Castellano v. Young & Rubicam Inc.

• Decision Date: 19 March 2001
• Docket Number: Docket No. 00-7803
• Citation: 257 F.3d 171
• Parties: (2nd Cir. 2001) UGO CASTELLANO, Plaintiff-Appellant, v. YOUNG & RUBICAM, INC., Defendant-Appellee. August Term 2000 Argued:
• Court: U.S. Court of Appeals — Second Circuit

Page 171

257 F.3d 171 (2nd Cir. 2001)

UGO CASTELLANO, Plaintiff-Appellant, v. YOUNG & RUBICAM, INC., Defendant-Appellee.

Docket No. 00-7803

August Term 2000

UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT

Argued: March 19, 2001

Decided: July 19, 2001

Castellano was an employee shareholder of Young & Rubicam (Y&R), a closely-held corporation. Shortly after Castellano resigned from the firm and resold his shares to Y&R, it entered into a leveraged recapitalization that reaped valuable rewards for shareholders. Castellano brought federal and state claims based both on Y&R's alleged misrepresentations regarding the leveraged recapitalization and its failure to inform him of various negotiations and decisions that preceded the recapitalization. The district court dismissed all claims on Y&R's motion for summary judgment, based on Castellano's failure to show materiality as to some claims, reliance as to others and loss causation as to the remainder.

Affirmed in part, vacated in part and remanded.

[Copyrighted Material Omitted]

[Copyrighted Material Omitted] VICTOR GENECIN, New York, NY (Pavia & Harcourt, Richard L. Mattiaccio, Paul B. Lyons, of counsel), for Plaintiff-Appellant.

LAWRENCE B. FRIEDMAN, New York, NY (Cleary, Gottlieb, Steen & Hamilton), for Defendant-Appellee.

Before: FEINBERG, NEWMAN and SACK, Circuit Judges.

FEINBERG, Circuit Judge:

Plaintiff Ugo Castellano appeals from a grant of summary judgment by the United States District Court for the Southern District of New York (Sidney H. Stein, J.) to defendant Young & Rubicam (Y&R). The appeal principally raises questions of materiality and loss causation under the federal securities laws. We affirm in part and reverse and remand in part for further proceedings.

I. Background

A. Castellano's Departure from Y&R

Y&R is an international advertising agency. For many years, it employed Castellano in various management positions in its offices in Brazil and Italy. Beginning in 1984, Castellano served as the Chief Executive Officer of Y&R Italia S.p.A. In 1993, however, relations between Castellano and Y&R began to sour, apparently as the result of a criminal investigation of allegations that Castellano had bribed an Italian health official in connection with an AIDS-prevention advertising campaign. Y&R's internal investigation of these allegations did not produce sufficient evidence to warrant terminating Castellano for cause, but Y&R began negotiating with Castellano in an effort to persuade him to resign. These negotiations continued for over two years, eventually resulting in Castellano's resignation on April 1, 1996.

Y&R was at this time a privately-held corporation, owned by a select group of employees, and had been since its founding. Prior to his resignation, Castellano was one of the largest Y&R stockholders, owning approximately 1.2% of all outstanding equity at the time he resigned and holding both common and preferred stock. The Y&R Common Stockholders Agreement provided that no shares could be sold or transferred without first offering them to Y&R. It also provided that if a shareholder's employment with Y&R should end, Y&R had an option to purchase the holder's shares for their book value as of the end of the preceding fiscal year. Book value was defined as Y&R's consolidated net income, plus or minus certain specified adjustments, divided by the aggregate number of equity units and options outstanding. Y&R's Preferred Shareholders Agreement provided that a preferred stockholder's employment with Y&R could only be terminated for cause or with one year's notice. There was no public market for Y&R's stock.

Castellano negotiated his resignation with the Chairman of Y&R, Peter Georgescu, the Vice Chairman, Alan Sheldon, and the General Counsel, Stephanie Abramson. Georgescu, Sheldon and Abramson were also Y&R equityholders and together had effective control over Y&R decision making.

Eventually, the negotiations focused on the terms under which Y&R would buy back Castellano's stock. Under the Common Stockholder's Agreement, Y&R was permitted to pay a departing employee for his stock in installments over five years, with market-rate interest. Castellano was interested in receiving the benefit of the projected increases in the book value of Y&R's stock through December 31, 1997. As a result, Y&R's negotiators agreed that if Castellano resigned in 1996 and received 1996 book value for his shares, Y&R would make its installment payments to Castellano at a higher-than-market interest rate, thus effectively compensating Castellano for not benefitting from the 1997 projected increase in book value. Castellano was also concerned that by retiring immediately, he would lose the opportunity to profit as an equityholder if Y&R went public. According to Castellano, when he raised these concerns with Sheldon in January 1996, Sheldon assured him the company was not going to go public and that "nothing was going to change in the near future." Nevertheless, Castellano asked for and received price protection in the event of an underwritten initial public offering (IPO): if an IPO occurred before December 31, 1996, Castellano would receive 100% of the difference between the book value of his stocks and the IPO price, and in the event of an IPO during 1997, he would receive 50% of this difference. With this agreement in place, Castellano resigned on April 1, 1996, and Y&R exercised its option to repurchase his shares on the same day, at book value of $48.20 per share.

B. Y&R's Exploration of Restructuring

Castellano soon came to regret his decision to resign from Y&R. Unknown to Castellano, while he was negotiating his resignation, the individuals negotiating with Castellano on behalf of Y&R were also exploring various options for restructuring the company. In March 1995, Castellano had received a letter from Georgescu stating, "As a private company, Young & Rubicam's profits belong to the people most responsible for generating those profits. This principle has guided our company since its founding, and will continue to serve us well into the future." Nevertheless, in August 1995, Y&R commenced tentative merger negotiations with True North, a publicly-traded competitor. In connection with these discussions, Y&R hired Bear Stearns & Co. (Bear Stearns) as investment bankers. Ultimately, True North and Y&R failed to come to terms, and negotiations between the two companies ended sometime between October and December 1995.

Also in the final months of 1995, Y&R, with the assistance of Bear Stearns, evaluated for the first time the possibility of becoming a publicly-traded company through an underwritten IPO. On December 14, 1995, Bear Stearns recommended to Y&R executives, including those negotiating with Castellano, that Y&R not undertake an IPO for a couple of years, until it could show a history of financial performance comparable with other publicly-traded advertising companies. Bear Stearns further advised that Y&R's financial performance might be improved by a leveraged recapitalization. Y&R management identified Forstmann, Little & Co. (Forstmann Little), a leveraged buyout firm, as a potential financial investor. Shortly thereafter, on January 17, 1996, Geogescu had an initial meeting with the CEO of Forstmann Little.

In March 1996, Forstmann Little began conducting a "due diligence" inquiry, meeting with Y&R management to learn about the company and reviewing financial and strategic information provided by Y&R. In the final week of March, Forstmann Little communicated to Y&R that it was considering a transaction that would price Y&R's equity at double its current book value. On March 31, 1996, Bear Stearns presented to Georgescu, Sheldon, Abramson and other Y&R executives an analysis of Y&R equity values potentially available in a leveraged recapitalization, advising that in such a recapitalization, Y&R shares could be worth $101.32 to $162.23 each. One Y&R executive made a note during this presentation that if there were fewer outstanding shares (as would be the case if a current equityholder, like Castellano, sold his shares to Y&R), the price per share would be greater. Forstmann Little made a formal offer (subject to completion of final due diligence) to Y&R on April 15, 1996, which would have paid double the current book value to selling equityholders. On April 21, 1996, Y&R rejected this proposal because of the low valuation offered by Forstmann Little, and authorized Bear Stearns to investigate options for Y&R with other leveraged buyout firms.

Thereafter, Bear Stearns approached Hellman & Friedman, another such firm. By June 1996, Hellman & Friedman was negotiating with Y&R regarding a possible leveraged recapitalization. On August 9, 1996, the Y&R Board approved a transaction with Hellman & Friedman in which holders of Y&R equity received $115 per share--2.4 times the book value received by Castellano at his resignation. This transaction was based on the analyses prepared by Bear Stearns in February and March 1996 in connection with the Forstmann Little negotiations.

C. Proceedings in the District Court

Castellano brought suit against Y&R in July 1997, asserting that his decision to resign on April 1, 1996, rather than a few months later, cost him almost $7 million dollars. The complaint alleged securities fraud under federal law in violation of § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j, and Rule 10b-5, 17 C.F.R. § 240.10b-5, and fraud, breach of fiduciary duty, negligent representation, unjust enrichment and rescission under New York common law. In December 1999, the district court adopted the report and recommendation of Magistrate Judge Henry Pitman and granted Y&R's motion for summary judgment in part. The court held that Castellano had failed to show any affirmative misrepresentations on which he relied and that all but one of the facts that Castellano alleged were concealed from him in violation of ...