filed: September 13, 1988.
HENRY HERSKOWITZ, ON BEHALF OF HIMSELF AND ALL OTHER SIMILARLY SITUATED
NUTRI/SYSTEM, INC., HAROLD KATZ, A. DONALD MCCULLOCH, JR., ALBERT J. DI MARCO, REEF C. IVEY, II, DUANE E. JARVIS, NORMAN AMSTER, MARTIN S. BEGUN, MERRILL LYNCH CAPITAL MARKETS, INC., CONNECTICUT NATIONAL BANK, JOHN E. SYLVESTER, THOMAS W.L. CAMERON, HENRY HERSKOWITZ, APPELLANT NO. 87-1786 CONNECTICUT NATIONAL BANK, CROSS-APPELLANT NO. 87-1798; ALAN ROSMAN, ON BEHALF OF HIMSELF AND ALL OTHERS SIMILARLY SITUATED V. NUTRI/SYSTEM, INC., HAROLD KATZ, A. DONALD MCCULLOCH, JR., ALBERT J. DI MARCO, REEF C. IVEY, II, DUANE E. JARVIS, NORMAN AMSTER, MARTIN S. BEGUN, MERRILL LYNCH CAPITAL MARKETS, INC., CONNECTICUT NATIONAL BANK, JOHN E. SYLVESTER, THOMAS W.L. CAMERON, ALAN ROSMAN, APPELLANT NO. 87-1787 CONNECTICUT NATIONAL BANK, CROSS-APPELLANT NO. 87-1799; JOSEPH FABIAN, ON BEHALF OF HIMSELF AND ALL OTHERS SIMILARLY SITUATED V. NUTRI/SYSTEM, INC., HAROLD KATZ, A. DONALD MCCULLOCH, JR., ALBERT J. DI MARCO, REEF C. IVEY, II, DUANE E. JARVIS, NORMAN AMSTER, MARTIN S. BEGUN, MERRILL LYNCH CAPITAL MARKETS, INC., CONNECTICUT NATIONAL BANK, JOHN E. SYLVESTER, THOMAS W.L. CAMERON, JOSEPH FABIAN, APPELLANT NO. 87-1788 CONNECTICUT NATIONAL BANK, CROSS-APPELLANT NO. 87-1800; NISSIM HUSNI, ON BEHALF OF HIMSELF AND ALL OTHERS SIMILARLY SITUATED V. NUTRI/SYSTEM, INC., HAROLD KATZ, A. DONALD MCCULLOCH, JR., ALBERT J. DI MARCO, REEF C. IVEY, II, DUANE E. JARVIS, NORMAN AMSTER, MARTIN S. BEGUN, MERRILL LYNCH CAPITAL MARKETS, INC., CONNECTICUT NATIONAL BANK, JOHN E. SYLVESTER, THOMAS W.L. CAMERON. NISSIM HUSNI, APPELLANT NO. 87-1789 CONNECTICUT NATIONAL BANK, CROSS-APPELLANT NO. 87-1801; DONALD SUNSHINE, ON BEHALF OF HIMSELF AND ALL OTHERS SIMILARLY SITUATED V. NUTRI/SYSTEM, INC., HAROLD KATZ, A. DONALD MCCULLOCH, JR., ALBERT J. DI MARCO, REEF C. IVEY, II, DUANE E. JARVIS, NORMAN AMSTER, MARTIN S. BEGUN, MERRILL LYNCH CAPITAL MARKETS, INC., CONNECTICUT NATIONAL BANK, JOHN E. SYLVESTER, THOMAS W.L. CAMERON, DONALD SUNSHINE, APPELLANT, NO. 87-1790 CONNECTICUT NATIONAL BANK, CROSS-APPELLANT NO. 87-1802; JACK POTOK, FRED POTOK, JOINT TENANTS, ON BEHALF OF THEMSELVES AND ALL OTHERS SIMILARLY SITUATED V. NUTRI/SYSTEM, INC., HAROLD KATZ, A. DONALD MCCULLOCH, JR., ALBERT J. DI MARCO, REEF C. IVEY, II, DUANE E. JARVIS, NORMAN AMSTER, MARTIN S. BEGUN, MERRILL LYNCH CAPITAL MARKETS, INC., CONNECTICUT NATIONAL BANK, JOHN E. SYLVESTER, THOMAS W.L. CAMERON, JACK POTOK AND FRED POTOK, APPELLANTS NO. 87-1791 CONNECTICUT NATIONAL BANK, CROSS-APPELLANT NO. 87-1803
On Appeal from the United States District Court For the Eastern District of Pennsylvania, D.C. Civil Nos. 86-0711, 86-0712, 86-0725, 86-0800, 86-0828, 86-0877.
Gibbons, Chief Judge, and Higginbotham and Hunter, Circuit Judges.
Shareholders of Nutri/System, Inc., who are plaintiffs in six consolidated class actions challenging the terms of a leveraged buyout, appeal from a judgment in favor of the defendants. The defendants include the Corporation, its senior management which purchased Nutri/System's business, its board of directors, and Connecticut National Bank, which issued an opinion letter on the fairness of the transaction. The shareholders challenged the leveraged buyout on the ground that its approval by shareholders was procured by use of a materially false and misleading proxy statement in violation of sections 10(1) and 14(a) of the Securities Exchange Act of 1939. 15 U.S.C. §§ 78j(b) and 78n(a). They also alleged that the buyout was at an unfair price in violation of Pennsylvania law which reached fiduciary duties owed by its officer and directors to Nutri/System's public shareholders. Connecticut National Bank has filed a protective cross appeal contesting the standard of care on which the plaintiffs' claim against it was submitted to the jury. We conclude that two trial errors require a new trial. Since we will remand for a new trial it is appropriate to address and reject other claimed errors.
Nutri/System, founded in 1972 by Harold Katz, operates and franchises weight-loss centers. From a single weight-loss center in Philadelphia, Nutri/System had grown by 1983 to a nationwide chain of 70 centers producing annual revenues of $133 million. In that year a secondary public stock offering was made by Katz, who retained a majority interest. Soon thereafter the company experienced a decline in its fortunes, including litigation with some of its franchisees. A settlement of this litigation reduced Nutri/System profits on sales of food products to franchisees, and competition in the industry put pressure on revenues. Katz decided to sell his share of the company in 1984. A proposed sale of the whole company to an acquisition 7 group at approximately $9.00 a share ($90 million) fell through early in 1985, when the acquisition group was unable to obtain adequate financing. By the spring of 1985 the management was demoralized, and Nutri/System stock was trading at less than $4.00 a share.
In March 1985 Katz hired A. Donald McCulloch, Jr. as president of Nutri/System. Mcculloch had a strong record in revitalizing other foundering companies, and he hired Albert J. Di Marco in marketing, Reef C. Ivey for administration and as General Counsel, and Norman A. Sylvester for operations. These three, with McCulloch, eventually made the leveraged buyout. During the negotiations with McCulloch over his employment, Katz promised that if he decided to sell Nutri/System McCulloch would have the right to make an offer.
In November 1985, Katz offered to sell Nutri/System to McCulloch's group for $70 million, which would yield approximately $7.00 a share for all shareholders. The stock was then selling at about $4.00 a share, no offers from outside the company were pending, and its business was still on a downtrend. Merrill Lynch Capital Markets was retained to provide financial advice and assistance in raising the cash which Katz desired. After performing a due diligence investigation, Merrill Lynch proposed in January, 1986, that the transaction be financed by $40 million in senior notes financed by Merrill Lynch, $20 million in cash in the Nutri/System treasury, $10 million in subordinated debentures issued to the shareholders, and $5 million in equity funds invested by the McCulloch group. The purchasers and their wives were able to borrow $2 million on the security of their homes and other assets, but could not find venture capital for the $3 million shortfall. Merrill Lynch then restructured the transaction by increasing the senior note underwriting to $45 million, with detachable warrants entitling the senior noteholders to acquire 35% of the new company within five years. Under the restructured transaction existing Nutri/System shareholders would receive $7.16 a share.
In January 1986, the Company appointed Thomas Cameron and Dr. Martin Begun, the only two members of the board of directors not personally involved in the buyout, to investigate its fairness. Cameron and Begun retained Connecticut National Bank to prepare a fairness opinion on a negotiated fee for service basis. The agreement, according to the proxy statement, provided that Connecticut National Bank would receive $50 thousand for its opinion and an additional $25 thousand if it were published. To evaluate the fairness of the $7.16 a share price Connecticut National Bank made a discounted cash flow analysis in appraising Nutri/System's value. That analysis was based on cash flow projections made by the McCulloch group. Certain downward adjustments were made to the McCulloch group's projections to eliminate risks. Connecticut National Bank also assumed, for purposes of the discounted cash flow analysis, that Nutri/System's income would continue to be taxed for the next five years at the then-existing 46% corporate tax rate. In February of 1986, Connecticut National Bank issued a fairness opinion stating that the $7.16 a shareprice was fair to shareholders because the company was worth between $6.50 and $8.50 a share.
A proxy statement was filed with the Securities Exchange Commission in April of 1986. After several revisions, it was mailed to Nutri/System's shareholders on July 11, 1986, for a vote at a shareholders meeting on August 6, 1986.
The shareholders' suit was filed on August 1, 1986, seeking preliminary and permanent injunctive relief against the leveraged buyout. A motion for a preliminary injunction against holding the shareholders meeting was denied. The shareholders voted overwhelmingly in favor of the proposed sale, and the leveraged buyout was closed on August 13, 1986.
Thereafter an amended complaint was filed and the case proceeded to trial before a jury. The district court during the trial precluded the shareholders from introducing any evidence relating to Nutri/System's performance following the buyout. Before submitting the case to the jury, the district court partially granted defendants' Fed. R. Civ. P. 50(a) motion by removing certain issues raised by the shareholders from consideration by the jury. The case was submitted to the jury on special verdict interrogatories the answers to which favored the defendants. Judgment was entered in favor of the defendants, and these appeals followed.
While the shareholders claim numerous trial errors, we find only two which require a new trial.
The D irected V erdict on U se of a 48% T ax R ate A ssumption
The parties agree that the district court in effect granted defendants a directed verdict on the shareholders' contention that in selecting to project a 46% tax rate for 5 years Connecticut National Bank made an unreasonable choice. A more realistic choice, according to the shareholders, would have produced a significantly higher projected cash flow and thus a significantly higher valuation than $7.16 a share. Under Fed. R. Civ. P. 50(a) a "directed verdict may be granted only if, as a matter of law, viewing all the evidence which has been tendered and should have been admitted in the light most favorable to the party opposing the motion, no jury could decide in that party's favor." Indian Coffee Corp. v. Procter & Gamble Co., 752 F.2d 891, 894 (3d Cir.), cert. denied, 474 U.S. 863, 88 L. Ed. 2d 150, 106 S. Ct. 180 (1985). There must be "sufficient evidence to submit to the jury for the purpose of resolving conflicts in the evidence or inferences permissibly drawn from the evidence, or both" Edward J. Sweeney & Sons, Inc. v. Texaco, Inc., 637 F.2d 105, 116 (3d Cir. 1980), cert. denied, 451 U.S. 911, 68 L. Ed. 2d 300, 101 S. Ct. 1981 (1981). This court exercises plenary review of the grant of a directed verdict. Indian Coffee Corp., 752 F.2d at 894; Finkle v. Gulf & Western Mfg. Co., 744 F.2d 1015, 1021 (3d Cir. 1984).
An opinion or projection, like any other representation, will be deemed untrue for purposes of the federal securities laws if it is issued without reasonable genuine belief or if it has no basis. Eisenberg v. Gagnon, 766 F.2d 770, 776 (3d Cir.), cert. denied, 474 U.S. 946, 106 S. Ct. 342, 88 L. Ed. 2d 290 (1985). Accord, Gottreich v. San Francisco Investment Corp., 552 F.2d 866, 867 (9th Cir. 1977) (treating as actionable an opinion without adequate or reasonable basis); S.E.C. v. Okin, 137 F.2d 862, 864 (2d Cir. 1943) (treating as actionable an opinion for which there was "no ground"). Cf. First Virginia Bankshares v. Benson, 559 F.2d 1307, 1314 (5th Cir. 1977), cert. denied, 435 U.S. 952, 55 L. Ed. 2d 802, 98 S. Ct. 1580 (1978); Marx v. Computer Sciences Corp., 507 F.2d 485, 489-90 (9th Cir. 1974) (treating opinions as actionable where there was a gross disparity between them and the facts). The district court based its decision to remove the assumed tax rate issue from the jury on the fact that the proxy statement includes the following statement:
Pending or Proposed Tax Legislation. The United States Congress is currently considering various tax reform proposals. Among the various proposals are provisions which, if enacted, would reduce ordinary income tax rates for both individuals and corporations, increase tax rates on capital gains, and strengthen the minimum tax and alternative minimum tax. If any such legislation is enacted, whether such changes would affect particular items of income or loss discussed below could depend on the effective dates chosen by Congress.
Thus the district court based its ruling not on the reasonableness of Connecticut National Bank's projections in its fairness opinion, but on the disclosure in the proxy statement that the tax law might change. Concentrating on the notice of possible tax reform, the district court failed to address the separate issue of possible fraudulence in the fairness opinion itself. The fairness opinion had independent significance to shareholders, for it was obtained by the disinterested directors for the purpose of determining whether the offer from management was fair. It was, moreover, an opinion of an expert on valuation. Indeed, Connecticut National Bank impliedly recognizes that the district court's basis for removing the question from the jury is irrelevant, when it argues that "to overturn the trial court's directed verdict, plaintiffs must demonstrate that there was more than a scintilla of evidence that CNB either did not genuinely believe in the propriety of its use of a 46% tax rate in calculating the fairness of the $7.16 price per share offered by Nutri/System's management or that CNB had no sound factual or historical basis for the use of the 46% rate." Cross-Appellant's brief p. 36. Thus, we must examine the evidence presented by the stockholders on the reasonableness in July of 1986 of a projected cash flow valuation using the 46% tax rate assumption.
The shareholders' expert witness, John B. Torkelson, testified that it was inappropriate, in presenting a fairness opinion in July of 1986, to project a 46% effective tax rate over five years because "it was generally recognized by knowledgeable people in the field of financial analysis by July 1986 that the tax reform legislation pending before Congress was virtually certain to become law; that corporate income tax rates would be reduced to between 33 and 36 percent; and, that if CNB had used a tax rate in the 33 to 36 range in its discounted cash flow analysis, . . . . the range of values for the company would be from $7.58 to $10.35 per share," rather than a range which included $7.16. J.A. at 699, 2073. Torkelson pointed out that by the summer of 1986, "articles throughout the financial press were all saying the same thing, which is that the House bill is one rate, the Senate bill is another rate, they are extremely close, they are going to compromise and the bill will take effect on July of 1987." J.A. 739-740. Employees of the Connecticut National Bank who worked on the fairness opinion testified that they were aware of the impending tax reforms. J.A. at 891, 997, 1027. Nutri/System management in preparing its budget took into account the fact that tax rates would change effective July 1, 1987. Exhibit No. 29, J.A. 1912.
There was conflicting evidence as well. An employee of Connecticut National Bank, Cathy Ann Tagan, noted the confusion and uncertainty surrounding the expected effects of tax reform, J.A. 996-97, and the fact that Nutri SM Systems had paid in excess of a 46% rate over the prior five years when state and local taxes and amortization were included, J.A. 222. There was, moreover, evidence that Nutri SM System paid total taxes amounting to 45% in the first year under the new tax law. J.A. at 743. The defendants urge that despite the ...
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