Data Probe Acquisition Corp. v. Datatab, Inc., 267

• Citation: 722 F.2d 1
• Decision Date: 22 November 1983
• Docket Number: D,No. 267,267
• Parties: Fed. Sec. L. Rep. P 99,569 DATA PROBE ACQUISITION CORP. and Data Probe, Inc., Plaintiffs-Appellees, v. DATATAB, INC., Sanford C. Adams, Lee D. Gallaher, John L. Lobel, CRC Information Systems, Inc., and CRC Acquisition Corp., Defendants-Appellants. ocket 83-7639.
• Court: United States Courts of Appeals. United States Court of Appeals (2nd Circuit)

Page 1

722 F.2d 1

Fed. Sec. L. Rep. P 99,569

DATA PROBE ACQUISITION CORP. and Data Probe, Inc. Plaintiffs-Appellees, v. DATATAB, INC., Sanford C. Adams, Lee D. Gallaher, John L Lobel, CRC Information Systems, Inc., and CRC Acquisition Corp., Defendants-Appellants.

No. 267, Docket 83-7639.

United States Court of Appeals Second Circuit.

Argued Sept. 2, 1983.

Decided Nov. 22, 1983.

Edward Labaton, New York City (Stuart D. Wechsler, Joel C. Feffer, Lawrence A. Sucharow, John H. Riley, Kass, Goodkind, Wechsler & Labaton, New York City, on brief), for plaintiffs-appellees.

Francis E. Lake, Jr., New York City (Allen G. Burgoyne, Putney, Twombley, Hall & Hirson, New York City, on brief), for defendants-appellants.

Before KEARSE, CARDAMONE and WINTER, Circuit Judges.

WINTER, Circuit Judge:

Plaintiffs Data Probe, Inc. and its wholly owned subsidiary Data Probe Acquisition Corp. (collectively "Data Probe") brought this action to enjoin the merger of defendants CRC Acquisition Corp., a wholly owned subsidiary of defendant CRC Information Systems, Inc. (collectively "CRC"), and Datatab, Inc. ("Datatab"). CRC and Datatab had entered into an Agreement and Plan of Merger (the "Merger Agreement") under which Datatab would become a wholly owned subsidiary of CRC. In its complaint, Data Probe, which itself was attempting to gain control of Datatab through a tender offer, alleged that Datatab and CRC had committed various violations of federal securities laws and regulations. After an expedited trial, the district court, 568 F.Supp. 1538, found that an option to purchase Datatab stock acquired by CRC was a "manipulative" device proscribed by Section 14(e) of the Securities Exchange Act of 1934 (the "Act"), 15 U.S.C. Sec. 78n(e) (1976). It also found that a letter written by Datatab to its shareholders failed to satisfy the disclosure requirements established by Section 14(e) of the Act and by Securities and Exchange Commission ("SEC") Rule 14e-2, 17 C.F.R. Sec. 240.14e-2 (1983). For these two reasons the district court enjoined exercise of the option by CRC, thus preventing the merger as well. This expedited appeal followed.

We reverse on both grounds.

BACKGROUND

In December, 1982, the management of Datatab, a publicly traded New York corporation engaged in the market research business, approached the management of CRC, a privately held New York corporation in the same field, to discuss the possibility of CRC's acquiring Datatab. The decision to approach CRC was prompted by the deteriorating financial condition of Datatab, which had been experiencing mounting losses. Negotiations ensued, and on April 29, 1983, the two companies announced the Merger Agreement, which provided that a wholly owned CRC subsidiary would be merged into Datatab and that holders of Datatab common stock would then receive $1.00 per share in cash, leaving Datatab a wholly owned subsidiary of CRC.

Applicable New York law required the approval of two-thirds of Datatab's shareholders and Datatab's Board scheduled a special meeting of shareholders to be held on June 23, 1983. On May 26, proxy materials announcing the meeting and describing the merger were sent to Datatab shareholders. Among the conditions of the merger described in the proxy materials was an undertaking by CRC to enter into employment agreements with Sanford Adams, Lee Gallaher and John Lobel, who were officers of Datatab or a subsidiary and who comprised Datatab's Board of Directors. Each was to receive a three-year contract. It is undisputed that the proxy materials, including the disclosure of the employment agreements, conformed to the requirements of applicable state and federal law.

On June 21, 1983, two days before the shareholders' meeting, Data Probe, a New York corporation also engaged in the market research business, announced a cash tender offer for any and all shares of Datatab stock at $1.25 per share. The offer, which was apparently not discussed with the management of Datatab or CRC, was On the evening of June 21, Yitzhak Bachana, president and majority shareholder of Data Probe, met over dinner with Sanford Adams of Datatab to discuss Data Probe's interest in Datatab. ¹ The two men took up the subject of the future of current Datatab employees in the event Data Probe's tender offer was successful. Adams's notes from the meeting indicate that Bachana thought that discussion of the employment contracts of Adams, Lobel, and Gallaher was "premature." Bachana testified at the hearing that he indicated to Adams that "he could not make any promises" with respect to the future of current Datatab management.

contingent on the failure of Datatab shareholders to approve the proposed merger between Datatab and CRC. Its announcement caused Datatab's Board to adjourn the special shareholders' meeting.

Further negotiations between Datatab and CRC were held and, on July 1, the two firms concluded a revised merger agreement (the "July 1 Agreement") under which Datatab shareholders would receive $1.40 per share. As a part of the July 1 Agreement, Datatab granted CRC a one-year irrevocable option to purchase 1,407,674 authorized but unissued Datatab shares at $1.40 per share. Since Datatab had only 703,836 shares of common stock outstanding, the practical effect was to guarantee that CRC could acquire Datatab by exercising the option, no matter how many of the outstanding shares were tendered to Data Probe. It could then vote its resulting two-thirds interest in Datatab for the merger with its subsidiary.

In a letter to its shareholders also dated July 1 (the "July 1 shareholders' letter") the Datatab Board announced its response to the still outstanding Data Probe tender offer. The letter was sent to conform with the duty imposed by SEC Rule 14e-2, 17 C.F.R. Sec. 240.14e-2 (1983), which requires that within ten business days of the making of a tender offer the subject company must inform its shareholders of its position with respect to the offer and of the reasons supporting its position. The letter advised that "[i]n view of the new $1.40 per share merger offer from CRC, the Board recommends that [shareholders] not tender ... shares for the $1.25 price ... offered by Data Probe." (Emphasis in the original). The letter described the CRC option to purchase Datatab shares, but it drew no explicit connection between the grant of the option and the likely outcome of the struggle for control of Datatab.

On July 14, Data Probe increased its offer to $1.55 per share, conditioned upon termination of the CRC option or a judicial determination of the option's invalidity. At the same time it commenced this action by filing a complaint that alleged, among other things, that the option was a "manipulative act or practice" committed in connection with a tender offer in violation of Section 14(e) of the Act. The complaint alleged no violations of state law. The relief sought was, inter alia, an injunction barring exercise of the option.

After a hearing, Judge Sofaer announced his findings and conclusions and rendered final judgment in favor of plaintiff Data Probe. He held that Section 14(e), by forbidding "manipulative ... practices in connection with any tender offer," proscribed acts that "unduly obstruct the exercise of informed shareholder choice." Because CRC's option to purchase the unissued Datatab shares effectively nullified Data Probe's tender offer, Judge Sofaer concluded that the option was proscribed by Section 14(e). He also found that the July 1 shareholders' letter was materially misleading in that it did not state as a reason for the Board's position the fact that, unlike Data Probe, CRC had guaranteed employment to Adams, Lobel and Gallaher, and in that it drew no connection between the grant of the option and the outcome of the contest for control of Datatab. Judge Sofaer enjoined exercise of the option.

Following the district court's decision Data Probe went forward with its $1.55 per share tender offer. As of August 9, 1983, more than 60 percent of Datatab's outstanding This appeal, also expedited, followed.

stock had been tendered to Data Probe.

DISCUSSION

1. Manipulative Devices Under Section 14(e)

Congress added Section 14(e) to the Act in 1968 by passing the Williams Act, Pub.L. No. 90-439, 82 Stat. 454 (codified at 15 U.S.C. Secs. 78m(d)-(e), 78n(d)(f) (1976)). Section 14(e) provides in pertinent part that "[i]t shall be unlawful for any person ... to engage in any fraudulent, deceptive, or manipulative acts or practices ... in connection with any tender offer." ² Relying exclusively on this language for authority and assuming the option's validity under the New York State Corporation Law, the district court held the CRC option invalid. Since we must also assume the option's validity under state law, the question presented on appeal is whether Section 14(e) authorizes federal courts to review the substantive validity of corporate actions undertaken during the course of a tender offer. We conclude that it does not.

Viewing the CRC option solely as a self-serving barrier created by Datatab's management to prevent its shareholders from choosing the Data Probe offer, the gravamen of the wrong alleged is a breach of fiduciary duty which we are not free to condemn under existing federal legislation. In Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 97 S.Ct. 1292, 51 L.Ed.2d 480 (1977), the Supreme Court explicitly refused to extend the prohibition against "manipulative ... devices," SEC Rule 10b-5, 17 C.F.R. Sec. 240.10b-5 (1983), to "instances of corporate mismanagement ... in which the essence of the complaint is that shareholders were treated unfairly by a fiduciary." Id. at 477, 97 S.Ct. at 1302. The Court construed the term "manipulative" in a "technical sense of artificially affecting...