Cir. 1978) ("Absent bad faith or some other corrupt motive, directors are normally not liable to the corporation for mistakes of judgment, whether those mistakes are classified as mistakes of fact or mistakes of law"), the Court will not second guess those who are presumed better able to make decisions related to the daily operation of the business.
Plaintiffs' allegations of mismanagement do not establish demand futility, with respect to Counts III and IV, under the standards of Pennsylvania law and Aronson. Nor will the allegation at Complaint P 106, that the individual defendants "wasted the [Westinghouse Corporation's] assets by using the proxy solicitation process . . . illegally and improperly," excuse demand. That allegation merely restates, and is dependent upon the success of, plaintiffs' Section 14(a) claims in Counts I and II, for using the proxy solicitation process as plaintiffs allege the individual defendants did can only be improper in conjunction with a determination that the proxy statements were materially false and misleading, in violation of the statute. Similarly, plaintiffs' conclusory statements at Complaint PP 101-04 that the individual defendants are liable to the corporation for contribution in connection with the purchaser class action, besides lacking ripeness, are not accompanied by particularized facts supporting demand futility. Counts III and IV will be dismissed.
B. Statute of Limitations
The United States Court of Appeals' for the Third Circuit recently held in Westinghouse Elec. Corp. v. Franklin, 993 F.2d 349 (3d Cir. 1993), that the uniform federal limitations period for actions brought under Section 10(b) of the Exchange Act, pursuant to which plaintiffs must bring securities claims actions within one year of the time they discover the alleged fraud, and no later than three years of the securities law violation itself, also applies to actions brought under Section 14(a) of the Exchange Act. Therefore, plaintiffs' Section 14(a) claim based upon an allegedly false and misleading 1987 proxy statement is time-barred.
Westinghouse issued its 1988 proxy statement on March 14, 1988. It is undisputed that the appropriate date for measuring the start of the uniform federal limitations period is April 12, 1991, which is when plaintiff Joselow originally filed his Section 14(a) claim. The claims of the instant derivative plaintiffs, who share an identity of interest with Mr. Joselow, relate back under Fed. R. Civ. P. 15(c)(2) to the date of the original pleading. Defendants contend that plaintiffs' claim based upon the allegedly false and misleading 1988 proxy statement is also time-barred, since Mr. Joselow did not bring his claim by March 14, 1991, three years after the proxy statement was issued. Plaintiffs argue that defendants had a continuing duty to correct previously disclosed incorrect information, which duty extended "at least until the annual meeting of shareholders [was] held," on April 27, 1988. Plaintiffs' Memorandum at 46 n.29. If plaintiffs are correct, their claim based upon the 1988 proxy statement is not time-barred, since Joselow filed his action prior to April 27, 1991.
An issuer violates Section 14(a) by using a proxy statement or other communication containing false or misleading statements of material fact to solicit a proxy. The violation occurs when the false or misleading proxy statement is issued. See Stull v. Bayard, 561 F.2d 429, 432 (2d Cir. 1977), cert. denied, 434 U.S. 1035, 54 L. Ed. 2d 783, 98 S. Ct. 769 (1978) (Section 14 of the Exchange Act violated when an issuer "muddies the pool of information accessible to [it's] shareholders" by making a false or misleading disclosure); Levinger v. Shepard Niles Crane & Hoist Corp., 616 F. Supp. 21, 23 (W.D.N.Y. 1985). The continuing duty to disclose, as discussed in the cases cited by Plaintiffs' Memorandum at note 29 and codified at 17 C.F.R. § 240.14a-9,
, applies to issuers who discover, subsequent to an earlier disclosure, that their disclosure is false or misleading. Such issuers are under an obligation to correct the earlier statements prior to the consummation of the transaction that was the subject of the false disclosure. See Isquith v. Middle South Utilities, Inc., 847 F.2d 186, 205 n. 13 (5th Cir.), cert. denied 488 U.S. 926, 102 L. Ed. 2d 329, 109 S. Ct. 310 (1988) (continuing duty to disclose obtains when "subsequent events" make earlier statements inaccurate, or when those statements are "later discovered" to have been false or misleading from the outset). An allegedly false or misleading statement is made at a particular point in time; the continuing duty to disclose does not somehow extend the making of such statements -- a matter of discrete historical fact -- beyond the date of issuance to a later point in time. Accordingly, plaintiffs' Section 14(a) claim based on Westinghouse's 1988 proxy statement is also time-barred by the three year statute of limitations.
What remains of plaintiffs' Amended and Supplemental Derivative Complaint are Counts I and II, claims made pursuant to Section 14(a) of the Exchange Act and SEC Rule 14a-9 based upon Westinghouse's 1989-92 proxy statements.
C. The Section 14(a) Claim
To establish a cause of action for violation of Rule 14a-9, plaintiffs must demonstrate that: (1) Westinghouse's proxy statements contained false or misleading statements of material fact, or omitted to state a material fact necessary in order to make the statements factually accurate; (2) the misstatement or omission of material fact was made knowingly, recklessly, or negligently, see Herskowitz v. Nutri/System, Inc., 857 F.2d 179, 190 (3d Cir. 1988), cert. denied 489 U.S. 1054, 103 L. Ed. 2d 584, 109 S. Ct. 1315 (1989); and (3) the proxy solicitation itself was an "essential link" in accomplishing the proposed corporate transaction. Mills v. Electric Auto-Lite Co., 396 U.S. 375, 385, 24 L. Ed. 2d 593, 90 S. Ct. 616 (1970). Because plaintiffs do not allege that the transaction solicited by Westinghouse's proxy materials (i.e., the directors' elections and re-elections) directly caused a financial loss to the corporation, no claim for money damages exists. See Gen. Elec. Co. v. Cathcart, 1992 WL 68328 (E.D.Pa. 1992). Plaintiffs' claim is therefore one for equitable relief, specifically, voiding the elections of the directors.
As the proxy statements at issue indicate, Westinghouse directors are elected for three year terms. See 1989 Proxy Statement at 2; 1990 Proxy Statement at 2; 1991 Proxy Statement at 2; 1992 Proxy Statement at 2 (Plaintiffs' Request for Judicial Notice Exhibits C-F). The terms of all directors elected in 1989 and 1990 have therefore expired, and plaintiffs' claims with respect to those years' elections are moot. Accordingly, plaintiffs' Section 14(a) claims based upon the 1989 and 1990 proxy statements will be dismissed with prejudice. See Browning Debenture Holders' Comm. v. Dasa Corp., 524 F.2d 811, 816-17 (2d Cir. 1975); CNW Corp. v. Japonica Partners, L.P., 776 F. Supp. 864, 868 (D.Del. 1990).
At Complaint P 80, plaintiffs allege that Westinghouse's 1991 proxy statement was false and misleading because of representations it made regarding Board committees, the qualifications of the individual defendants to serve on the Board committees, and descriptions of Board committee meetings and activities. And at Complaint P 81, plaintiffs aver that statements made in Westinghouse's 1990 annual report were false and misleading because they attributed the company's business reversals to "external market factors" rather than to "the lack of an adequate internal control system" and "the individual defendants' failure to implement and maintain an adequate system of internal controls." As a proximate result of the dissemination of the 1990 annual report and 1991 proxy statement, plaintiffs were allegedly injured by the re-election of defendants Lego, McLaughlin and Pivirotto to the Board, and by shareholder approval of an employee stock plan that effectively increased the benefits of, inter alia, employees of WFSI and WCC. See Complaint P 82. Similar allegations are made with respect to Westinghouse's 1992 proxy statement. Complaint PP 83-87.
These are pure allegations of mismanagement, and of failure to disclose mismanagement, almost identical to those dismissed in Solfanelli v. Mainwaring, 1992 WL 332223 (E.D.Pa. 1992). Following In re Craftmatic Securities Litigation v. Kraftsow, 890 F.2d 628 (3d Cir. 1989) and Shapiro v. UJB Financial Corp., 964 F.2d 272 (3d Cir.), cert. denied 121 L. Ed. 2d 278, 113 S. Ct. 365 (1992), the Solfanelli court held that while the failure to disclose a company's poor financial condition is material, the failure to disclose managerial inadequacies leading to the poor financial condition is not actionable. Representations about director qualifications, the cause of economic woes, and the employment of internal controls are simply not grist for a Section 14 claim unless the plaintiff can show that defendants knew the statements to be false at the time they were made, or "acted with indifference to their falsity." Hayes v. Gross, 982 F.2d 104, 106-07 (3d Cir. 1992). Plaintiffs' reliance on Securities and Exchange Comm'n v. Falstaff Brewing Corp., 203 U.S. App. D.C. 28, 629 F.2d 62 (D.C. Cir. 1980), cert. denied 449 U.S. 1012 (1980), is misplaced, for that case involved allegations that the defendants falsely represented the very existence of an audit committee. Instantly, plaintiffs do not dispute the existence of any Board committees; rather, plaintiffs challenge the qualifications of the directors sitting on the committees, and the rigor with which the committee members monitored, or should have monitored, Westinghouse's lending practices.
Plaintiffs also aver that the individual defendants misrepresented the adequacy of their monitoring practices, because "as has ultimately begun to become apparent over the course of time, Westinghouse's systems of internal control were woefully inadequate. . . ." Complaint P 90. But alleging that subsequent results contradict positive statements made earlier by a corporation, and "that the difference must be attributable to fraud" is not the same thing as pleading with particularity circumstances constituting fraud. See DiLeo v. Ernst & Young, 901 F.2d 624, 627 (7th Cir.), cert. denied 498 U.S. 941, 111 S. Ct. 347, 112 L. Ed. 2d 312 (1990). The derivative plaintiffs have not alleged with requisite particularity that statements contained in the 1991 and 1992 proxy statements were fraudulently made.
Plaintiffs also may not bootstrap statements made in Westinghouse's 1990 and 1991 annual reports to their Rule 14a-9 claims. Liability does not attach to statements made in annual reports that only "accompany," or are "effectively" incorporated into proxy materials. Annual reports may only support a claim for violation of Rule l4a-9, which rule proscribes solicitation of a proxy by false and misleading proxy statements, when they are specifically incorporated by reference into the proxy statement. Solfanelli, 1992 WL 332223 at *3 (citing Dillon v. Berg, 326 F.Supp 1214 (D.Del. 1971), aff'd, 453 F.2d 876 (3d Cir. 1971) ("no liability may be imposed under Federal proxy rules, other than 14a-3, for any false or misleading statement of material omission contained in the corporation's annual report")). Plaintiffs' Amended and Supplemental Complaint contains no claims for an alleged violation of Rule 14a-3. For the reasons enumerated in this section, Counts I and II, plaintiffs' Rule l4a-9 claims, will be dismissed.
Finally, because plaintiffs do not own more than 5 percent of the outstanding shares of any class of Westinghouse stock, or Westinghouse stock having a market value in excess of $ 200,000, defendants are within their rights to request that plaintiffs be required to post security. 15 Pa.C.S.A. § 1782. However, the amount of security that must be posted is (and continues to be in the event that one of the parties shows that the security provided has become inadequate or excessive) within the discretion of the Court. Neither plaintiffs' suggestion that the Court is constrained to require only a "nominal" bond, nor defendants' position that derivative plaintiffs must post as security the amount of all costs that defendants may incur in defending the action is supported by caselaw.
The purpose of the security for costs statute is to prevent de minimis shareholders and "entreprenneurial attorneys"
from prosecuting derivative strike suits with the hope of extracting settlements or winning large attorney's fees "'and with no intention of benefiting the corporation on behalf of which suit is theoretically brought.'" Levine v. Bradlee, 378 F.2d 620, 624 (3d Cir. 1967) (citation omitted). The Court by no means considers this action a strike suit, and must avoid setting the security bond so high that legitimate derivative plaintiffs are prevented from maintaining their claims. Yet, defendants' are statutorily entitled to require security for reasonable expenses, and the Court is cognizant of the costs involved in defending derivative actions of this magnitude. However, at this juncture, because all of plaintiffs' counts have been dismissed, there is technically no derivative action remaining to which the security requirement applies. Therefore, defendants' request for security will be denied. Defendants may of course raise the issue again in the event that plaintiffs file an amended complaint, move for reconsideration, or appeal from this memorandum opinion and order.
An appropriate order follows.
AND NOW, this 27th day of July, 1993, consistent with the foregoing Opinion, plaintiffs' Amended and Supplemental Derivative Complaint (Document No. 85) is dismissed. Counts Three and Four are dismissed with prejudice. Counts One and Two are dismissed without prejudice to repleading.
Plaintiffs' Second Amended Complaint shall be filed on or before August 20, 1993.
BY THE COURT,
D. Brooks Smith
United States District Judge