553 F.2d 750 (2nd Cir. 1977), 622, Hirsch v. du Pont
|Docket Nº:||622, Docket 76-7428.|
|Citation:||553 F.2d 750|
|Party Name:||Howard C. HIRSCH et al., Plaintiffs-Appellants, v. Edmond du PONT et al., Defendants, and Haskins & Sells and New York Stock Exchange, Inc., Defendants-Appellees.|
|Case Date:||April 07, 1977|
|Court:||United States Courts of Appeals, Court of Appeals for the Second Circuit|
Argued March 7, 1977.
[Copyrighted Material Omitted]
Sheldon D. Camhy, New York City (Richard L. Spinogatti and Shea, Gould, Climenko & Casey, New York City, of counsel), for plaintiffs-appellants.
David R. Hyde, New York City (James P. Tracy and Cahill, Gordon & Reindel, New York City, of counsel), for defendant-appellee Haskins & Sells.
Russell E. Brooks, New York City (Samuel H. Gillespie, III, Toni C. Lichstein and Milbank, Tweed, Hadley & McCloy, New York City, of counsel), for defendant-appellee New York Stock Exchange, Inc.
Before KAUFMAN, Chief Judge, and SMITH and MULLIGAN, Circuit Judges.
IRVING R. KAUFMAN, Chief Judge:
In the late 1960's and early 1970's the collapse of the securities market threatened the very structure of the securities industry. 1 Such highly respected firms as Hayden, Stone, Goodbody & Co., and F.I. du
Pont found themselves on the brink of insolvency. Some succumbed, and others saved themselves by providential mergers or emergency transfusions of capital. 2 The delicate financial maneuverings of this crisis period have spawned much litigation, including the case before us.
The appellants, Howard Hirsch, Paul Kohns, and Marshall Mundheim, former partners in Hirsch & Co., claim in this action that the New York Stock Exchange and Haskins & Sells, in order to facilitate the merger of Hirsch and F.I. du Pont, concealed the convoluted means by which F.I. du Pont was maintaining compliance with the Exchange's net capital rule and thereby violated the Securities and Exchange Commission's rule 10b-5. 17 C.F.R. § 240.10b-5. We agree with the district court that neither the Exchange nor Haskins & Sells owed a duty of disclosure to the appellants. We further agree that the information at issue was available to the appellants upon the exercise of due diligence to procure it. Accordingly, we affirm the judgment of Judge Carter dismissing the appellants' claims after trial to the bench. 3
A brief summary of the complex pattern of events that give rise to this controversy is in order.
A. The appellants begin their search for a merger. The appellants were the principal general partners of Hirsch & Co., a long-established and highly respected brokerage firm with an especially strong reputation in Europe. All three men were wise in the ways of Wall Street as a result of long and prosperous experience.
Like other brokerage houses, Hirsch & Co. came upon hard times in 1969. For the first time in its history the firm registered an operating loss of approximately $2.8 million. Two years earlier the overheated market had entered a state of frenzy; the volume of trading created the most active securities market in American history. The paperwork simply overwhelmed the processing capacity of the industry carried on in the "back offices," and as the market fell in 1969, many firms found themselves in serious difficulty. By the middle of 1969 it became apparent to the appellants that the
Hirsch firm was not viable: the heavy trading volumes of the "new" market required sophisticated data processing techniques that were beyond the means of the medium-sized brokerage. Moreover, some major partners of Hirsch & Co. especially Maurice Meyer, whose interest was second in size to that of Kohns were withdrawing their capital from the firm, thus aggravating the difficulties inherent in the circumstances creating the market crisis. Accordingly, from the middle of 1969 the appellants began to explore the possibilities of merger with another brokerage. After a number of unsuccessful discussions with other firms, the appellants commenced negotiations with F.I. du Pont in March, 1970.
B. F.I. du Pont: a giant in trouble. In 1969 du Pont was the third largest house on Wall Street but, nevertheless in deep trouble. The operating loss posted that year was a staggering $7.7 million, one of the largest ever suffered by a member of the New York Stock Exchange. Such losses inevitably generated capital shortages. Accordingly, in both June and July du Pont found itself in violation of the Stock Exchange's net capital rule, which prohibits a firm's aggregate indebtedness from exceeding 2000% of net capital. 4
A still more imposing reason for alarm, however, was the utter disarray of du Pont's back office. The firm was censured by the Exchange in the spring of 1969 for record-keeping inadequacies, but this disciplinary action seemed to have had little impact. The level of customer complaints continued to be so high that in October the Exchange and the SEC commenced an investigation of du Pont's operating difficulties.
Against this background of financial and organizational distress, du Pont's accountants, Haskins & Sells, conducted their annual "surprise audit". The auditors' report was rendered as of November 26, and filed with the SEC shortly thereafter. It revealed that, as of September 28, 1969, du Pont was seriously out of compliance with the net capital rule. The ratio of aggregate indebtedness to net capital was 3242%, representing a capital deficiency of approximately $6.8 million. In addition, du Pont had about $30 million in long security count differences and another $7 million in short differences. 5 This information was, of
course, available to anyone who chose to inspect SEC records and perform the necessary calculations.
The Stock Exchange, dissatisfied with Haskins & Sells's net capital calculation, decided in December to charge net capital for dividend differences. This brought du Pont's capital deficiency, as of September 28, to $17.3 million. The recomputed net capital ratio was an astonishing 76,000%. These figures exaggerate du Pont's actual plight, however: since the original deficiency of $6.8 million had been cured by the end of November, the task confronting du Pont in December was to find capital to compensate for the additional charge. Nondisclosure of this additional charge and the means by which capital was raised to bring du Pont into net capital compliance by year's end constitute the nub of the appellants' complaint.
C. The December 16, 1969 conclave. By any standard, of course, a capital shortage of over $10 million is cause of concern. A meeting was accordingly convened at the New York Stock Exchange on December 16, 1969, for the purpose of discussing F.I. du Pont's difficulties. Among those present were Paul Chenet and Robert Bishop of the Exchange, Samuel Gay and Milton Speicher of du Pont, and Edward Lill of Haskins & Sells. At this meeting Bishop suggested that a special effort be made to resolve long securities count differences by "research," since there existed a substantial likelihood that du Pont actually owned many of the securities in which it had a long position. This suggestion was followed, and by the end of the year du Pont's capital deficiency was eliminated. The liquidation of long differences contributed $6 million to this recovery.
The parties are in vigorous disagreement over whether these differences were actually resolved by "research". We regard this controversy as a quibble over words. On the record before us, there can be little dispute that du Pont resolved some of the differences by tracing them back to the original error and others by a process of elimination if careful research did not reveal the true owner of the securities in question, it was assumed that du Pont was the owner.
Moreover, it is clear that the Exchange, F.I. du Pont, and Haskins & Sells understood Bishop's use of the word "research" to be broad enough to cover both procedures. Bishop conceded on the stand that, though he expected du Pont to trace the differences in most cases, in
some instances they might determine the firm owned the securities through exhausting other possibilities.
Samuel Gay, of F.I. du Pont, confirmed this understanding of Bishop's suggestion:
Q. And so then your position is that if I look through all of these things and I can't find somebody else claiming it, then it is a legitimate long difference?
A. I would say that's so.
Q. And that was the kind of a difference which you thought you could liquidate?
A. That's what I felt that Mr. Bishop meant when he talked about liquidating long differences.
Similarly Edward Lill's contemporaneous memorandum of the December 16 meeting makes it clear that he too understood that du Pont would be selling some securities that had not been traced to a specific error. He wrote:
It was clearly understood that there would be market risk in such liquidation procedures in that a customer or broker may subsequently claim a liquidated position.
Of course, such risks arise only if differences are resolved by elimination.
Accordingly, the real controversy regarding F.I. du Pont's liquidation of long differences is not over the thoroughness of the firm's research. Rather, the question posed
by the appellants is whether the process of elimination was a proper technique, especially in light of du Pont's abysmal record keeping, or at least a sufficiently meaningful departure from ordinary practices to require disclosure.
D. The Hirsch & Co.-F.I. du Pont negotiations: Round I. In March, 1970, Hirsch & Co. formed a committee to investigate the desirability of a merger with du Pont. The Hirsch firm was, of course, unaware of the results of Haskins & Sells's surprise audit and the means by which du Pont had brought itself into compliance with the net capital rule...
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