113 F.3d 738 (7th Cir. 1997), 96-2870, Eisenstadt v. Centel Corp.
|Docket Nº:||96-2870, 96-3028.|
|Citation:||113 F.3d 738|
|Party Name:||Herbert EISENSTADT, Joseph Meyer, and Harvey Meyer, on behalf of themselves and all others similarly situated, Plaintiffs-Appellants, v. CENTEL CORPORATION, John P. Frazee, Jr., and J. Stephen Vanderwoude, Defendants-Appellees.|
|Case Date:||May 12, 1997|
|Court:||United States Courts of Appeals, Court of Appeals for the Seventh Circuit|
Argued Feb. 24, 1997.
Rehearing and Suggestion for Rehearing En Banc Denied June 19, 1997.
[Copyrighted Material Omitted]
Michael J. Freed, Michael B. Hyman, Ellyn M. Lansing, Much, Shelist, Freed, Denenberg & Ament, Chicago, IL, Patricia M. Hynes (argued), Deborah Clark-Weintraub, Kenneth J. Vianale, Milberg Weiss, Bershad, Hynes & Lerach, New York City, Arthur N. Abbey, Judith L. Spanier, Abbey & Ellis, New York City, Michael D. Craig, Schiffrin & Craig, Buffalo Grove, IL, for Herbert Eisenstadt, Joseph Meyer, Harvey Meyer and Brenda Drucker in No. 96-2870.
Michael J. Freed, Michael B. Hyman, Ellyn M. Lansing, Much, Shelist, Freed, Denenberg & Ament, Chicago, IL, Patricia M. Hynes (argued), Deborah Clark-Weintraub, Kenneth J. Vianale, Milberg Weiss, Bershad, Hynes & Lerach, New York City, Marvin A. Miller, Patrick E. Cafferty, Kenneth A. Wexler, Miller, Faucher, Cherlow, Cafferty & Wexler, Chicago, IL, Arthur N. Abbey, Judith L. Spanier, Abbey & Ellis, New York City, Michael D. Craig, Schiffrin & Craig, Buffalo Grove, IL, for Herbert Eisenstadt, Joseph Meyer, Harvey Myer and Paul Schmergel in No. 96-3028.
Susan Getzendanner, Matthew R. Kipp (argued), Christina M. Tchen, Skadden, Arps, Slate, Meagher & Flom (Illinois), Chicago, IL, for John P. Frazee, Jr. and J. Stephen Vanderwoude in No. 96-2870.
Susan Getzendanner, Matthew R. Kipp (argued), Christina M. Tchen, Skadden, Arps, Slate, Meagher & Flom (Illinois), Chicago, IL, for Centel Corporation, John P. Frazee, Jr. and J. Stephen Vanderwoude in No. 96-3028.
Before POSNER, Chief Judge, and FLAUM and EVANS, Circuit Judges.
POSNER, Chief Judge.
The plaintiffs in this class action under sections 10(b) and 20(a) of the Securities Exchange Act, 15 U.S.C. §§ 78j(b), 78t(a), and the SEC's Rule 10b-5, 17 C.F.R. § 240.10b-5, seek to recover the damages they claim to have suffered as a consequence of buying stock in Centel Corporation during a period in which, according to the complaint, the defendants (Centel and two of its officers) were exaggerating the prospects for a planned auction of the company. The district judge granted summary judgment for the defendants on the ground that there had been no actionable misrepresentations.
Centel comprised local telephone companies and cellular phone systems. The cellular-phone business was hot, and the local-telephone business cool, and Centel's board believed that the combination was unlovely to investors and that the firm's assets would be worth more if the company were sold either as a unit (presumably to a telecommunications firm whose assets would make a good fit with Centel's assets) or in pieces. The disadvantage of a sale in pieces was that Centel might owe corporate income tax on the difference between the sale price of its assets and its basis in the assets, which was low, whereas a merger of the entire firm into another firm would avoid corporate income tax. See Boris I. Bittker & James S. Eustice, Federal Income Taxation of Corporations and Shareholders pp 12.42, 12.62 (6th ed.1994); 1 Martin D. Ginsburg & Jack S. Levin, Mergers, Acquisitions, and Buyouts: A Transactional Analysis of the Governing Tax, Legal, and Accounting Considerations §§ 302, 603 (1997).
Rather than just seek out possible purchasers and negotiate privately with them, Centel decided to organize an auction at which bidders could bid on the whole company or on parts of it as they wished. The auction was intimated in a public announcement by Centel on January 23, 1992, that it had hired two prominent investment banks to "explore strategic alternatives to maximize shareholder value, including the possible sale of the company." On the day of the announcement, the price of Centel's shares rose from $37 to almost $48. Centel's investment bankers explored the possibility of a sale of part or all of the company to one or more of the seven Baby Bells or GTE, but all eight of these companies were noncommittal. Either despite or because of its failure to extract a quick commitment, Centel on February 17 confirmed its intention to conduct an auction, announcing that its board of directors had "decided to solicit proposals for the purchase of all or part of the company as a result of the indications of interest received since the
company's January 23 announcement." Two weeks later, on March 5, GTE announced that it would not participate in the auction. Although Centel responded by bravely claiming that "[w]e believe that this [GTE's statement] has no impact on our process [and w]e continue to move along," a week later it met with its investment bankers in private to consider the viability of a "survivor entity" consisting of those assets of Centel that would not fetch an attractive price at the auction. The conclusion (not publicly announced) of the participants in the meeting was that any such entity would "very clearly bear the taint of a nonsaleable telco property which has been aggressively (and publicly) marketed to 'the world.' "
The countdown to the auction continued. On March 25, Pacific Telesis, one of the Baby Bells and a potential bidder for Centel's Nevada properties, a major asset, announced that it wouldn't bid for them after all. Centel reacted with a public statement that "the bidding process continues to go very well" and "very smoothly." By this time, several other large potential purchasers had expressed a lack of interest as well, and Centel was beginning to suspect that it would receive fewer bids than it had expected. The price of its stock had drifted lower than its peak on January 23, but it was still above $40.
April 16 was the deadline for the submission of bids. As the day approached, Centel's investment bankers visited several potential purchasers in an effort to stimulate bids. On April 13, Centel's chief executive officer announced publicly that there was "widespread interest almost down to every [Centel telecommunications] exchange," and the next day the Chicago Tribune reported that "people involved in the auction of Centel Corp. said Monday [April 12] that as many as 35 to 40 parties have explored submitting bids for the Chicago company or its pieces by Thursday's deadline. An investment banker for Centel provided the number of parties that have conducted so called due-diligence reviews of the company's books."
We must pause here to explain the term "due-diligence reviews." "Due diligence" is used in the corporate context in two senses. The first, which is irrelevant to this case, is as a defense to liability for a false registration statement. See 1 William E. Knepper & Dan A. Bailey, Liability of Corporate Officers and Directors § 13-4, p. 521 (5th ed.1993). The second sense of the term (which one encounters in a variety of legal contexts besides corporate law; see, e.g., Clark v. Robert Young & Co., 5 U.S. (1 Cranch) 181, 192-93, 2 L.Ed. 74 (1803)) is simply the exercise of due care. In re Integrated Resources, Inc., 3 F.3d 49, 51 (2d Cir.1993). Boards of directors have to be careful before committing themselves to major transactions, lest they be sued by disgruntled shareholders if the transaction is a bust. Right after announcing the auction, Centel had designated a room in which potential bidders could inspect confidential data concerning Centel's operations and finances. In order to be admitted to the data room, they had to sign an agreement promising not to use the data for any purpose other than formulating a bid. Visiting the data room was an appropriate step in conducting a due-diligence review of a contemplated purchase of some or all of Centel's assets. Whether it was a necessary step is another question. Centel was a publicly regulated company, so a great deal of information about it was available without a visit to the data room; its "books" were largely a matter of public record. A prospective purchaser might deem the incremental value of the data in the data room offset by the potential liability if he signed, and was later accused of violating, the confidentiality agreement. Signing the agreement might thus inhibit the signer's ability to compete with Centel, should Centel survive the auction.
We don't know exactly what the term "due-diligence reviews of the company's books" as it appeared in the Tribune article means, because the reporter who wrote the article was not deposed. What we do know is that only 16 firms visited the data room (and two of those announced before the interview with the Tribune's reporter that they had lost interest in bidding), although at least two dozen had expressed a serious interest in submitting bids and perhaps a dozen others had expressed some interest, which would
bring the total number of firms that had explored the possibility of submitting a bid into the 35 to 40 range. Three of the Baby Bells were among the seriously interested.
The auction was held on April 16 as scheduled, but it was a bust. Only seven bids were submitted, none for the whole company. Although Centel kept mum, it accepted none of the bids. Instead it approached Sprint hat in hand and quickly negotiated a sale of the entire company to Sprint at a price equivalent to only $33.50 a share, which was $9 below the then-current market price and roughly 10 percent below the market price before the auction was first intimated. As soon as the deal with Sprint was announced, on May 27, 1992, the value of Centel's shares plummeted, from...
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