SANTA FE INDUSTRIES, INC. v. GREEN
Legal provision: Securities Act of 1933, the Securities and Exchange Act of 1934, or the Williams Act
Argument of William R. Glendon
Chief Justice Warren E. Burger: We’ll hear arguments next in 1753, 1660, 1782, Santa Fe Industries against Green.
Mr. Glendon, you may proceed.
Mr. William R. Glendon: Mr. Chief Justice, and may it please the Court.
My name is William R. Glendon.
I represent the Santa Fe parties who were defendants below and are petitioners here.
In this proceeding, there are raised some very troublesome and even startling problems by the decision below in reference to the scope of the Securities Laws particularly 10 (b) of the 1934 Act and further the entire relationship between Federal and State governments.
The case arises out of fact that the plaintiffs are suing, claiming that in a short-form merger, pursuant of the Delaware statute, the price that they were given of a $153 was grossly undervalued and that this constitutes a violation of scheme and contrivance under Rule 10b-5 because it was given without notice, although the Delaware statute doesn’t require any notice.
In fact, all the Delaware statutes were complied with and in this action under a statute requiring manipulation and deceit, it is clear that there was no deceit and there was no nondisclosure.
Nonetheless, two members of the Court of Appeals said that the conduct pursuant to the statute was a fiduciary breach and they said that this was a scheme to defraud.
The dissenting opinion, Judge Moore said to say that, “the facts here presented a scenario of defraud -- of fraud was patent distortion of the term.
It was no fraud at all.”
The facts very quickly are that Santa Fe acquired 60% of the Kirby Lumber Company in 1933 under a reorganization.
In 1967, they acquired another 25% at a price, and I will remind Your Honors, the price claimed here to be undervalued, grossly undervalued as $160 -- as $125.
In 1967, the remaining 25% to get them up to 90% was acquired at the price of $65.00.
There were additional purchases of the stock in between 1967 and 1974 at prices of $65 to $92 to bring them up to the number of 90%.
Under the Delaware law, you may enter into a short-form merger if you have 90%.
Santa Fe decided to invoke the provisions of the Delaware short-form statute and have a short-form merger.
To do this, it did a number of things.
It first of all caused appraisals to be made of the physical properties of the Kirby Lumber Company and this physical appraisal of the property showed a value of the asset value of $320 million.
It also had an appraisal made of the mineral properties and this too was submitted to Morgan Stanley along with the asset appraisal whom Santa Fe had engaged to give it an independent advice as to the fair market value of the stock of the minority, the fractional shareholders.
The Morgan Stanley did an appraisal of the minority -- of this value, true market value of the stock and came up with a figure after considering a variety of factors including the appraisals which were submitted to them of $125.
Justice William J. Brennan: Why is that -- can’t the stock traded over-the-counter?
Mr. William R. Glendon: The very thin market, Mr. Justice.
I think that it was not even traded over-the-counter.
There just wasn’t much trading in it.
The record reflects the buys by Santa Fe during the period 1960, 1967 on, and as you will see, they have a very small numbers of shares.
Santa Fe took the Morgan Stanley recommendation of a $125, increased it to a $150. Parenthetically, this would be 12.5 times earnings for the previous year.
It set up a corporation called Forest Products, Inc. to implement the merger.
It gave Forest Products $3.8 million to affect the -- have the money to buy in the minority stock.
And I mentioned this because the lower court took the misapprehension, was under the misapprehension that Kirby itself paid for the stock, that the stock was paid out of Kirby’s fund.
This simply wasn’t so.
The parent provided the money.
The merger, pursuant to the statute, was affected on --
Justice John Paul Stevens: Mr. Glendon, is that really a significant point as did in Kirby incurring indebtedness to get the money from the parent?
Mr. William R. Glendon: No.
Justice John Paul Stevens: You mean the parent -- it was just capital contribution?
Mr. William R. Glendon: Yes.
There was no -- and I stressed it because Your Honors will probably read the Marshel case along with this case which is another case that came out of the Second Circuit.
And it was great -- stressed later in that case that a merger without a corporate purpose, where the company’s funds were used was a violation of 10 (b).
And I just want to make the distinction here that that didn’t happen here.
The merger occurred on July 1 -- on July 31 and on August 1 the next day, as provided by the statute, notice was sent to the fractional or minority shareholders.
Along with the notice and this is very important to our case, along with the notice went a ream of material, describing the background of the merger, describing the merger, describing the appraisals, concluding the appraisals, every single bit of relevant information that could possibly be put out was put out.
And there was, in fact, there’s no claim that any of that material was misleading, that it misrepresented anything, that it said that something was only a half-through, or that it failed to disclose anything.
There was simply no claim with reference to this material.
Indeed, the claim itself, the fact the claim of undervaluation is based on the figures disclosed by the information we gave them which, in this compassing strange in a 10b-5 nondisclosure case.
We moved to dismiss in the District Court.
The District Court took a, it seemed to us and of course were prejudice, it seemed to us, took a realistic and rather straightforward view of this case.
It said, there is no deception in the case.
It’s a 10b-5 case.
There’s no claim of nondisclosure.
Therefore, it is not a 10b-5 case and dismissed it to the claim that there was no corporate purpose.
It said, “You don’t need a corporate purpose in Delaware.”
To the claim that there should have been prior notice, it said the statute provides proposed merger notice.
And I might just say there that that we think is the relevant time because that’s the time the minority stockholder needs the information in order to make an investment decision.
He wants to know at that time, “Do I accept the $150 or do I seek the appraisal rights which I have under the Delaware statute?”
So, we say and Judge Breen in the lower court said that this was proper and adequate notice under the statute.
Chief Justice Warren E. Burger: I think we will resume there at 10 o’clock in the morning.
We’ll resume arguments, Santa Fe Industries against Green.
Mr. Glendon, you may pick up where you left off yesterday.
Mr. William R. Glendon: I would like to reserve three minutes for rebuttal, Mr. Chief Justice.
Chief Justice Warren E. Burger: Very well.
Mr. William R. Glendon: Mr. Chief Justice, and may it please the Court.
I think as we suspended yesterday, I was referring to the Judge Moore’s dissent in saying that, to say that the circumstances here presented as scenario of fraud was a patent distortion of the term.
To put the facts into a little sharper focus, I would like to refer to a couple of matters the Judge Medina in the majority opinion in approaching the subject involved, made reference to schemes of loyal and cunning and so sophisticated as to almost defy belief.
In fact, as Judge Moore noted, this circumstances here were such that he found there were matters of utmost simplicity and patent reasonableness.
In the concurring opinion, Judge Mansfield, invade against the idea of companies going public when the market is flourishing and then going private when the market is depressed.
In fact, as the records will show us here, Kirby has always been a public company.
The price that was paid for the stock was much -- offered for the stock was much higher than anything shown in the record before.
We don’t know what the plaintiff’s basis here for the stock was, but it is interesting to note.
I think it’s at page 102 of the joint appendix that he pleads as complaints of the fact that he is going to have to pay a capital gain’s tax on this transaction which is certainly a most unusual complaint of a victim of a claimed fraud.
Chief Justice Warren E. Burger: And of course, its claim is addressed to the fact that he didn’t have any option about disclosure.
Mr. William R. Glendon: Well, he does have -- he has another action, of course, of getting a fair valuation and the Delaware statute, as I pointed out Mr. Chief Justice, specifically provides in this part of his contract in the charter of the corporation that minority stockholders can be eliminated from the corporation.
I think the first principle that we should consider here is the fact that the Securities Acts, the 1933 and 1934 Acts, are disclosure statutes.
This Court said in the Affiliated Ute case that the philosophy was to substitute a philosophy of full disclosure for that of a caveat emptor.
We think the court below ignored that as well as ignored their own holding in the Popkin case only two years before when they said the function of the statute is primarily to disclose and inform rather than becoming involved in passing judgments -- becoming a master in passing judgments on the information disclosed.
They ignored too, we feel the language of the statute itself which, as this Court said in the Ernst & Ernst case, speaks so specifically of manipulation and deceit.
And we find no reference in the Court’s decision, the majority decision, to the language of the statute itself, and we think that, of course, we must begin there with the statute.
The language says, “Prohibits manipulative and deceptive devices in contrivance and contravention of the rules of the commission.”
And to us, it’s clear that that means, they are talking about deceit and deception.
The Court of Appeals met this problem not by tackling on headlong but simply eliminating deception and deceit from the statute.
Even though, as I’ve said, I just previously stated a couple of years before that the disclosure was a key purpose of the statute.
The plaintiff tries to avoid this problem by a variety of references to other cases, other statutes relying, principally, it seems to us, upon arguments in cases which invoke matters of constructive fraud.
But the statute is a disclosure statute; it did not, I repeat, did not try to take on all the wrongs of the world.
It said and the Congress adopted a philosophy of disclosure, and it says, when you disclose, you cannot make deceitful disclosures, deceptive disclosures, and that, we feel, is the problem before the Court today.
The cases that this Court has considered on a matter, we think support that.
The plaintiffs seem to get support from the Bankers Life case but that was a clear case where this Court said that the statute should be read flexibly and we certainly agree with that.
But the Bankers Life case was a deception case.
It was a clear case of deception.
The Court referred there to the fact that misrepresentations have been made -- that the Board of Directors had been duped.
So, that case really offers no help, in our view, to the plaintiffs.
The Court too has said that the statute will not be read narrowly and that artificial barriers -- and has removed the artificial barriers too to the administration of the statute.
For example, in (Inaudible) in the Bankers Life, suggests that and has broadened some of the categories in terms of reliance and such.
But it has not and has never, and I don’t believe it should or could remove the concept of deceit from the statute because if you do, if that is done, then you do not have a statute that involves deception.
And it seems to us, it’s as simple as that.
They may be wrong, but people can lay claims too, so we don’t think so in this case.
They may be conflicts of interest; they may be fiduciary breaches; they may be actions of waste, but they are not actions for deceit and the statute says deceit.
Justice William H. Rehnquist: Mr. Glendon, what if the majority shareholders, moving under the Delaware short-form merger statute, did engage in deceptive conduct and saying discussing valuation with the minority shareholders, would the minority shareholders then have a 10b-5 action for damages?
Mr. William R. Glendon: If they engaged in deception and the disclosure, yes, Mr. Justice Rehnquist, I think they would and the Popkin case made clear that 10b-5 in a short-form merger is not nugatory thing because the short-form -- the splinter shareholder has an investment decision to make.
He can either accept the offer or he can take his appraisal remedy under the Delaware statute.
I think, perhaps, the fallacy in the plaintiff’s approach and in the majority’s decision is simply that, they believe that every wrong or possible wrong or conceivable wrong that may arise in connection with securities, shouldn’t be cured by the application of 10b-5.
I will discuss later what that may do to the federal courts but quite apart from the result, of such a thing, the fact simply is, we feel that the Congress never intended that and starting as we must to clear language of the statute, it just seems there is no basis for doing so.
It is not and Judge Medina in his majority opinion recognizes 10b-5 is not a panacea for all wrong doings.
It has a limited purpose which has and should be construed broadly, of course, but it has a limited purpose of requiring disclosure and having an informed investor.
Now, the court below passing fraud, moved in to the area of fiduciary breach and it engrafted upon 10b-5 not fraud, but said that there was a fiduciary breach here.
We do not think that fiduciary breach and fraud are the same thing.
There may be deception in a fiduciary breach but whether there is overreaching or conflict of interest or other aspects of fiduciary breach, they do not come under 10b-5.
We think, it’s difficult to understand how the Court did that but then to engraft a fiduciary breach onto it, but it is almost impossible to explain what the breach was here.
And I would like to go into that just briefly.
The Court said that the allegation of gross undervaluation alone was not enough.
That was not a fiduciary breach.
But what it said was that undervaluation, combined with a lack of expressed corporate purpose other than the obvious advantages that may come to a company from going private.
But the Court said, the absence of another expressed corporate purpose and the absence of prior notice, although, as I think as I said yesterday that Delaware statute requires post-merger and not prior notice.
The Court said that the combination of those three things constituted a breach of fiduciary duty and that breach resulted in a violation of 10b-5.
It was a scheme and contrivance and artifice to defraud.
Now, that we think is a startling proposition.
It has the obvious vice of rewriting the Delaware statute because the Court had to rewrite the Delaware statute in order to come to that result.
The Delaware courts have said that the very purpose of 10b-5 is to permit the elimination of the splinter shareholders.
Commentators and I may say that some 30 other states have the same or somewhat provisions where minority shareholders can be eliminated.
So, to engraft on that, a requirement of corporate purpose nullifies, in effect, the Delaware statute.
Secondly, to engraft on or amend the statute, which now says, you must give notice 10 days after -- within 10 days after the merger.
To say, you must give notice before the merger again rewrites the Delaware statute.
Judge Moore said something to the effect that the Court, while it was engrafting changes on corporate charters, was also putting the torch to Erie v. Tompkins and I think that’s a fair statement of fact.
The Court simply rewrote the Delaware law.
Now, in terms of corporate purpose, it seems to us that apart from the act of changing the statute, and not supplementing, not supplementing state law but supplanting state law.
But in doing that --
Justice John Paul Stevens: Mr. Glendon, could I interrupt for just a second.
I don’t quite understand the significance of your argument on rewriting the Delaware statute.
If, for example, the Delaware statute said, “certain information shall not be disclosed and it required that there would be a nondisclosure.”
And Rule 10b-5 would require a disclosure, wouldn’t 10b-5 prevail?
Mr. William R. Glendon: Well, that would be in the area of disclosure and that’s what the statute is about Mr. Justice Stevens.
The statute requires disclosure.
It is not, however, a statute that --
Justice John Paul Stevens: But in the event that there is a conflict between the Delaware statute and the requirements of Rule 10b-5, Rule 10b-5 would apply, would it not?
Mr. William R. Glendon: But we are saying -- we are saying to you here, sir that there cannot be that conflict under this aspect of the case.
This is not a disclosure requirement.
Justice John Paul Stevens: Well, I understand your argument --
Mr. William R. Glendon: It is a regulation; It is a regulation of Delaware corporations who were chartered by the State of Delaware and set up and governed by the laws of the State of Delaware.
And the State of Delaware says that, “you may eliminate a minority shareholder.”
And they have a statute in the courts, the Supreme Court of Delaware who said that, “the very purpose of that statute is to be able to eliminate.”
That’s what it’s about.
Now, what the Court has done here is said, “you have got to have another purpose.”
Now, this isn’t disclosure; this is not under the disclosure statute.
This is regulating a Delaware corporation contrary to what the Delaware law says.
Justice John Paul Stevens: But isn’t your basic proposition that there’s simply no violation of Rule 10b-5?
Mr. William R. Glendon: Yes.
Justice John Paul Stevens: And if that’s true, then it doesn’t matter whether a violation would require a revision of the Delaware statute or not?
Mr. William R. Glendon: Well, what we are saying simply is that to get to the result that it got, the Court had to rewrite the statute and to do that, to take a federal statute and apply it so that you have got to rewrite a state statute in the essence of a clear intent by the Congress that they are to do that, an expressed intent that if Congress had said here, “you may regulate”, and they may pass, they may pass a federal corporation law and say, “everything that’s unfair from now on in corporate matters will be governed by Federal law.”
But they haven’t done that.
They have said simply one thing.
They have said there shall be disclosure.
And what I’m trying to point out that when they say, not only disclosure, but when they say you have to have an expressed different corporate purpose, they are telling Delaware how to run its collaborations and amending, we say, the statute.
They amended in another way too, and that is on the fact of notice, and I think that I have pointed that out.
And this is interesting I think because that requirement is a useless requirement, really.
They have said that there must be prior notice but Delaware has said that you can eliminate the shareholders and they have set it up to statutory procedure in that fashion.
There is no pre-merger going into Court, the Delaware Court has said, as a matter of fact, the Supreme Court has said that it would be difficult to assume any situation where there could be such actual fraud as to set aside of a merger because the whole purpose, whole purpose of the thing is to -- of the statute is to do that.
Justice William H. Rehnquist: Well, what if Delaware had said, you may not eliminate minority stockholders in this manner and your client, they’d come along give a notice to these shareholders, hey we know it’s a violation of Delaware law and this is what the Delaware law says and this is what we are going to do.
We had -- it's contrary the Delaware law but there was no misrepresentation in connection with it?
Mr. William R. Glendon: I don’t think that would be 10b-5 case.
I don’t think it would be because this is disclosure and this is what we are talking about.
Chief Justice Warren E. Burger: You’re not foreclosing the possibility of state remedies by that?
Mr. William R. Glendon: Of course not, Mr. Chief Justice.
And there is here, of course, a state remedy in the (Inaudible).
If they don’t like the price that’s offered to them, they go to the appraisal route and, in fact, appraisal proceedings by others are going on now in the Delaware Court.
There always are, I suppose, in this type of merging.
I do wish though to advert to our concern, Mr. Justice Stevens, to the question that you raised.
We think it is a very serious matter.
We think that the principles of federalism have really been abused by this decision and I would think any Delaware lawyer or Delaware legislator would feel the same way.
They have determined in their legislative wisdom that this can happen.
It can happen under certain circumstances there may be those who don’t like it.
They may be some who feel it’s unfair.
There may be others and 38 States have felt this way who have felt that elimination of minority splinter interest, where its 90 or 95% ownership is socially desirable.
But that is not a question for the courts when you get into the policy of that.
And we fear that that is what the majority have done in this case.
Your Honor, I think at this point, I would reserve the rest of my time.
Chief Justice Warren E. Burger: Very well, Mr. Glendon.
Argument of Sidney Bender
Mr. Sidney Bender: Mr. Chief Justice and may it please the Court.
This case first arose because of the fact that the defendants made a motion to dismiss, so that all of the allegations and the fair inferences from the fact stated in the amended complaint are deemed to be true for purposes of this particular appeal.
Now, Ernst & Ernst stated that the 1933 Act was to protect investors against fraud and to promote ethical standards of honesty and fair dealing.
And certainly, the same stricture applies to 1934 Act.
Now, 1934 Act uses the term manipulative or deceptive device in contravention of the rules to be promulgated by the Securities and Exchange Commission and the SEC did promulgate 10b-5.
10b-5, clearly, on its face, covers fraud, and this Court in Ernst & Ernst when it was talking about 10 (b) and 10b-5 used the term deception, manipulation, or fraud.
Now, deception and fraud are synonymous.
When a person deceives, he may deceive by nondisclosure in a nonverbal way or he may be deceived by affirmative misrepresentations.
Clearly, clauses one and three of 10b-5, as held by this Court in Superintendent of Insurance, stated that, “misappropriation is a garden-variety type of fraud.”
The most important part about the deceit and fraud in Superintendent of Insurance was the fact the majority stockholder used the funds of the corporation to purchase the controlling interest.
But the defendants do not quarrel with the Schoenbaum case which has been decided in the Second Circuit.
And what did Schoenbaum decided, it was an en banc decision.
The majority stockholder --
Unknown Speaker: Mr. Bender, you’re going to point out where the fraud lies here?
Mr. Sidney Bender: Yes, Your Honor.
Should I get to that right now?
The fraud here is that the --
Unknown Speaker: If you are leading up to it.
Mr. Sidney Bender: Yes, I’m sorry.
Unknown Speaker: After you get this done.
Mr. Sidney Bender: Alright.
The fraud here, Your Honor, is that an appraisal was made in February of 1974 by Santa Fe of the timberlands of Kirby Lumber Company.
That showed a fair market value for those timberlands of $320 million.
The book value was $9 million.
Now, when you -- so that means that Santa Fe knew that the true worth of the assets, the physical assets of Kirby was equivalent to $772 per share and that has to be an assumed fact that’s been alleged and it’s accepted as the fact for purposes of this appeal.
Now, that means --
Unknown Speaker: No stock has ever moved at that figure, has it?
Mr. Sidney Bender: No, it has not because it was never a disclosure to the stockholders that the timberlands were worth $320 million.
Unknown Speaker: And you will explain the non-satisfactory character of the State remedy.
Mr. Sidney Bender: Yes, I will but wanted to first get into the fraud, as Your Honor, first addressed yourself to.
Now, with a physical value of $320 million and a book value of $9 million, fair market value means that Kirby could go out, obtain a willing buyer and sell those timberlands for $320 million.
For our purposes and for valuation purposes, that’s cash in the bank.
So, the physical assets must be deemed to be the equivalent of $772 cash in the bank.
Now, they retained the prestigious firm of Morgan Stanley and Company to come in and appraise the worth of the shares.
They appraised it to a $125 per share.
That was in June of 1974.
In July of 1974, they created a dummy corporation, Forest Products Inc. solely for the purpose and it stated in the information statement which went out after the merger took place, solely for the purpose of increasing their percentage of ownership from 95% to 100% of that corporation which meant eliminate the minority.
Now, then in end of July, the merger effectively took place between FPI Corporation and Kirby.
Now, there was no notice given to the stockholders and what was the effect and what were the terms of the merger.
The terms of the merger were that Santa Fe decided that they were going to pay the minority stockholders unilaterally a $150 per share.
No stockholders’ meeting, nothing on July 30, 1974.
There was no reason given on July 30, 1974 as to why they decided a $150 was fair.
They only had the Morgan Stanley appraisal which showed the fair value, according to Morgan, at $120.
But Morgan had in its possession the appraisal of Appraisal Associates which showed that the breakup value of these physical assets was $320 million just for the timberlands.
Justice Lewis F. Powell: Mr. Bender, would that be defrauding you if I offered to sell you a stock at $150 per share and at the same time, said, here is an appraisal which says the stock, if you liquidate it and were able to sell all of the assets, it would be worth $720 a share?
Mr. Sidney Bender: You would be defrauding me Mr. Justice Powell if you had in your power 95% of the stock which meant that you could force me to accept $150 a share and if I refuse, despite my refusal, you voted in such a way that I have to accept that $150 a share.
And the mere fact that you disclosed to me beforehand, the fact that direct true value was $720 a share, would still amount to a fraud because you were breaching your fiduciary obligation to me because you would be in effect forcing me to accept by reason of your 95% control.
Forcing me to accept the transaction, and in addition to that, you were deliberately undervaluing the shares at $150 a share when you knew the true worth was $772 a share or $720 --
Justice Lewis F. Powell: But you’ve omitted one very important fact in this situation and that is that nobody has forced your client to take $150 per share.
Mr. Sidney Bender: They certainly have, Your Honor
Justice Lewis F. Powell: Wait one minute.
Let me finish the question.
Mr. Sidney Bender: I am sorry.
Justice Lewis F. Powell: You have the right if you think that this wold be an unfair price to pursue your appraisal remedy, of course.
Mr. Sidney Bender: But let me first answer that in a two-prong way, Your Honor.
First of all, on the date that my clients were required to accept the $150 a share, they didn’t even know they sold their shares at a $150.
So there was no disclosure.
This is a complete myth that there was disclosure before the fraud took place.
When they purchased the shares of the minority on July 31, 1974, there was no disclosure.
They had, within their own possession, the knowledge that they had an appraisal which showed the true worth was $770 a share and it’s no different than a majority stockholder who knows that oil has been discovered.
Like in the Schoenbaum case, goes to the corporation and says, “Gentlemen, I’d like to buy your treasury shares because I’m the controlling stockholder at the prevailing market price when no disclosure has been made to the public, so that the prevailing market price does not reflect the fact that a major oil discovery has been made.”
In Schoenbaum just to set Judge Hayes in the Second Circuit said, “A clear case of fraud could not be set forth, because the majority controlling influence used his shares to force the corporation to sell him shares at a totally inadequate price.”
Justice Lewis F. Powell: May I ask you this question?
Mr. Sidney Bender: --and a fraud on the minority stockholders.
Justice Lewis F. Powell: You talk so fast; you don’t give me opportunity to ask any question.
Mr. Sidney Bender: I am sorry, Your Honor, but I do have a limited time.
Justice Lewis F. Powell: I understand that.
I will try not to interrupt you too frequently.
The District Court found there was no misstatement of any material fact or omission at the material fact.
The Court of Appeals accepted that.
You are arguing, as I understand, that both of those Courts are wrong in that respect.
Mr. Sidney Bender: No, I am not arguing that the Court of Appeals was wrong.
The Court of Appeals said and Judge Mansfield said that disclosure after the consummation of the merger is virtually equivalent to no disclosure at all.
And that’s certainly true.
It’s like the president of a corporation, dealing with securities of that corporation, were to abscond to Florida with $15 million of securities while the corporation was selling securities.
After he gets to Florida the next day, he sends a warrant to the corporation and says, “Gentlemen, I have absconded with your securities and here I am in Florida.”
But now, because of that confession --
Justice William H. Rehnquist: Just a minute, Mr. Bender.
Slow down and start answering some questions, will you?
Mr. Sidney Bender: I am sorry.
Justice William H. Rehnquist: Supposing he absconds but before he absconds he tells the corporation, I am going to abscond to Florida tomorrow morning and I am going to take $15 million worth of securities that don’t belong to me with me.
Has he defrauded anybody?
Mr. Sidney Bender: Of course he has, because the mere fact disclosure does not mean that if he has in his control the ability to still steal those securities, disclosure doesn’t cure a fraud.
If I have the possession to consummate the transaction because of the fact that I have 95% of the stock in my possession, and I tell the minority, even in a full disclosure case beforehand, which didn’t happen here.
If I tell the minority beforehand, “Gentlemen, your stock is worth $770 per share but yet I’m going to pay you, because I am, the majority stockholder, only $150 a share and if you don’t like it, you can seek an appraisal in state court.
Now, that has two vices.
The majority stockholder is breaching its fiduciary obligation, number one, because of the fact that he has the ability, because of his 95% ownership to force the transaction or the minority even if they say, “No, we’re not going to accept it.”
He still, because of the fact that he’s a 95% shareholder.
He can force them to take that $150 or seek an appraisal.
And I will get to the question of whether or not that’s an adequate remedy.
And why is it a fraud?
Because he knows that the true worth of those shares is $772 per share and yet despite that he has fixed as a fair value only $150 a share.
Justice Thurgood Marshall: Mr. Bender, do you see --
Mr. Sidney Bender: He could have fixed a dollar a share.
Justice Thurgood Marshall: Mr. Bender, what’s the difference between violation of your fiduciary relationship and fraud?
Mr. Sidney Bender: The difference between the --
Justice Thurgood Marshall: They’re different animals?
Mr. Sidney Bender: No, they’re not, Your Honor.
This is --
Justice Thurgood Marshall: They are synonymous?
Mr. Sidney Bender: They are not synonymous with this respect --
Chief Justice Warren E. Burger: Better stay, better stay close to your microphone here.
Mr. Sidney Bender: I am sorry.
They’re not synonymous in this respect.
What we have here as Justice Powell stated in Ernst & Ernst, “What is required under 10b-5 now is an intent to defraud.”
Now, what do we have here?
We have a fiduciary.
And what is it intent to defraud?
It is a knowing willful conduct to misappropriate.
What did the Court say in Superintendent of Insurance?
Misappropriation is a garden-variety type of fraud, and that’s what we have here.
It’s a misappropriation of the difference between the true worth of $772 and what they agreed to pay, namely $150.
Justice Lewis F. Powell: Mr. Bender, you’ve placed a great deal of emphasis on what you call the true worth, at other times you referred to it as a fair value, the fair market value.
Suppose somebody asks you right now, what is the fair market value of, say, IBM or AT&T or any other stock that’s traded actively?
Well, take International Paper which probably owns most timberland than any company in the world.
Where would you go to find that the fair market value of that stock?
Would you not go to the stock exchange quotations --
Mr. Sidney Bender: Well, in that kind of case --
Justice Lewis F. Powell: -- disclosed yesterday?
Mr. Sidney Bender: In that kind of case, yes that would be true now.
But if the --
Justice Lewis F. Powell: Let me finish my question.
Mr. Sidney Bender: I am sorry.
Justice Lewis F. Powell: Are you suggesting that the fair market value of stock always is equivalent to the net asset value per share.
Mr. Sidney Bender: Not always.
Well, not S. Ex. value, if it was going to be liquidated and the majority stockholder was going to capture the underlying values.
Yes, if that was higher than a capitalization of earning situation.
Justice Lewis F. Powell: If you are right on that, you get your $752 a share or whatever it is?
Mr. Sidney Bender: We would not; not under Delaware law, because Delaware law provides, number one, that they will not consider anything except historical earnings.
It doesn’t say anything about it, in fact, the cases say and this was pointed out but Judge Mansfield at, I think it was Page 138 to 140 in the Appendix in its Footnote that it does not pay for prospective earning power, potential.
And under Delaware law, you are not in an adversary proceeding.
I couldn’t go into Delaware and obtain a discovery and inspection of this company’s books to determine true value.
Only the appraiser is permitted to see the books.
Furthermore, the Delaware law has this further shortcoming.
There is no equitable relief.
The merger could not be set aside on grounds of fraud.
And, in addition, appraisal is your exclusive remedy.
Procedurally, if I were the party to initiate the appraisal in Delaware, I cannot go to my -- to others who have sought appraisal and seek a contribution for expenses to further the appraisal proceeding.
And in addition to that, this crucial evidence of potential value has been thereby captured by the majority stockholder at its whim and caprice when he has decided that it is time to buy the minority stockholder out.
Now, it’s clear under regular corporate purposes.
What is this?
This is a forced tender offer.
Justice John Paul Stevens: Mr. Bender, can I ask you a question?
Mr. Sidney Bender: Yes sir.
Justice John Paul Stevens: The appraisal dated February 19, 1974 contains this fair market value of $320 million.
That’s in effect an admission by your adversary that that’s the fair market value of the tangible asset.
Mr. Sidney Bender: That’s correct.
Justice John Paul Stevens: Would that be admissible in evidence in the appraisal proceeding?
Mr. Sidney Bender: Well, I think now, it would certainly because they have disclosed it after the fact.
Justice John Paul Stevens: Well, at the time you have filed your lawsuit, you had that appraisal in your possession.
Mr. Sidney Bender: I sure did have it in my possession.
That was the reason that we alleged that the true value of the assets was $772 per share.
Justice John Paul Stevens: And so, all of the information on which you rely for your allegation of $772 per share is available in that appraisal in a form which would be admissible in the appraisal proceeding in the Delaware Court.
Mr. Sidney Bender: In this particular case, yes but in fact, the value of those timberlands may even be greater than $320 million.
I’d been in many proceedings where experts have been retained, sir.
And with all due deference to experts when they’d been retained by a particular party to give appraisals that many, many times, we found that even though the appraisal was substantially more than what appears in the books that nonetheless, that that is even an understatement of the true worth.
Justice John Paul Stevens: But you haven’t alleged that the appraisal was an undervaluation?
Mr. Sidney Bender: Pardon me?
Justice John Paul Stevens: You have not alleged that the appraisal was too conservative.
Mr. Sidney Bender: We have alleged the value of the shares were at least $772 and this matter has proceeded to this point without any discovery or inspection by us of books and records of Santa Fe.
This was strictly a pleading matter and the pleading was dismissed on the face of it.
And all the allegations in the pleading are deemed to be correct.
But since the defendants were stuck with that $772, because of the fact that after the fraud was consummated they disclosed that fact to the stockholders, then we come to the situation we’re sure we have it to allege in our complaint --
Justice John Paul Stevens: Is it not correct, just so I have the sequence right, that after the February appraisal of tangible assets had been completed, that appraisal was given to Morgan Stanley and that was one of the factors they considered in coming up with $125 per share price?
Mr. Sidney Bender: That’s correct and that’s why we allege that Morgan Stanley rendered a fraudulent appraisal, because -- gentlemen, here is the situation where $772 is the breakup value of an asset.
Now, what is happening?
The majority stockholder is simply, at its time and at its price, decided to pay and only for the purposes of appearing generous, upping the price of $150 and is, in effect, paying the total minority of 25,000 shares approximately $3,800,000.
And what are they getting back from the minority?
They are getting back the total equity interest of the minority in this corporation which is truly worth close to $20 million.
Justice Lewis F. Powell: Mr. Bender, suppose the corporation in a short-form merger had offered minority stockholders $772, would you be here?
Mr. Sidney Bender: No, I would not, Your Honor.
Justice Lewis F. Powell: You’re not attacking the validity of short-form mergers?
Mr. Sidney Bender: Not per se, I only say in this particular case that was a means, a device utilized and abused to eliminate the minority at a fraudulently low price which the majority knew to be fraudulently low.
Justice Lewis F. Powell: Let me ask you this question.
You’re talking about liquidation.
In a number of stocks on the New York Stock Exchange sell at prices far in excess of liquidating value.
Let’s turn these figures around.
Suppose the market price of this stock by the appraisal of somebody on the New York, one of these investment banking has as such as the one you mentioned with $772 and the liquidation value were $150, would the fraud have been committed on you if the liquidating value have been offered?
Mr. Sidney Bender: Of course, it would, because we’re entitled to --
Justice Lewis F. Powell: You want it either way.
Mr. Sidney Bender: Well, Justice Powell, with all due deference to the assumption behind the question, it’s not that I want it either way.
I want it that the stockholder be treated honestly.
Honesty requires, in a situation like this that if the fair market value is $150 -- I mean $772 wouldn’t actually is entitled to that.
And if the majority stockholder knows that the shares are not being traded at all, which is this situation, and yet knows that he himself can go out and sell these timberlands for $320 million and pocket that $320 million.
If he only pays the minority shareholder in a pro-rata basis $150, well, he is gaining the difference between that $150 and $772.
What could be a clearer case of misappropriation?
He didn’t ask the minority stockholder would he sell it at $150.
He told him, I’m taking your stock at $150, you like it or not.
Justice John Paul Stevens: Mr. Bender, is it correct that your legal theory is that the fraud consist in the failure to make any disclosure before the transaction is completed?
Mr. Sidney Bender: My legal theory is --
Justice John Paul Stevens: Because you don’t complain of the adequacy of the disclosure after the transaction?
Mr. Sidney Bender: Well, we do but that’s -- I’ll explain that in a moment.
But the legal theory is this, yes it’s nondisclosure but it’s more than nondisclosure.
It’s at knowing, taking -- it’s a knowing devaluation, knowing undervaluation --
Justice John Paul Stevens: Why does that have to be so?
Why wouldn’t, under your theory, any nondisclosure, it’s a material nondisclosure if you don’t tell the minority shareholder anything until the short-form merger is completed?
Mr. Sidney Bender: Because the important thing here is that a fiduciary owes a duty --
Justice John Paul Stevens: -- of disclosure in advance, isn’t that your point?
Mr. Sidney Bender: More than that.
Of a self-deal, he is sitting on both sides of the table.
Justice John Paul Stevens: Well, let me -- I really want to understand your theory.
Mr. Sidney Bender: It must be objectively fair.
Justice John Paul Stevens: Mr. Bender, I am trying to understand your theory not to debate with you.
Mr. Sidney Bender: That’s what I want to say to you.
Justice John Paul Stevens: Is it critical to your case that there was no disclosure before the transaction was completed?
Mr. Sidney Bender: I would say this that on the facts as they’ve been presented, it’s not critical, because in my opinion, whether or not a majority stockholder discloses the facts beforehand or not is irrelevant in a case where he has the ability with a 95% ownership to force the transaction on the minority and still deliberately undervalues.
But I am stronger than that because I also have nondisclosure.
Justice John Paul Stevens: Well, would your case will -- would you be here if the disclosure had been 10 days in advance of the --
Mr. Sidney Bender: I would still be here if the disclosure had been 10 days in advance.
Justice John Paul Stevens: So, you don’t quarrel with the Delaware procedure then?
Mr. Sidney Bender: Pardon me?
Justice John Paul Stevens: You don’t quarrel with the Delaware procedure, you’re just saying --
Mr. Sidney Bender: I do quarrel with the Delaware procedure, because as far as we are concerned, the Delaware procedure is unconscionable in regular as Judge Hayes stated in the Marshel case, “a majority cannot eliminate a minority simply by voting his shares under regular corporate processes.”
So, what did they do here?
Under Delaware law, without any business purpose, they create a dummy corporation solely for the purpose of eliminating the minority.
Justice John Paul Stevens: Do you say -- then am I correct in believing, you say all of these 30-stage short-form merger statutes conflict with Rule 10b-5?
Mr. Sidney Bender: In my opinion sir, they all do conflict because they’re performed without any notice to the stockholders.
Justice John Paul Stevens: Would they not also conflict if they provided for notice in advance but did not give the minority shareholder the option to say no?
It still conflict if I understand your theory correctly?
Mr. Sidney Bender: In my opinion, any freeze out --
Justice John Paul Stevens: Any freeze out violates 10b-5?
Mr. Sidney Bender: Any freeze out without business violates 10b-5.
I add without business purpose because the purpose here is just to create a dummy corporation for eliminating the minority.
Justice John Paul Stevens: Well, on the business purpose point, what is the minority shareholder’s reason for being interested in business purpose if business purpose justifies getting them out of the company?
Mr. Sidney Bender: Well --
Justice John Paul Stevens: He has no interest in the business purpose after he’s out, so why should that be critical?
Mr. Sidney Bender: But sir -- but business purpose means that a purpose other than just to eliminate the minority.
These stockholders, it’s like the Courts said --
Justice John Paul Stevens: I understand what it means but I’d be interested in your answer to the question.
Mr. Sidney Bender: I am sorry.
Justice John Paul Stevens: Why is it relevant; why do you attach so much significance to the business purpose of the surviving company as a justification for eliminating the squeezed out shareholder?
Mr. Sidney Bender: The business purpose of the surviving company, it’s the business purpose of consummating the merger.
And there must be a business purpose to consummate the merger not just to line the pockets of the controlling stockholder.
In this particular case, the sole purpose of the merger was to increase the ownership of the majority stockholder from 95% to 100% and also to cheat them at the same time.
Justice John Paul Stevens: No, but leaving out the “also to cheat”, what’s -- the first part accepting it when you say, how does that conflict with Rule 10b-5?
Mr. Sidney Bender: Because sir, in my view, a stockholder --
Justice John Paul Stevens: And that he could be squeeze out.
Mr. Sidney Bender: Well, under regular corporate --
Justice John Paul Stevens: I think your view is, he can never be squeezed out no matter what the statute provides.
Mr. Sidney Bender: For cash.
This was a public company.
Santa Fe is a public company.
Justice John Paul Stevens: Maybe you’re right.
I just want to understand your theory.
Mr. Sidney Bender: My theory is and this is not necessary to a holding of Rule 10b-5 in this case.
I want to say that, so Your Honor understands fully that it’s not necessary to my position in this case.
You’ve asked me for my philosophical opinion.
My philosophical opinion is that it is wrong to squeeze out a minority stockholder when the parent corporation is a continuing public company.
And Santa Fe was a continuing public company and all they were doing was --
Justice John Paul Stevens: Well, not after they own a 100% of the stock, it’s not.
Mr. Sidney Bender: Santa Fe was still continuing.
The parent is still a continuing public.
All they were doing was squeezing out the minority in one finger of their joint enterprise.
Justice Lewis F. Powell: Mr. Bender, it seems to me that you are arguing the old doctrine of vested constitutional right of a stockholder never to be squeezed out for cash.
Mr. Sidney Bender: Your Honor, this is why I cautioned, made my comment to Justice Stevens.
I really don’t think and it really detracts to my argument to really get into the question of whether or not my personal philosophy and what I believed happened here also, is necessarily a violation of 10b-5.
That’s really the perimeter of my case and I want to focus on what I consider to be and what you asked before Justice Powell or Justice Stevens, I forget as to what the heartland of my case is.
And heartland, my case is this, that when a majority stockholder with his 95% ownership uses that 95% ownership solely for the purpose of increasing his own ownership from 95% to 100% and at the same time knows that the true value of the shares of the minority is $772 and deliberately undervalues those shares at $150 then he has misappropriated the difference between $150 and $772.
And it’s an intentional misappropriation under Ernst & Ernst and for that reason, we have a clear 10b-5 fraud case and they used the device of the short-form merger.
Justice John Paul Stevens: Mr. Bender, if this is the heart of your case then in every short-form merger case or every merger case, all the minority shareholder has to do is to allege that the shares have a higher value than they ought to be?
Mr. Sidney Bender: No.
Your Honor, I am glad you asked that question because this is what we stated in our brief.
It’s not like we, the plaintiffs, came in and said, this value is $772 a share.
Justice John Paul Stevens: Well, they allege it’s higher and the other side it didn’t disclose --
Mr. Sidney Bender: Right.
It’s their own knowledge that we’re alleging.
Chief Justice Warren E. Burger: Let me ask you just one question, when you get into the state appraisal proceeding, can you show the evaluation of $320 million?
Mr. Sidney Bender: Pardon me?
Chief Justice Warren E. Burger: Can you show any evidence?
Mr. Sidney Bender: Oh, certainly we can, but that still does not give us an adequate protection because you have stockholders with 10 shares, 100 shares throughout the whole United States and what it means to go to the State of Delaware is every stockholder has to retain an attorney and get an appraisal.
Now, you know Your Honors, that as a practical matter, all the stockholders are not going to do that.
And that’s the reason these corporations proceed this way and in Delaware because the net effect is that if 20% of the minority goes to Delaware, that means they’ve already gotten away with the misappropriation on 80% and to the extent that Delaware does not give a proper and full remedy, then that means as to the 20%, they’re still going to gain there.
This is an incentive not for a high standard of honesty and fair dealing but on the contrary, this is an incentive to defraud the minority.
And all that this is going to mean is, ultimately, that people will not have confidence in corporation because this is not a unique situation.
This is happening throughout the country where stockholders, and now, there are 39 states, with the lowest state Nebraska saying, “if you have 80% ownership, you can do this.”
Well, that doesn’t mean that states in the future won’t say, “If you have 50%, you can have a short-form merger.”
And what does this mean?
This means the elimination of the minority stockholders and you have a further concentration of wealth but in addition to that, people will not buy into corporations in a regular public market for fear that in a two-stage situation, namely an initial tender offer to get over the required 80% and then followed by a freeze-out merger, people are cheated.
Now, that’s all this amounts to.
This is a simple cheating of minority stockholders because the majority knows the true value is $770 a share and they paid them $150.
What’s to stop them from paying them $10 a share or $1 a share?
Justice Byron R. White: Mr. Bender, are you defending the judgment of the Court of Appeals and its opinion or not?
Mr. Sidney Bender: Oh!
Yes, I certainly am.
And the Court of Appeals stated these things.
Justice Byron R. White: Do you think the Court of Appeals went on the notion that you were cheated?
Mr. Sidney Bender: Oh, certainly!
The assumption --
Justice Byron R. White: Now, wait a minute; wait a minute.
On the basis that your shares were undervalued?
Mr. Sidney Bender: Well, certainly that was the prime holding of the Court of Appeals.
In part B of the Court of Appeals’ decision by Judge Medina, one of the premises and the assumption in Judge Mansfield’s opinion in a footnote was that, “The fair value of the shares was $772, and what was being paid was $150 a share.”
First of all, if Your Honors would look at, they’re here on Page 134 (a) and this is Judge Medina’s decision and conclusion in its holding, “We hold that the complain alleges” and then I’ll skip, “the minorities --
Justice Byron R. White: Don’t skip.
Just read the rest of the sentence.
Mr. Sidney Bender: Oh!
“The complaint alleges that claim under Rule 10b-5 when it charges in connection with Delaware short-form merger that the majority has committed a breach of its fiduciary duty to deal fairly with minority shareholders by affecting the merger without any justifiable business purpose --”
Justice Byron R. White: Now, stop right there.
Mr. Sidney Bender: Right.
That’s up to that point.
Justice Byron R. White: Now, that sounds to me exactly what you said a moment ago to Justice Stevens was your personal, philosophical --
Mr. Sidney Bender: Well, I said that’s the perimeter, the perimeter.
Justice Byron R. White: I know but that’s --
Mr. Sidney Bender: That’s not necessary to my conclusion.
Justice Byron R. White: It may not be, I’m talking about the Court of Appeals of what they held.
Mr. Sidney Bender: The Court of Appeals thought that was necessary.
Justice Byron R. White: Well they --
Mr. Sidney Bender: I’m not deviating from that.
I think that’s necessary too; I think this is an important --
Justice Byron R. White: Do you think they thought something else was necessary?
Mr. Sidney Bender: Yes, then they go on.
The minority shareholders are given no prior notice to the merger; thus, having no opportunity to apply for injunctive relief, and the proposed price to be paid is substantially lower than the appraised value reflected in the information statement.
Justice Byron R. White: Now, you think that is an essential part of their holding.
Mr. Sidney Bender: I think it certainly is.
I think that what is most significant here is that the corporation knew that the value was $772 per share and yet paid only $150.
Justice Byron R. White: And then they go on and say, we do not hold that charge of excessively low valuation by itself satisfies the requirements of Rule 10b-5.
Mr. Sidney Bender: And I think what they mean there that if we were a stockholder and if it was in a situation where you have an arms length negotiation, and no self-deal.
That’s what they’re talking about.
And in addition, even arguendo, they’re certainly not talking about our situation because here, the plaintiffs did not opine that the true worth was $772.
Our case is much narrower.
Our case is that the majority stockholder knew that the true value was $772 and yet paid a $150, and that is a fraud.
Chief Justice Warren E. Burger: Your time is up for now Mr. Bender.
Mr. Sidney Bender: Thank you Your Honors.
Chief Justice Warren E. Burger: Mr. Glendon, you have about three minutes left.
Rebuttal of William R. Glendon
Mr. William R. Glendon: Thank you Mr. Chief Justice.
The plaintiff, I think, perceives from an erroneous assumption as to the facts of life on this case he’s taking an asset valuation.
And basing on an asset valuation, which is only one element of stock valuation, is charging a fraud.
And of course then, charging undervaluation.
Of course, that just isn’t the fact.
Justice Potter Stewart: Well, we assume don’t really that there was undervaluation for the purpose of -- that’s right.
Mr. William R. Glendon: For the purpose of the motion, we of course have to concede.
We do not however concede anything like the --
Justice Byron R. White: Now, but we also assume, don’t we, or we take as true the allegation that the majority stockholder knew it was worth more.
Justice Potter Stewart: Yes.
Mr. William R. Glendon: No, there was no such allegation.
They don’t make that allegation.
And that’s the point here if you have to read, then you have to read their complaint.
They charged as a legal conclusion that there was a fraudulent appraisal.
But you have to consider it in the light of what was disclosed in every fact that the plaintiff says constitutes a fraudulent appraisal was disclosed.
Justice Byron R. White: Well, would your case be different if we took it as true that the majority stockholder did know it?
Mr. William R. Glendon: Knew that there was a fraudulent, that would --
Justice Byron R. White: No, not knew that it was fraudulent but knew that the stockholder didn’t know the any appraisal.
Mr. William R. Glendon: And did not disclose it.
Justice Byron R. White: Well, they disclosed, it disclose all the facts, they had an appraisal from Morgan Stanley and yet they said that they put in this report -- the valuation was much higher.
Mr. William R. Glendon: Mr. Justice White, we are dealing with an intangible.
We are dealing with a value and we can do no more than disclose all the facts that we know and have an independent appraisal and give him all the facts that we have and then disclose all of them to the stockholders who must make the investment decision.
Justice Byron R. White: So, your answer to my last question is that it wouldn’t make any difference in your case.
I mean, you would still be here arguing as you are arguing that it’s not a 10b-5 violation even if the majority stockholder knew, is that right?
Mr. William R. Glendon: Yes.
Justice Byron R. White: Or not?
Mr. William R. Glendon: Well, if the majority stockholder put out what he knew to be a fraudulent appraisal and didn’t disclose --
Justice Byron R. White: Well, I know but that isn’t the case.
Mr. William R. Glendon: But that’s what we’re talking about Mr. Justice White.
We’re talking about disclosure and we’re talking --
Justice Byron R. White: I know but let’s just assume this case is exactly the way it is, except for one thing --
Mr. William R. Glendon: Yes.
Justice Byron R. White: -- and that is just add and assume that the majority stockholder knew that the stock was worth more.
Mr. William R. Glendon: That he would be -- then, I think, he would be misleading by not disclosing what he knew.
Justice Byron R. White: Well, but he does --
Mr. William R. Glendon: But he doesn’t have anything here to know anymore than what’s on the record.
Justice Byron R. White: Was he supposed to disclose his opinion that it’s worth more or what?
Mr. William R. Glendon: No, I think in the terms of opinion, no.
I think that the only thing he can really disclose is facts.
Justice Byron R. White: He put --
Mr. William R. Glendon: You can’t commit a fraud, I don’t believe, by an expression of an opinion, and particularly, in this area you have to --
Justice Byron R. White: He disclosed all the facts on the basis of which evaluation judgment would be made.
Mr. William R. Glendon: Yes.
Yes, that’s right.
Justice Byron R. White: And on that basis, you say, it couldn’t be a 10b-5 violation?
Mr. William R. Glendon: That’s right.
When he makes that discovery --
Justice Byron R. White: Whatever his private opinion on what’s the evaluation --
Mr. William R. Glendon: Yes, that’s right.
That would be our position Mr. Justice White.
I think --
Chief Justice Warren E. Burger: Your time is up Mr. Glendon.
Mr. William R. Glendon: Alright.
Chief Justice Warren E. Burger: Thank you gentlemen.
The case is submitted.