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Shlensky v. Dorsey

filed: March 6, 1978; As Amended April 10, 1978, May 10, 1978.


Appeals from the United States District Court for the Western District of Pennsylvania (Civil Actions Nos. 75-377, 75-607, 75-758, 75-875, 75-1219, 76-22, 76-63 and 76-78 Consolidated).

Garth and Maris, Circuit Judges, and Meanor, District Judge.

Author: Maris


MARIS, Circuit Judge

We are here presented with three appeals from orders of the District Court for the Western District of Pennsylvania terminating a consolidated derivative suit which had been brought by shareholders of Gulf Oil Corporation (herein "Gulf"). At our No. 77-1156 the plaintiffs appeal from the district court's order entered November 18, 1976, dismissing Price Waterhouse & Company (herein "Price Waterhouse") as a party defendant in the action. At our No. 77-1157 the Project on Corporate Responsibility, Inc. (herein "the Project"), an objecting shareholder, appeals from the court's order also entered November 18, 1976, approving the compromise and settlement of the case to which all of the parties to the litigation with the exception of Price Waterhouse had agreed. Pat S. Holloway, also an objecting shareholder, appeals at our No. 77-1158 from the court's order entered November 19, 1976, awarding to the plaintiffs' accountants and attorneys payment of their fees and reimbursement of their expenses in the amount of $607,777.95. The Project joined in the district court in Holloway's attack on the award of fees and expenses and also appeals from that order at our No. 77-1157.


The eight actions comprising the consolidated derivative suit now before us were instituted between March and November of 1975 in five separate district courts,*fn1 including the District Court for the Western District of Pennsylvania to which the suits were eventually transferred and there consolidated. Named as defendants are Gulf, eighteen of its present and former officers and directors, an officer of a former Gulf subsidiary, and Price Waterhouse, Gulf's former independent certified public accountant and auditor. The shareholders seek recovery on behalf of Gulf of allegedly illegally expended corporate funds in excess of $18,800,000, incidental monetary damages and costs incurred by Gulf, equitable relief and the plaintiffs' litigation expenses.

The derivative suits arose out of public revelations in 1973 and 1975 by Gulf officials and the Securities and Exchange Commission of alleged illegal corporate action. Investigation by the Watergate Special Prosecution Force into the activities of the Finance Committee to Re-Elect the President (in 1972) precipitated Gulf's disclosure in 1973 that its vice president in charge of government relations, Claude C. Wild, Jr., had, in 1971 and 1972, donated out of corporate funds $100,000, $15,000 and $10,000 to the 1972 presidential election campaigns of President Nixon, Representative Mills and Senator Jackson, respectively. The contributions amounting to $125,000 were subsequently returned to Gulf. In November 1973 Gulf and Wild pleaded guilty to criminal charges of violations of the Federal Election Campaign Act, 18 U.S.C. § 610. Gulf was fined $5,000 and Wild, $1,000.

The Project and three other Gulf shareholders on March 27, 1974, filed a derivative action in the District Court for the District of Columbia, Project on Corporate Responsibility, Inc. et al. v. Gulf Oil Corp., et al., Civil Action No. 74-493, naming as defendants Gulf, Wild and seven other officers and directors of Gulf. The plaintiffs sought on behalf of Gulf reimbursement for the corporation's expenses incurred in connection with the unlawful corporate campaign contributions, the ensuing investigations, prosecutions and imposition of fines. The case was subsequently dismissed pursuant to the court's approval of a settlement agreement entered into on June 27, 1974, by the parties. On August 3, 1976, however, the suit was reinstated and is presently pending in the District Court for the District of Columbia.*fn2

On March 11, 1975, the Securities and Exchange Commission filed a civil complaint in the District Court for the District of Columbia against Gulf and Wild for violations of the full disclosure and accurate reporting requirements of sections 13(a) and 14(a) of the Securities and Exchange Act of 1934, 15 U.S.C.A. §§ 78m(a) and 78n(a), and of various of the Commission's rules promulgated under the Act.

The Commission alleged a course of conduct by Gulf officials from 1960 to the date of the filing of the complaint whereby a secret fund of corporate monies was maintained and disbursed for unlawful political purposes. The corporate financial statements and other reports sent to shareholders and filed with the Commission for the period in question failed to disclose the existence of the fund. Over $10,000,000 of Gulf funds were allegedly channeled, by means of false entries in corporate books and records, through Bahamas Exploration Company, Ltd.,*fn3 a subsidiary of Gulf located in Nassau. The Bahamas, for eventual distribution to political individuals and entities in the United States and foreign countries. Some $5,400,000 was allegedly returned to the United States for such use and the balance distributed overseas.

Preliminary to the filing of its complaint, the Commission's staff had conducted extensive examination of corporate documents and had taken the testimony and affidavits of a number of Gulf's officers and directors. The Commission's prior contacts and negotiations with Gulf led to the entry with Gulf's consent, on the date of the filing of the complaint, of a final judgment granting a permanent injunction against Gulf accompanied by an undertaking by Gulf to establish a Review Committee consisting of a chairman not connected with Gulf and two independent Gulf board members. The committee was authorized to review investigations and to make its own inquiry into the use of Gulf's funds for political purposes. At the end of 120 days the committee was to submit a written report of its findings and recommendations to Gulf's board of directors for appropriate action by the members not involved in the activities set forth in the Commission's complaint. Copies of the report were to be filed with the Commission and in the district court. The committee's report, commonly known as the McCloy Report*fn4 was released on December 30, 1975, and was made available to the shareholders of Gulf.

On March 26, 1975, Shlensky v. Wild et al., the first filed of the derivative actions consolidated in the case before us, was filed in the District Court for the Western District of Pennsylvania. The district court ordered a stay until October 1, 1975, of the proceedings in view of the pendency of the Review Committee investigation directed by the consent judgment entered in the suit instituted by the Securities and Exchange Commission in the District Court for the District of Columbia. The stay was subsequently extended to January 15, 1976, and was applied to the three related cases filed in the District Court for the Western District of Pennsylvania.

By January 16, 1976, the related actions filed in the various other district courts had been transferred to the District Court for the Western District of Pennsylvania which, on that date, ordered the consolidation of the actions and the filing of a consolidated amended complaint, designated lead counsel for purposes of initiating discovery and conducting settlement negotiations, and issued a preliminary pretrial schedule.

The consolidated amended complaint, filed February 17, 1976, asserted that the individual defendants, acting singly and in concert made, or caused to be made, unlawful contributions to federal election campaigns in violation of the Federal Election Campaign Act, 18 U.S.C. § 610. It set forth details of the disclosures contained in the Securities and Exchange Commission's complaint against Gulf and Wild in connection with Gulf's failure to disclose in annual reports and other corporate statements the maintenance within the corporation of a fund out of which unlawful disbursements were made for political purposes. In addition, it was asserted that B. R. Dorsey, chairman of Gulf's board of directors and its chief executive officer until January 1976, and other top level executives and directors, named as defendants in the action, were cognizant of the arrangements whereby corporate funds were expended for over a decade for illegal purposes. The complaint stated that Price Waterhouse knew or should have known of the bookkeeping irregularities which concealed the creation and use of the secret funds and that it aided in a cover-up of the unlawful diversion of Gulf's funds.

The plaintiffs asserted that illegal contributions of Gulf's funds amounting to $4,460,000 were made to the ruling parties in Korea and Bolivia between 1966 and 1970 and to an Arabic public relations group to help promote the Arab cause within the United States and that the failure of subsequently elected directors to communicate their knowledge of these contributions to shareholders invalidated the elections and required that they be set aside.

The plaintiffs further stated in the complaint that, in November 1974, Gulf's board of directors rescinded certain compensatory stock options with an option price of $21.75 per share previously issued to various officers and directors. The board replaced the surrendered options with stock options at the reduced price of $17.8125. It was alleged that this action violated the terms of a 1974 stock option plan approved by the shareholders and damaged the corporation in that the resulting enrichment of those officers and directors by approximately $4,000,000 served to reward or silence them with respect to the illegal diversion of corporate funds. It was further alleged that the exercise of stock appreciation rights under the 1974 stock option plan violated section 16(b) of the Securities and Exchange Act of 1934, 15 U.S.C.A. § 78p(b).

The plaintiffs asserted that the foregoing acts of the defendants which were not disclosed to shareholders or the Securities and Exchange Commission constitute violations of sections 10(b), 13(a) and 14(a) of the Securities and Exchange Act of 1934.

The plaintiffs also asserted pendent state law claims against the officers and directors of Gulf, who, it was alleged, knew or should have known of their own and others' malfeasance with respect to the diversion of corporate funds, for waste, misuse of corporate assets, breach of fiduciary duties, fraud and the negligent failure to seek recovery from Gulf's insurance carriers. And it was asserted that Price Waterhouse and Royce H. Savage, a former general counsel of Gulf, breached their professional and fiduciary duties owed to Gulf and its shareholders.

Finally, in a "Twelfth Cause of Action" it was alleged that the compromise and settlement and subsequent dismissal of Civil Action No. 74-493 brought by the Project in the District Court for the District of Columbia were fraudulently obtained and void and, therefore, must be set aside.

In answer to the allegations and claims contained in the consolidated amended complaint, the defendants denied liability for acts which they contended were performed in good faith in the carrying out of their corporate responsibilities and in the exercise of sound business judgment. They contended that they neither knew of nor should have known of the matters complained of before they were disclosed to the general public and that following the issuance of the McCloy Report, stricter internal procedures for auditing and reporting political contributions had been inaugurated and implemented within the corporation.

Among other defenses, the defendants asserted the bar of the applicable statutes of limitations, the absence of damage to the corporation caused by the transactions complained of and entitlement to indemnification from Gulf for any adverse judgment entered against them. They asserted shareholder approval and ratification of the 1974 stock option plan and the failure of the plaintiffs to make demand upon the directors or shareholders to enforce a cause of action based upon the directors' reduction, without shareholder approval, of compensatory stock option prices or to make the demand as to other causes of action required under Rule 23.1 of the Federal Rules of Civil Procedure.

The defendants further contended that there was no private cause of action for damages under section 13(a) of the Securities and Exchange Act of 1934 or under section 610 of the Federal Election Campaign Act. They contended that the plaintiffs lack standing to assert claims under section 10(b) or 14(a) of the Securities and Exchange Act absent allegations of fraud in connection with a purchase or sale of securities and shareholder approval of a corporate transaction on the basis of misleading proxy material.

On March 17, 1976, Price Waterhouse filed a motion in the district court to dismiss the complaint as to it for noncompliance with Rule 23.1, F.R.C.P. Oral argument on the motion was held September 15, 1976.

Opting to settle the case rather than proceed to trial, the parties, with the exception of Price Waterhouse, entered into a "Stipulation of Compromise and Settlement" and on September 29, 1976, petitioned the district court for its approval.

The stipulation provided for the termination of the settling defendants' liability to each other and to the plaintiffs as to all claims asserted or which might have been asserted in the complaint, the crossclaim*fn5 and a related complaint filed in the Court of Common Pleas of Allegheny County, Pennsylvania*fn6 based upon the matters alleged therein or directly or indirectly arising out of matters contained in the McCloy Report.

Gulf agreed to reimburse and indemnify the settling defendants, with certain qualifications in regard to Viglia*fn7 and Wild, as to their reasonable expenses, including counsel fees, incurred in connection with the consolidated action or any other action, judgment or penalty arising out of the matters contained in the McCloy Report. Gulf also agreed to the adoption of and further implementation of already initiated internal auditing and reporting procedures designed to avoid a recurrence of unlawful political contributions.

The North River Insurance Company, the insurance carrier under Gulf's directors' and officers' liability and corporate reimbursement policy, agreed to pay $2,000,000 to Gulf conditioned on the execution of releases by Gulf and the defendants named as insured in the policy.

Certain of the individual defendants agreed not to contest the rescission by Gulf's board of directors on July 13, 1976, of stock option rights and attendant stock appreciation rights previously granted them under the 1974 stock option plan and the board's denial of incentive compensation awards for 1975 amounting to $370,000. Gulf agreed to refuse delivery to other defendants of Gulf stock valued at $250,000 previously awarded them. Other Gulf employees, not defendants, consented to the denial of incentive compensation due them aggregating $23,882.28. A retired employee, Joseph E. Bounds, was denied all future payments to him under a 1964 agreement with Gulf. Gulf admitted reimbursement by recipients of illegal or unauthorized contributions from Gulf funds amounting to $57,261.55.

Lastly, based upon the complexity of the litigation, the competence of the attorneys and accountants involved and the benefits to Gulf and its shareholders from the compromise and settlement of the case, Gulf agreed not to oppose an application, with supporting data, to the district court by the plaintiffs' attorneys and accountants for payment by Gulf of their reasonable fees and reimbursement of their expenses in an amount not to exceed $600,000 for fees and $25,000 for expenses.

A summary of the settlement terms was sent to the more than 300,000 Gulf shareholders of record with directions to file in advance of a settlement hearing to be held November 18, 1976, their written objections, if any, to the settlement and notice of their intention to appear if they desired to do so. The district court, in addition, ordered the submission of proposed findings of fact, conclusions of law, drafts of opinions, judgments and ...

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