Auto-Lite by Mergenthaler and Ameri-

can Manufacturing so that the shareholders could

pring their own independent judgment to bear on the

directors’ endorsement of their merger proposa

(App. 446-447). It ruled that the proxy statement

violated Section 14(a) and Rule 14a-9 because it

failed ‘‘to disclose * * * that members of the Board

of Directors of Auto-Lite were nominees of Mergen-

thaler’”’ (App. 448).° In a subsequent opinion grant-

ing, as to Count II of the complaint, the plaintiffs’

motion for summary judgment, the court further held

that “[w]here the accused proxy material is not

merely ‘randomly present’ in the context of the trans-

action, a causal relationship is established as intimate

and direct, particularly where a merger is involved.

** * Such a direct causal relationship [between the

proxy material and the merger] exists in the present

case” (App. 681).

“TThe district court subsequently stated that the action taken

in that memorandum opinion and order “was a specification

of facts appearing without controversy relating to Count II

of the amended and supplemental complaint, pursuant to Rule

56(d) of the Federal Rules of Civil Procedure” (App. 464).

361-667-692

——

The court of appeals agreed that the proxy solici-

tation material violated Rule 14a-9. It held that “as a

matter of law the proxy statement failed, in connec-

tion with the advice tendered by the board, adequately

to bring out the relationship between the board mem-

bers [of Auto-Lite] and Mergenthaler. This * * *

was an omission of a material fact’’ (App. 1011). The

court further explained that “in light of the [Auto-

Lite] board’s statements recommending and giving

opinions favorable to the merger the failure to give

similar emphasis to the relationship with Mergen-

thaler was the omission of a material fact necessary

to make the laudatory statements not misleading”

(403 F’, 2d at 436).°

The court of appeals disagreed, however, with the

district court’s holding on the issue of causal rela-

tionship, ruling that the granting of summary judg-

ment with respect to this issue was improper because

“there is an issue for trial with respect to the causal

relationship between the deficiency in the proxy state-

ment and the merger” (App. 1012). The court of ap-

peals stated that because it was too late to prevent the

merger “[t]he court must now determine in retro-

spect whether the unlawful act caused some inequity

or damage which the court should relieve or redress”;

8

* The court of appeals pointed out that in the course of a pro-

ceeding before the Commission, in which American had sought

and obtained an exemption from provisions of the Investment

Company Act of 1940 and which was terminated two months be-

fore the solicitation of the proxies herein, American had made a

statement that tended to show “that the management of Ameri-

can selected directors for Mergenthaler and Autolite, and that

Autolite was under the control of American” (App. 1008-1009).

9 °

that “evidentiary material tending to show that the

merger has merit and the terms were in fact fair and

equitable to the minority shareholders * * * does bear

on the cause question”; and that, consequently, it may

be possible for the defendants “to satisfy the court, by

a preponderance of probabilities, that the merger

would have received a sufficient vote even if the proxy

statement had not been misleading in the respect

found” (App. 1011-1013). The court held that “the

burden of persuasion” on the issue of causal relation-

ship would be

on defendants, who are responsible for the vio-

lations, but if they are able to carry the burden,

there would be no sound basis for disruption of

the merger or other relief. We do not consider

that the policy of the ’34 act requires the court

to unseramble a corporate transaction merely

because a violation occurred [App. 1013-1014].’

The court of appeals reversed the judgment and or-

dered that “the costs * * * be taxed in favor of de-

fendants” (App. 1015).

INTRODUCTION AND SUMMARY OF ARGUMENT

Where stockholders have established that a proxy

statement sent out to solicit votes to authorize a

merger was materially misleading in violation of the

Commission’s proxy rules, they have proved their

cause of action, and it is unnecessary for them to

’ The district court had reserved for subsequent determination,

pursuant to the recommendations of a master, the issue of ap-

propriate relief (App. 683-684). The court of appeals found

the reference to the master inappropriate in the circumstances

(App. 1014).

|

10

prove, in addition, that the merger would not have

been approved if the proxy solicitation had not been

misleading.

If such a violation of the proxy rules has been

established prior to the corporate meeting at which

the proxies were intended to be used, a resolicitation

prior to the meeting will normally serve to undo any

harm. Where, however, the violation is not discovered

until after the meeting * or for some other reason pre-

liminary injunctive relief has not been obtained,’ we

agree with the court of appeals that, contrary to the

petitioners’ contention, proof of the violation does not

necessarily require that a merger approved at the

meeting through voting of the proxies and subse-

quently fully consummated must be undone (although

such relief is available to the court). A court of

equity may properly conclude that, in the circum-

stances of the case, undoing of the merger would be

contrary to the best interests of the parties or of in-

nocent third persons and, therefore, unwarranted. It

would normally be necessary, however, to grant other

appropriate relief to those who have been harmed by

the violation.

Where, as here, the misleading aspect of the proxy

solicitation did not relate to the terms of the merger,

the stockholders should be entitled to monetary relief

only to the extent that they can show they suffered

* Cf. J. I. Case Co. v. Borak, 377 U.S. 426, 432-433.

° Preliminary injunctive relief is sometimes conditioned on

the plaintiffs’ providing a bond, the expense of which may be

a deterrent. Cf. Electronic Specialty Co. v. International Con-

trols Corp., CCH Fed. Sec. L. Rep. § 92,342 at 97,633 (C.A. 2,

January 24, 1969).

—_

11 ,

pecuniary damages from the merger. If assets and

operations of the merged companies have become so

intermingled that it is impossible to ascertain whether

such injury resulted, the appropriate relief to be ac-

corded, if any, will depend principally on whether the

terms of the merger were fair.

The holding of the court below that a showing of

“causal relationship”? between the proxy violation and

the merger is a necessary part of the plaintiffs’ cause

of action has the unfortunate ancillary effect of de-

nying to stockholder-plaintiffs who can establish a

violation of the proxy rules assurance that their rea-

sonable litigation expenses will be reimbursed. Once

the violation has been established, the plaintiffs’ ex-

penses, both in establishing the violation and in at-

tempting to show unfairness of the merger, should

be borne by their corporation; otherwise, private ac-

tions under the Commission's proxy rules, which are

a necessary supplement to the Commission’s enforce-

ment activity, would be seriously inhibited.

ARGUMENT

I. FAIRNESS OF THE MERGER TERMS IS NOT A DEFENSE TO A

PRIVATE ACTION COMPLAINING OF MATERIALLY MIS-

LEADING SOLICITATION OF PROXIES WHICH AUTHORIZED

A CORPORATE MERGER, BUT IS A RELEVANT CONSIDERATION

IN DETERMINING APPROPRIATE RELIEF.

1. Having established a violation of the antifraud

provisions of the proxy rules, the plaintiffs should

be deemed to have proved their cause of action. J. I.

Case Co. v. Borak, 377 U.S. 426, 433. Thus, as the

court of appeals reeognized (App. 1011), where a ma-

terial violation of the proxy rules has been established

ee YLT HA RTEMNTM LIN

12

before the meeting at which the proxies were intended

to be used, courts will enjoin the voting unless there

should be resolicitation.”

We disagree with the apparent conclusion of the

court of appeals that, even where a timely complaint

is filed (as was true here), the plaintiffs would have

no case, notwithstanding the violation, if the defend-

ants were to show that there probably would have been

a sufficient vote to approve the merger had there been

no defect in the proxy statement. There are two princi-

pal reasons for our disagreement with the court of

appeals on this point.

First, it is wholly impracticable to determine directly

whether or not the result of the shareholder vote

would have been different if the improperly omitted

information had been included in the proxy statement.

The court of appeals apparently recognized this ™ and

focused the inquiry, instead, on the fairness of the

merger—based on an apparent assumption that, if the

merger were in fact fair, it would have been approved

by the shareholders in response to a proper solicita-

tion of their proxies. By thus apparently making the

plaintiffs’ rights wholly dependent on whether the

merger was fair, the decision erroneously insulates a

category of proxy violations from private redress. For,

no matter how outrageous the misrepresentations in

1° Studebaker Corp. v. Gittlin, 360 F. 2d 692, 698 (C.A. 2);

Willoughby v. Port, 182 F. Supp. 496 (S.D. N.Y.) affirmed as

modified per curiam, 277 F. 2d 149, 150 (C.A. 2); cf. Mutual

Shares Corp. v. Genesco, Inc., 384 F. 2d 540 (C.A. 2).

1 It stated that actual “[r]eliance [on the misleading material]

by thousands of individuals, as here, can scarcely be inquired

into” (App. 1013, n. 10).

nial tO,

wn

13

the proxy material soliciting votes to approve a

merger, the shareholders would have no cause of

action if the terms of the merger were found to be

fair. Such a result—particularly if carried over to the

Commission’s enforcement actions, as it seemingly

would be if the fairness of the merger were regarded

as a defense to a suit for violation of the proxy rules—

unjustifiably subverts the proxy rules. Under those

rules, shareholders have an independent interest in

full and fair disclosure irrespective of the underlying

fairness of the merger. They are entitled to receive an

accurate proxy statement which is adequate to enable

them to exercise their own informed judgment as to

the desirability of the merger.”

Second, as discussed more fully in Part II, infra,

there is the practical problem that, if the fairness of

the merger were a complete defense, small stock-

holders would be discouraged by this additional risk

in the litigation from attacking allegedly defective

proxy statements. This would seriously impede private

enforcement of the proxy rules.

Accordingly, we agree with the petitioners that the

causation requirement is satisfied if the proxy solicita-

tion itself, rather than the particular defect in the

proxy material, was an essential link in the chain of

events that brought about the merger. Causation under

” Even where the terms of a proposed merger appear to be

fair, the outcome necessarily involves uncertainties. The busi-

ness and operations of the two companies may not fit together

as well as was hoped. Shareholders might wish to avoid such

risks by voting against a merger unless it appears to them to be

affirmatively beneficial rather than merely fair. Moreover,

stockholder may prefer independent operation rather than

merger into another company even on @ fair basis.

14

this standard is present here, since some of the votes

solicited by the defective proxy material were neces-

sary in order to obtain the required shareholder ap-

proval of the merger.” In these circumstances, a plain-

tiff need show only that the defect in the proxy state-

ment was sufficiently material that it might have in-

fluenced the vote of a reasonable shareholder.

In the present case, there might well have been

stockholders who accepted the advice of their directors

in favor of the merger without studying its details, but

who would not have accepted that advice without inde-

pendent study if they had been adequately informed

that there was a question as to the disinterestedness of

the directors. Since there is no practical way to meas-

ure how many votes were affected, the doubt should be

resolved in favor of those against whom the violation

was directed and for whose protection the statute was

designed, rather than in favor of the violators. East-

side Church of Christ v. National Plan, Inc., 391 F. 2d

357, 362 (C.A. 5).** The objective test suggested above

is not only practical and workable but will serve to

Tt is unnecessary in this case to resolve the question,

presented in Barnett v. Anaconda Company, 238 F. Supp. 766

(S.D. N.Y.), of causation in the situation where the management

has enough votes to approve the transaction, whichever way the

minority votes. Even in that situation, however, if it is neces-

sary, for legal or practical reasons, to solicit the proxies of

minority shareholders, proxy solicitation could be found suf-

ficiently related to the merger to satisfy the causation require-

ment. See Laurenzano v. Einbender, 264 F. Supp. 356 (E.D.

N.Y), and the quotation therefrom in n. 14, infra.

“Tt has been said that, even where the controlling person

has sufficient stock to vote to effect the merger, “[i]t is not

* * * to be assumed without evidence that the solicitation of

proxies was a gratuitous and, therefore, purposeless and legally

15 ,

effectuate the underlying purposes of the proxy rules—

fair disclosure to shareholders when their votes are

solicited.

2. We agree with the court of appeals, however,

that the issue of fairness of the terms of the merger

may be important—but as relevant to the question of

relief, rather than as a complete defense to the cause

of action.

It does not follow from the fact that the merger

may have been brought about by misleading proxy

material that it should necessarily be undone in an

attempt to restore the status quo. The combined en-

tity is not inherently unlawful, as it would be,

for example, if the combination had been found to

violate the antitrust laws; and in some instances at-

tempts to unseramble the holdings in the corporate

entities could be harmful to innocent third parties (who

may have purchased or retained shares in the com-

inert act.” Laurenzano v. Einbender, supra, 264 F. Supp. at

361. The court in that case continued :

It may be that an unfavorable vote from the minority

stockholders would have brought about modification or re-

consideration of the transactions; in corporate circles, con-

sensus can be a desideratum. It may be that a value was

perceived and sought in just such a favorable vote as was

obtained from the one-quarter of the minority stockholders

who mailed in their proxies. Such seemingly pointless ap-

probations have their uses, and even the record of dis-

closure itself may serve a range of useful purposes. * * +f

But cf. Robbins v. Banner Industries, Inc., CCH Fed. Sec. L.

Rep. §91,861 at 95,952-95,953 (S.D. N.Y., December 21, 1966),

where the court pointed out that “[t]here is no insurer liability

under section 14(a) ; the alleged violation of the proxy rules does

not give [rise] to a cause of action under this section unless

there is some causal connection between the violation and the

injury.”

16

bined entity in reliance on the seemingly valid

merger) or, indeed, to the very class of persons who

were misled.

Nor do we agree with petitioners’ contention that

Section 29(b) of the Securities Exchange Act of 1934

(supra, p. 3), which declares contracts made or per-

formed in violation of the Act or a rule thereunder to

be “void * * * as regards the rights of’’ the violator

and knowing successors in interest, automatically re-

quires that the merger be set aside because the merger

agreement is a “void” contract. We recognize that the

merger agreement is a “contract made [or performed]

in violation of’’ the Act, and a rule thereunder, within

the meaning of Section 29(b), but we believe that,

properly interpreted, that Section—which declares

such contracts to be “void” only as against the rights

of certain persons—basically means that such a con-

tract is voidable at the option of the innocent party

thereto rather than necessarily a nullity even if the in-

nocent victim of the violation wishes to enforce his

rights under the contract. As the court of appeals for

the Eighth Circuit explained in Greater Iowa Corp. v.

McLendon, 378 F. 2d 783, 792:

* * * Subsection (1) only declares to be void

the rights of any person who violates the pro-

visions of the statute. The contract rights of the

party not in violation are in no way impaired.

Bankers Life and Casualty Company v. Bel-

lanea Corporation, 288 F. 2d 784, 787 (7 Cir.

1961), cert. denied 368 U.S. 827 * * *. Though

§ 29(b) speaks in terms of “void’’ and the guilty

party is clearly precluded from enforcing the

contract against an unwilling innocent party,

a

17

just as clearly the innocent party is left free to

enforce the contract if he so desires. This being

true the contract cannot possibly be considered

absolutely and totally void. It is a contract

“yoidable” at the option of the innocent party.

Royal Air Properties, Inc., v. Smith, 312 F. 2d

210, 213 (9 Cir. 1962). If this contract is “void-

able, ’ or void only at the option of the innocent

party, the contract must be considered valid

until voided by the party having the right of

recision. * * *

In the present case, because the plaintiffs are not

themselves parties to the merger agreement, they do

not enjoy the unqualified statutory right of an inno-

cent party to the contract to have it set aside under

Section 29(b) (although, as innocent victims of the

proxy violation,-they presumably would have the right

to rescind their own proxies if they had been sub-

mitted in favor of the merger in response to the un-

lawful solicitation). And, to the extent that the plain-

tiffs in their representative eapacity stand in the shoes

of Auto-Lite as a party to the merger agreement, it is

far from certain that the shareholders the plaintiffs

represent would wish to have the merger set aside. We

believe, therefore, that the proper meaning of Section

29(b) in the context of a suit such as the present one

is that the contract of merger entered into as a result

of the proxy violation is voidable, but should be set

aside only if a court of equity concludes, in all the cir-

cumstances, that it would be equitable to do so.

It also does not follow from the mere fact of the

proxy violation that the stockholders whose proxies

were wrongfully solicited are necessarily entitled to

18

substantial monetary relief, whether or not it might

be appropriate for the merger to be undone. If stock-

holders were misled as to the specific terms of the

merger, there should be an accounting so that they

would receive that which was represented to them in

terms of value. But where, as here, the misleading

aspect of the solicitation did not relate to the terms of

the merger, the misled stockholders should be entitled

to monetary or other relief only if the merger resulted

in a reduction to them of earnings or earnings poten-

tial. That is, stockholders whose company was merged

on the basis of materially misleading proxy solicita-

tions are entitled to recover damages resulting from

such merger to the extent that such damages can be

shown, as may be possible where assets and operations

of the merged companies remain separate. And mone-

tary relief would, of course, be inappropriate where

it could be shown that the complaining stockholders

were receiving greater earnings or earnings potential

than would have been the case had the companies

remained separate.

To establish direct injury resulting from the merger

in the foregoing manner would normally be impossible

in cases in which the assets and operations of the

combined companies have been intermingled. A deter-

mination of whether the terms of the merger had been

fair would then appear to be the proper basis for

deciding what relief is warranted. If the merger were

found to be unfair at the time it was consummated, it

could then be determined what relief would be appro-

priate to make whole the misled stockholders. Con-

sideration should be given, for example, to attempt-

—

19 .

ing to determine what would have been a fair ex-

change ratio as contrasted with that involved in the

merger, and of awarding minority stockholders whose

proxies were wrongfully solicited cash damages or

additional stock in the merged company sufficient to

make their treatment fair. If, on the other hand, the

merger terms were found to have been fair, there

would presumably be no damages payable or account-

ing required to those who have been misled, although

in appropriate circumstances injunctive relief might

be suitable. These, of course, are questions to be de-

cided by the district court on remand.

IL VIOLATION OF THE COMMISSION’S PROXY RULES SHOULD

ENTITLE THE PLAINTIFFS TO AN AWARD OF REASON-

ABLE LITIGATION EXPENSES, INCLUDING ATTORNEYS’ FEES,

BOTH IN ESTABLISHING THE VIOLATION AND IN AT-

TEMPTING TO SHOW UNFAIRNESS OF THE MERGER

If, as we have contended, the finding of a proxy

violation established the plaintiffs’ cause of action, the

court of appeals should have affirmed the judgment

in plaintiffs’ favor, with modification of the district

eourt’s reference of the case to a special master, if

this was inappropriate. The costs of the appeal would,

in that event, have been borne by the defendants.

Similarly, in our view, the plaintiffs, who have es-

tablished a violation of the securities laws by their

corporation and its officials, are entitled to litigation

expenses and reasonable attorneys’ fees (1) to enable

them to go forward with the trial on the issue of

appropriate relief and (2) for their efforts in estab-

lishing the violation.

a

Where, as here, prolonged litigation might be re-

quired to determine whether a corporation’s violation

has resulted in unfairness to its stockholders, it is in-

equitable for the stockholders who have established

the violation to be required to bear the expenses of

further litigation. It is appropriate, instead, that the

corporation (or the entity into which it has merged)

bear the expenses of presenting to the court the issue

of whether injury resulted and, if so, the determina-

tion of proper relief, as well as the expenses that the

stockholders have already incurred in order to estab-

lish the violation.

The court below held that the burden of persuasion

regarding the fairness of the merger has shifted to

those shown to have violated the securities laws, but

this is scarcely adequate interim relief for the stock-

holders who have established the violation. Because it

is common for corporations planning a merger to hire

experts to assess its fairness, it should not be difficult

in most cases for the defendants to meet the initial

burden by producing the studies and testimony of

these experts. The plaintiffs would then be required to

offset the evidence of defendants’ expert witnesses,

This would require them to engage their own expert

witnesses, to make audits and investigations of the

books and records of the defendants, to take deposi-

tions, and to carry on a full-dress trial.

These expenses of proving the plaintiff-stockhold-

ers’ case are incurred for the benefit of their corpora-

tion because there was “‘deceit practiced on the stock-

holders as a group.” J. I. Case Co. v. Borak, supra,

377 U.S. at 432. Certainly, if plaintiffs are able to

_—

21

show that the plan was unfair to Auto-Lite or its

shareholders and that the merger should be dissolved

or other relief awarded, there would be a direct finan-

cial benefit. Accordingly, plaintiffs’ subsequent litiga-

tion expenses, including reasonable attorneys’ fees (re-

flecting, among other things, the ultimate benefit, or

lack thereof, of the litigation to the corporation or the

stockholders as a group), should be borne by their

corporation (or the corporation into which it has

merged). To eliminate possible abuse, however, it

might be appropriate to require the plaintiffs, in order

to qualify for reimbursement of their subsequent liti-

gation expenses, to make a preliminary showing of a

substantial possibility that the defendants’ proof of

fairness might be successfully controverted.”

For the same reasons, the plaintiffs are even more

clearly entitled to reimbursement of their expenses

already incurred, including reasonable interim attor-

neys’ fees, in establishing the violation. “[I]n causes

like these which involve corporate therapeutics,’ ”

attorneys’ fees may be awarded notwithstanding the

absence of express statutory authorization therefor.

For example, in Smolowe v. Delendo Corp., 136 F. 2d

231, 241 (C.A. 2), certiorari denied, 320 U.S. 751, the

plaintiff shareholders were awarded attorneys’ fees

for their recovery of short-swing profits under Sec-

tion 16(b) of the Securities Exchange Act of 1934,

15 U.S.C. 78p(b), even though recovery of attorneys’

Cf, Dolgow vy. Anderson, 43 F.R.D. 472, 501-503 (E.D.

N.Y.).

% Murphy vy. North American Light and Power Co., 33 F.

Supp. 567, 570 (S.D. N.Y.).

22

fees is not expressely provided for in Section 16(b)

and is expressly provided for in two unrelated sections

of the same statute.” The court relied on the long recog-

nized principle that “a stockholder who is successful in

maintaining * * * an action [for his corporation’s

benefit which it has been unwilling to institute] is en-

titled to reimbursement for reasonable attorney’s fees

on the theory that the corporation which has received

the benefit of the attorney’s services should pay the

reasonable value thereof.’’ 136 F. 2d at 241.”

Award of attorneys’ fees has been deemed appro-

priate even where no fund at all may be produced by

the litigation. For example, in reorganization cases

under Chapter X of the Bankruptey Act, 11 U.S.C.

501, et seq., attorneys’ fees are awarded for various

activities considered beneficial to the debtor’s estate,

such as opposition to a plan not meeting the statutory

standards.”

If “benefit” to the corporation be the test of whether

it is equitable to award attorneys’ fees, benefit must

7 See Sections 9(¢) and 18(a) of the Securities Exchange

Act, 15 U.S.C. 78i(e) and 78r(a), respectively.

%* See, generally, 7'rustees v. Greenough, 105 U.S. 527;

Sprague v. Ticonic National Bank, 307 U.S. 161. See, also,

Maggiore v. Bradford, 310 F, 2d 519 (C.A. 6); cases cited in

Hornstein, Legal Therapeutics: The “Salvage” Factor in Coun-

sel Fee Awards, 69 Harv. L. Rev. 658, 675-679; and in Horn-

stein, New Aspects of Stockholders’ Derivative Suits, 47 Colum.

L. Rev. 1, 24-28. Of. Bakery and Confectionary International

Union v. Ratner, 335 F. 2d 691 (C.A. D.C.).

2° See Sections 241-246, 248 and 249 of the Bankruptcy Act,

11 U.S.C. 641-646, 648 and 649, respectively; 6A Collier, Bank-

ruptcy $13.02 at 914-915, § 13.06 at 954, § 13.12 at 981, $13.14

at 994 nn. 14, 15 (14th ed. 1968). See, ¢.g., Scribner & Miller

v. Conway, 238 F. 2d 905, 907 (C.A. 2); In re Consolidated

—

23 ,

be calculated in the light of the statutory policy re-

quiring fair disclosure in the solicitation of proxies.

If, for example, it had been feasible to try the issue

of violation in the present case prior to the meeting

at which the votes were cast, the plaintiffs surely would

have been entitled to attorneys’ fees even if the stock-

holders later voted to approve the merger after a

proper resolicitation of their proxies. The fact that, as

we urged in point I, it may no longer be practical or

equitable to set aside the merger does not compel

denial of a fee; the stockholders will here be bene-

fited by obtaining judicial scrutiny of the fairness of

the plan as a substitute for a properly informed vote

of the stockholders.

This Court has noted that “Private enforcement of

the proxy rules provides a necessary supplement to

Commission action.” J. I. Case Co. v. Borak, supra,

377 U.S. at 432; ef. Smolowe v. Delendo Corp., supra,

136 F. 2d at 241; Blau v. Rayette-Faberge, Inc., 389 F.

2d 469, 472 (C. A. 2); Gilson v. Chock Full O’Nuts

Corp., 331 F. 2d 107, 110 (C.A. 2). It provides an im-

portant deterent to unlawful proxy solicitation by

corporate management. Such enforcement will be dis-

Motor Parts, Inc., 85 F. 2d 579, 581 (C.A. 2); In re Midland

United Co., 64 F. Supp. 399, 410 (D. Del.), affirmed on other

grounds, 159 F. 2d 340 (C.A. 3). Cf. Abrams v. Textile Realty

Corp., 97 N.Y.S. 2d 492, 496 (Sup. Ct.) :

| [O]n the narrow issue of law as to “the right” to an allow-

| ance [of attorney’s fees], * * * there is no relevance in an

argument that this suit created no fund or property for

[the defendant corporation] or its security holders, or that

they or any of them would have been better off if the wtra

vires act had been performed. The law cannot refuse to

recognize as beneficial full observance of the law.

—

24

eouraged if interim relief such as suggested herein js

unavailable after a violation has been established. The

court in Smolowe, supra, 136 F. 2d at 241, noted that

the ‘‘possibility of recovering attorney’s fees’’ may

“provide the sole stimulus”’ for a shareholder to initi-

ate an action challenging questionable corporate activi-

ties. And a perceptive commentator summed up the

need for reimbursement of litigation expenses as

follows: ”

If reimbursement were not permitted to a

stockholder successfully prosecuting a suit to

redress a wrong to his corporation, the practi-

cal effect would be the same as if the suits were

prohibited and the small stockholder remedi-

less, for the expenses in most cases would ex-

ceed the increase in the value of his stock,

resulting in a net loss to him individually even

if he were successful in recovering for the

corporation. * * *

2 Hornstein, Zhe Counsel Fee in Stockholder’s Derivative

Suits, 39 Colum. L. Rev. 784, 791. See, also, Hornstein, Legal

Therapeutics: The “Salvage” Factor in Counsel Fee Awards,

69 Harv. L. Rev. 658, 663.

_

For the foregoing reasons, the judgment of the

eourt of appeals should be modified in accordance

with the views expressed in this brief.

Respectfully submitted.

ErRwINn N. GRIswoLp,

Solicitor General.

LAWRENCE G. WALLACE,

Assistant to the Solicitor General.

Puitie A. Loomis, Jr.

General Counsel,

Davip FERBER,

Solicitor,

MEYER EISENBERG,

Associate General Counsel,

WarrEN G. STOLUSKY,

Attorney,

Securities and Exchange Commission.

Aveust 1969.

25 °

CONCLUSION

U.S. GOVERNMENT PRINTING OFFICE: 1969