980 F.2d 927 (3rd Cir. 1992), 92-1356, General Elec. Co. by Levit v. Cathcart

Docket Nº:92-1356
Citation:980 F.2d 927
Party Name:GENERAL ELECTRIC COMPANY, DERIVATIVELY BY J. H. LEVIT v. SILAS S. CATHCART; LAWRENCE E. FOURAKER; JOHN F. WELCH; H. B. ATWATER; EDWARD E. HOOD, JR.; RICHARD T. BAKER; GERTRUDE G. MICHELSON; LAWRENCE A. BOSSIDY; C. C. DICKEY, JR.; DAVID C. JONES; B. S. PREISKEL; W. B. WRISTON; ANDREW C. SIGLER; ROBERT E. MERCER; LEWIS T. PRESTON; F. H. RHODES; H. H.
Case Date:December 03, 1992
Court:United States Courts of Appeals, Court of Appeals for the Third Circuit
 
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980 F.2d 927 (3rd Cir. 1992)

GENERAL ELECTRIC COMPANY, DERIVATIVELY BY J. H. LEVIT

v.

SILAS S. CATHCART; LAWRENCE E. FOURAKER; JOHN F. WELCH; H. B. ATWATER;

EDWARD E. HOOD, JR.; RICHARD T. BAKER; GERTRUDE G. MICHELSON; LAWRENCE A.

BOSSIDY; C. C. DICKEY, JR.; DAVID C. JONES; B. S. PREISKEL; W. B. WRISTON;

ANDREW C. SIGLER; ROBERT E. MERCER; LEWIS T. PRESTON; F. H. RHODES;

H. H. HENLEY, JR.; HENRY L. HILLMAN; GENERAL ELECTRIC COMPANY;

J.H. LEVIT, IN HIS OWN RIGHT, AND DERIVATIVELY ON BEHALF OF THE

GENERAL ELECTRIC COMPANY, APPELLANT

No. 92-1356

United States Court of Appeals, Third Circuit

December 3, 1992

Corrected Opinion Dec. 7, 1992.

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James R. Malone, Jr. (argued), Mark C. Rifkin, Richard D. Greenfield, C. Oliver Burt, III, Greenfield and Chimicles, Haverford, Pa., for appellant.

Lewis B. Kaden (argued), Lawrence J. Portnoy, Davis, Polk & Wardwell, New York City, for appellees except General Elec. Co.

J. Clayton Undercoffler, Michael R. Lastowski, William M. Janssen, Saul, Ewing, Remick & Saul, Philadelphia, Pa., for appellee General Elec. Co.

Before GREENBERG, NYGAARD, and HIGGINBOTHAM, Circuit Judges.

OPINION

GREENBERG, Circuit Judge.

I. FACTUAL AND PROCEDURAL HISTORY

J.H. Levit appeals in this shareholder derivative action from a district court order of March 30, 1992, dismissing his federal securities claims pursuant to Fed.R.Civ.P. 12(b)(6), and dismissing his state claims for lack of supplemental jurisdiction. We will affirm the district court's order with respect to all the claims except one, the appeal from which we will dismiss as moot. 1

Levit, a shareholder of General Electric Company, filed this suit on March 27, 1991, seeking damages and equitable relief against the individual appellees, 18 General Electric directors, some of whom were also senior officers of the company, to redress what he calls "ongoing rampant lawlessness that has pervaded the Company." Brief at 3. Count I of the complaint alleges violations of Section 14(a) of the Securities

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Exchange Act of 1934, 15 U.S.C. § 78n(a), and Rule 14a-9 of the Securities and Exchange Commission promulgated thereunder, 17 C.F.R. § 240.14a-9. In this count, Levit claims that the appellees disseminated false and misleading proxy statements to shareholders from 1987-1991, by failing to disclose criminal activity and misconduct of company employees. Counts II and III allege supplemental state law claims of breach of fiduciary duty in connection with the same allegations. 2

Levit organized his complaint around five categories of alleged corporate misconduct. The first category concerns several incidents in which the appellees purportedly allowed General Electric to engage in fraudulent billing practices with respect to certain defense contracts. In particular, the complaint describes how General Electric and two employees in its Management and Technical Services subsidiary were indicted in November 1988, and convicted in February 1991, for charges arising from General Electric's defrauding the United States government by inflating costs in a $21 million computer contract with the United States Army. As a result a $10 million fine was imposed on General Electric. The complaint also recounts that in 1985 General Electric pled guilty to charges of illegally claiming cost overruns on Minuteman missile contracts and was fined over $1 million. The complaint further avers that a March 17, 1991 court proceeding in Israel revealed that a senior executive in General Electric's General Aircraft division conspired with an Israeli general to divert more than $10 million from military engine contracts between General Electric and the Israeli Air Force, and that this conspiracy triggered governmental investigations of the executive and General Electric. 3 Levit claims that General Electric's conviction on any charges stemming from these incidents, when coupled with its conviction in the Management and Technical Services affair, will cause it to be debarred from government contracts for up to three years, subject it to fines and penalties, and oblige it to make restitution.

The second category of alleged misconduct involves the appellees' supposed failure to supervise General Electric's role in nuclear power plant construction. Levit alleges that the appellees permitted construction of nuclear containment vessels with serious design and safety flaws, potentially subjecting General Electric to liability for hundreds of millions of dollars. The complaint asserts that the Washington Public Power Supply System and the Long Island Lighting Company had brought actions against General Electric as a result of these failures.

The third category concerns the appellees' alleged mismanagement of General Electric's Financial Services subsidiary by permitting reckless investments in real estate and leveraged buy-outs, thereby making General Electric vulnerable to adverse economic developments. In addition, Levit charges that General Electric's falsely optimistic statements regarding that subsidiary have exposed the company to liability to investors for federal securities laws violations and for common law claims predicated on fraud and negligent misrepresentation.

The fourth category relates to Levit's claim that the appellees' condoning or ignoring General Electric's illegal dumping of approximately 500,000 pounds of polychlorinated biphenyls into the Hudson River ultimately could cost General Electric $270 million for clean-up costs.

Finally, Levit charges that the appellees' failure to supervise another General Electric subsidiary, Yokogawa Medical Systems, 4 led to the arrests of two employees

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on February 20, 1992, for bribing professors in Japan to buy General Electric medical equipment. Levit asserts that as a consequence the Japanese Ministry of Education stopped business transactions between all Japanese universities and university hospitals and Yokogawa Medical Systems.

Notwithstanding the broad allegations of his complaint, Levit does not set forth specific facts explaining how a particular appellee participated in or was directly responsible for the misconduct alleged, though he does accuse them collectively of wrongdoing, poorly supervising the company, and attempting to cover up the misconduct. 5 In count I of the complaint, Levit claims that the appellees violated Section 14(a) by omitting reference to the alleged misconduct in two sets of proxy statements: (1) the 1987-1991 proxy solicitations on behalf of their re-election as board members and (2) certain proxy materials relating to so-called "raincoat provisions," corporate governance rules designed to protect directors and officers from personal liability. Levit's allegations involve two raincoat provisions, i.e., the 1987 proxy solicitation seeking shareholder approval for an amendment to General Electric's by-laws to provide for directors' and officers' indemnification from certain liabilities and the 1988 proxy solicitation seeking shareholder approval for an amendment of the certificate of incorporation to limit directors' liability. 6

According to the complaint, the appellees deliberately omitted any information about their alleged misconduct from the proxy materials to ensure their re-election as directors and the passage of the raincoat provisions. Levit concludes that the information withheld was material to both sets of proxy statements, as it reflected on the appellees' ability to manage the company and their potential liability to General Electric's shareholders. He speculates that if the pertinent facts had been disclosed to the shareholders, they never would have voted for the appellees' re-election as directors or for the raincoat provisions. Accordingly, Levit seeks monetary damages and the invalidation of the 1987-1991 directors' elections and the raincoat provisions.

The appellees moved to dismiss the complaint for failure to state a claim upon which relief could be granted, arguing that Levit's allegations only charged them with failing to disclose mismanagement and potential litigation, matters not required to be revealed in proxy solicitations. 7 The district court granted the appellees' motion.

Viewing Levit's Section 14(a) allegations in what it considered the most favorable light, the district court read the complaint as alleging a claim for money damages in relation to the appellees' re-election as directors, and claims for equitable relief concerning the appellees' re-election and the

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raincoat provisions. 8 The court dismissed the Section 14(a) claim for money damages on the ground that Levit failed to show "transaction causation"--i.e., the court found that the causal connection between the misleading proxy statements and the alleged misconduct was too attenuated to state a claim for damages under Section 14(a). In so concluding, the court relied on cases holding that unless the challenged proxy materials actually cause the corporate action that results in a financial loss, there cannot be a recovery of money damages under Section 14(a).

But the district court found Levit's assertion that the proxy materials were misleading sufficient to satisfy the transaction causation requirement with respect to the claim for equitable relief arising from the appellees' re-election, as Levit was attacking the elections themselves rather than the underlying transactions. Nevertheless, the district court found the undisclosed allegations immaterial, because they involved only purported instances of mismanagement or waste of corporate assets and did not assert any self-dealing by the appellees. In reaching this result, the district court relied on Gaines v. Haughton, 645 F.2d 761, 776-77 (9th Cir.1981), cert. denied, 454 U.S. 1145, 102 S.Ct. 1006, 71 L.Ed.2d 297 (1982), and overruled on other grounds, In re Complaint of McLinn, 739 F.2d 1395 (9th Cir.1984), and...

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