Appeal from a judgment of the District Court for the Southern District of New York, Henry F. Werker, Judge, dismissing the complaint of plaintiff Rosalie M. Arlinghaus which alleged that defendants Ritenour and Lipsky defrauded her by entering into an agreement to purchase stock of Modern Teleservice, Inc. owned by her individually and as executrix of her husband's estate at less than what they knew to be its fair value. See Arlinghaus v. Ritenour, 543 F.2d 461 (2 Cir. 1976). Affirmed.
Before Friendly, Mansfield and Kearse, Circuit Judges.
This action, stemming from the sale of stock to the officers of a closely-held corporation, is before us for the second time, see 543 F.2d 461 (1976). It was brought in 1968 in the District Court for the Southern District of New York by plaintiff, Rosalie M. Arlinghaus, individually and as executrix of the estate of her husband, Frank M. Arlinghaus. The gravamen of the complaint was that defendants Ritenour and Lipsky, who were principal officers and also directors of Modern Teleservice, Inc. (Teleservice), and Sidney Pepper, who served as attorney for Mrs. Arlinghaus, for the estate of Frank Arlinghaus and for Teleservice, caused Mrs. Arlinghaus to sell stock in that company at what they knew to be an unconscionably low price, in breach of their fiduciary obligations and in violation of § 10(b) of the Securities Exchange Act and SEC rule 10b-5. Jurisdiction was predicated on diverse citizenship and also on § 10(b) and § 27 of the Securities Exchange Act.
After extended gestation, the action came to trial before Judge Werker in May, 1975. In an unreported opinion the district court dismissed all claims against Ritenour and Lipsky, but held Pepper liable for breach of fiduciary duty and ordered an accounting of profits accruing from the resale of shares sold to Pepper's wife, Miriam. While the accounting was in progress, the district court entered final judgment under F.R.Civ.P. 54(b) on the claims against Ritenour and Lipsky. Mrs. Arlinghaus took a timely appeal, which, however, this court dismissed for lack of jurisdiction after finding that a final judgment extending only to Ritenour and Lipsky might prejudice a later appeal which we thought Pepper would be likely to take after his accounting. See 543 F.2d at 463-64. The accounting was not concluded until November 9, 1978. On March 7, 1979, Judge Werker entered final judgment against Pepper's estate for $509,066 in compensatory and punitive damages, and again dismissed all claims against Ritenour and Lipsky as well as a separate claim against Miriam Pepper. The Pepper judgment was appealed by both sides, but a settlement for $175,000 was entered on September 17, 1979. This leaves before us Mrs. Arlinghaus' appeal of the dismissal of her claims against Ritenour and Lipsky.
This court's previous decision granted the parties leave to use the same submissions if the appeal was renewed, 543 F.2d at 464 n.4. Although availing themselves of this opportunity, they also submitted supplemental briefs and later, at this court's request, filed a third series of briefs on an issue raised by us at oral argument, namely, the extent of appellees' knowledge of the market value of Teleservice's shares at the time of the purchase from Mrs. Arlinghaus.
Teleservice, whose business was processing and distributing television commercials in New York and California, began as a division of Modern Talking Picture Service, Inc. (Talking Picture), a corporation founded by Frank Arlinghaus in 1937. Ritenour and Lipsky joined Talking Picture in the late 1940's, and, when Teleservice was spun off as an independent New York corporation in 1952, were appointed its president and vice president respectively. Their services were considered essential to Teleservice's success. Pepper, who had handled most of Talking Picture's legal work, likewise became counsel to Teleservice as well as continuing to serve as attorney for Frank Arlinghaus and, after his death, for Mrs. Arlinghaus and the estate.
When Frank Arlinghaus died in August, 1964, appellant became the owner, in practical effect, of the majority of Teleservice's 58,800 outstanding shares. As of April 25, 1967, she held 4,000 shares (6.8%) individually, 20,360 shares (34.6%) as executrix of Frank Arlinghaus' estate, and 8,400 shares (14.3%) distributed among three custodian accounts for her children. The seven remaining shareholders together owned 26,040 shares (44.3%), of which 1,540 belonged to Ritenour and 700 to Lipsky.
From Teleservice's inception, its shares were restricted by a buy-back agreement which provided inter alia that the estate of a deceased shareholder could require the corporation to purchase its shares at a formula price for a period of three years after the shareholder's death.*fn1 Because Frank Arlinghaus' estate faced a large tax assessment, Mrs. Arlinghaus, Pepper and Clemens Arlinghaus, appellant's brother-in-law and a member of Teleservice's board of directors, met in late December, 1966 to discuss whether the funds needed to pay the tax assessment should be raised by exercising the estate's "put" option under the buy-back agreement. However, this course was rejected, in part because the formula price of $16.00 per share fell below the $20.00 price that the participants considered attainable, the agreement provided for full payment over a lengthy four-year term, and, according to Pepper's deposition, Teleservice might not have been able to afford to purchase the estate's shares in any event.
The estate's decision not to offer its shares for purchase by either the corporation or the remaining shareholders frustrated Ritenour and Lipsky's longstanding ambition to increase their Teleservice holdings.*fn2 By apparent coincidence, however, the Teleservice board of directors authorized a search for potential merger or acquisition partners sometime during 1966, in the expectation that Teleservice alone might not be able to meet its growing capital needs. Ritenour and Lipsky not only carried out this mandate but simultaneously investigated arrangements that might also increase their holdings in Teleservice. On October 14, 1966, Ritenour spoke to Seymour Mintz, a business broker, about the prospect of obtaining financing for the purchase of Teleservice on Ritenour's behalf. Although the Mintz contact eventually led to more promising ones with other brokers, it produced only one company, Filmways, with a serious interest in Teleservice. According to Ritenour, Filmways was willing to "consider placing a price" on Teleservice of between five and eight times average earnings over the previous five years, that is, between $875,000 and $1,400,000 or $14.88 to $23.81 per share.*fn3 In addition to the Filmways negotiations, Teleservice was approached on a "yearly" basis by Chet Ross, the president of Bonded Film Services, a Teleservice competitor, to discuss a possible merger or acquisition deal. The record lacks any indication of the value placed on Teleservice by Ross until August 18, 1967, when Ross' company itself had been acquired by another firm; at that point, Ritenour related that Ross had also mentioned a price range between five and eight times average earnings. When Ritenour was asked whether he had responded to Ross' probes with a figure that Teleservice might find satisfactory, he stated "(if) I did, it would have been around the 3,000,000 mark" (or $51 per share) a proposal that, if made, would have been at some unidentified date between March 14 and August 18, 1967.*fn4
In April, 1967, Ritenour's investigations began to bear some fruit. Through circuitous contacts beginning with Mintz, Teleservice was called to the attention of another broker, Harris Shapiro, who in turn organized a small syndicate of investors headed by one Lewis Stat (the syndicate). After brief negotiations, the syndicate agreed to finance a tender offer in the names of Ritenour and Lipsky for all outstanding shares of Teleservice. The agreement, embodied in a letter from Stat dated April 23, 1967, provided that if Ritenour and Lipsky could persuade Teleservice's shareholders to sell, the syndicate would merge Teleservice into a new corporation; that Ritenour and Lipsky would each receive a 12.5% interest in this corporation; and that, in addition, they would be "gifted" with 25% of the difference between the purchase price paid to Teleservice shareholders and $1,200,000 (in other words, the lower the price paid to the shareholders, the larger the cash bonus to Ritenour and Lipsky). A separate understanding with the syndicate provided inter alia that if the deal succeeded, Ritenour and Lipsky would receive five-year employment contracts with the new corporation at their established salaries.
On, or slightly before, April 25, 1967, Ritenour and Lipsky in consultation with Pepper drafted the terms of an offer for the syndicate to purchase Teleservice's shares at $15 per share. By his own admission, Pepper had hoped that a successful deal would yield him a commission from the "selling group", presumably the Teleservice shareholders. Shortly before the April 25 offer, he suggested that he might pressure his client, Mrs. Arlinghaus, into acceptance by threatening that Ritenour and Lipsky would resign otherwise. The district court credited Ritenour's and Lipsky's testimony that they had flatly declined this invitation. Nevertheless, Mrs. Arlinghaus claimed, and Judge Werker found, that Pepper made such threats on numerous occasions, and, indeed, that rumors of their impending resignation circulated back to Ritenour and Lipsky. Although the record indicates that both Mrs. Arlinghaus and her brother-in-law, Clemens, learned that the syndicate or something like it existed, there is no suggestion that they knew the terms of its agreement with Ritenour and Lipsky or of the substantial interest of Ritenour and Lipsky in consummating the deal.
With one exception, Teleservice's minority shareholders accepted the $15 offer. On May 10, 1967, Mrs. Arlinghaus met with Pepper, Clemens Arlinghaus, Ritenour and Lipsky to discuss the offer in a meeting, about which there was conflicting testimony at trial. Ritenour claimed that he had expressly denied rumors that he and Lipsky would resign if the syndicate deal failed; Mrs. Arlinghaus could recall no such denial; and Clemens asserted that, far from assuring loyalty, Ritenour and Lipsky had actually threatened resignation. The district court credited Ritenour's testimony, but thought that appellant might have mistaken the evident enthusiasm of Ritenour and Lipsky for consummating the deal as an implicit threat to resign if it fell through. In any event, the meeting ended inconclusively and was immediately followed by a second discussion among Mrs. Arlinghaus, Clemens, and Pepper, during which it was decided to make a counteroffer to sell to Ritenour and Lipsky at $20 per share. Appellant testified that but for the threats of resignation she would never have agreed to the $20 price. However, the district court discounted this claim in light of both Mrs. Arlinghaus' need to raise funds for the estate tax assessment and earlier discussion of the $20 figure as a desirable price to receive for the estate's shares from the corporation.
The counteroffer was made and accepted, the remaining shareholders assented, and a closing was set for June 9, 1967. Given the terms of the syndicate's separate agreement to give Ritenour and Lipsky a 25% share of the corporation, the $20 offer to Teleservice's shareholders represented an actual cost to the syndicate of $26.80 per share. As the closing approached, the syndicate scrambled to raise the necessary.$1,182,000 ($1,176,000 for Teleservice's outstanding shares and $6,000 in bonuses for Ritenour and Lipsky). A June 6 telegram from Stat to Ritenour gave assurances that the funds were available, in part because Lehigh Valley Industries, a possible source of financing, would contribute its own stock on the basis of a future earnings formula that estimated Teleservice's total value ...