Genzer v. Cunningham

• Decision Date: 26 September 1980
• Docket Number: Civ. No. 77-71965.
• Citation: 498 F. Supp. 682
• Parties: Benjamin GENZER, Co-executor of the Last Will and Testament of Leo Genzer, deceased, and Charles Heit, Plaintiffs, v. Harry B. CUNNINGHAM, Otto Eckstein, Charles E. Exley, Jr., Martha W. Griffiths, Ray W. MacDonald, James A. McCullough, Paul S. Mirabito, Ben L. Rouse, Alan E. Schwartz, Robert M. Surdam, Clifton R. Wharton, Jr., DuRay E. Stromback, Harry B. Rottiers, Manuel Garcia, Robert J. O'Connell, Charles W. Peace, Jr., Thomas E. Garvale, A. Finley France, Lloyd William Cali, J. Roy Henry, Price Waterhouse & Co. and Burroughs Corporation, Defendants.
• Court: U.S. District Court — Western District of Michigan

498 F. Supp. 682

Benjamin GENZER, Co-executor of the Last Will and Testament of Leo Genzer, deceased, and Charles Heit, Plaintiffs, v. Harry B. CUNNINGHAM, Otto Eckstein, Charles E. Exley, Jr., Martha W. Griffiths, Ray W. MacDonald, James A. McCullough, Paul S. Mirabito, Ben L. Rouse, Alan E. Schwartz, Robert M. Surdam, Clifton R. Wharton, Jr., DuRay E. Stromback, Harry B. Rottiers, Manuel Garcia, Robert J. O'Connell, Charles W. Peace, Jr., Thomas E. Garvale, A. Finley France, Lloyd William Cali, J. Roy Henry, Price Waterhouse & Co. and Burroughs Corporation, Defendants.

Civ. No. 77-71965.

United States District Court, E. D. Michigan, S. D.

September 26, 1980.

Elwood S. Simon, Southfield, Mich., Sidney Garwin, New York City, for plaintiffs.

Wolfgang Hoppe, Detroit, Mich., for individual defendants.

Brian Sullivan, Detroit, Mich., for Price Waterhouse.

Donald M. Swan, Detroit, Mich., Edwin J. Wesley, New York City, for Burroughs Corp.

OPINION

GUY, District Judge.

This matter is before the court on defendants' motion to dismiss or for summary judgment in a stockholders' derivative suit brought on behalf of Burroughs Corporation, a Michigan corporation, raising claims under § 14(a) of the Securities and Exchange Act (SEA) of 1934, 15 U.S.C. § 78n(a) and state law.¹ Plaintiffs complain that during the period 1971 to 1975 certain directors of Burroughs Corporation authorized questionable overseas payments to foreign officials and that the corporation's accountant, Price Waterhouse, had knowledge of the payments.

A Special Litigation Committee consisting of two directors determined that maintenance of this action against either the directors or Price Waterhouse would be contrary to the best interests of the corporation and has recommended that the shareholders' action not be pursued. All defendants claim that this determination is conclusive under the "business judgment rule" and requires dismissal of the action, unless plaintiffs demonstrate that the Special Litigation Committee did not act independently and in good faith in arriving at their decision to terminate the litigation.

I. The Payments

In 1975, Burroughs' management requested that its independent public accountant, Price Waterhouse, include as part of its regular audits reports of any improper payments or political contributions made in violation of established policy. As a result of these inquiries, senior management was informed that questionable withdrawals had been made by Burroughs' personnel in Country A, that these withdrawals may have been used in connection with questionable payments to local officials or third parties to obtain orders, and that the Price Waterhouse firm in Country A may have been aware of the withdrawals and their purpose.

An investigation was immediately initiated by Price Waterhouse and Burroughs' management. The Board of Directors was informed of the questionable withdrawals on January 6, 1976, at which time they authorized Price Waterhouse to continue and to expand its investigation for questionable payments on behalf of the company for the five years prior to December 31, 1975. The Securities and Exchange Commission (SEC) was informed of the withdrawals and ongoing investigation on the following day.

On January 21, 1976, the Board of Directors established a Committee on Business Practices which consisted of three outside directors and was empowered to investigate possible questionable payments. The Committee on Business Practices retained the law firm of Cleary, Gottlieb, Steen & Hamilton (hereinafter Cleary-Gottlieb) who had previously done legal work for Burroughs as special outside counsel, and Price Waterhouse as independent accountants to work on the investigation.

The investigation covered the five years ending December 31, 1975, and encompassed operations in the United States and 21 overseas marketing units in twenty countries. Over 300 questionnaires were used to elicit information from officers, directors, key personnel, law firms, and consultants employed by Burroughs. In addition, 56 personal interviews of officers and employees were conducted as was a special review for compliance with the company's Business Practices Policy in the United States and 21 overseas marketing locations. A more detailed investigation was conducted in Country A by Price Waterhouse personnel from their Miami office.

After the detailed report of Cleary-Gottlieb and Price Waterhouse was submitted to the Committee on Business Practices, the Committee formulated its conclusions in a July 28, 1976 report to the Board of Directors which was also filed with the SEC. The Committee concluded that $1,695,000 was improperly withdrawn and presumably used to cover payments, most of which were used to obtain orders for equipment from government entities and some of which were apparently paid to low-level government personnel to facilitate the orders. The withdrawals were found to have been covered by fictitious invoices and a portion of the total figure was used to obtain the fictitious invoices. No former or present officer or director was found to have had knowledge of the payments in Country A. While the report to the Committee reflected that the Price Waterhouse partner in Country A knew of improper deductions relating to the payments taken on the corporate tax return, this was not specifically set forth in the Committee's report. The Committee's report did reflect that amended returns were being prepared.

The Committee also reported that similar payments totalling approximately $550,000 had been made in Countries B and C, and that no officer or director had knowledge of the payments. Finally, the Committee reported that approximately $161,000 in political contributions and approximately $177,000 in other questionable payments had been made in Country D by a joint venture company in which Burroughs had an interest, but that these payments were not known to Burroughs' personnel and no payments were made after Burroughs acquired control of that entity in 1975. Isolated instances of payments were also found to have occurred in four other countries but these were deemed inconsequential.

In addition to the investigation, Burroughs' management took disciplinary action against those Burroughs' personnel directly involved in the withdrawals and those who should have detected or instituted controls to prevent the withdrawals. They also disseminated the Business Practices Policy to employees and established procedures to review compliance with the policy, including establishment of a permanent Committee on Business Practices.

The Complaint

On August 11, 1977, Benjamin Genzer, as co-executor of the Estate of Leo Genzer, filed this derivative action against Burroughs' directors, insiders, and accountants.² The complaint consists of two counts, the first of which alleges common law and federal securities law claims based on insider trading. The claims in Count I were settled by the parties and dismissed by this court on February 14, 1978. The second count is concerned with the questionable payments described, supra, and raises claims against individual directors and Price Waterhouse. Plaintiffs allege that the illegal overseas payments were a waste of Burroughs' corporate assets and the individual director defendants are liable for breach of fiduciary duty owed to the corporation in that they caused, participated in, acquiesced in, knew of, or should have known of the payments. Plaintiffs further allege that the director defendants caused the issuance, from 1971 to 1976, of proxy statements which were false and misleading by failing to disclose the improper payments, and that the proxy statements were sent to shareholders prior to the election of directors and approval of Price Waterhouse as corporate accountant for those years. Plaintiffs allege that Price Waterhouse breached its contract with Burroughs by failing to conduct its audits in accordance with generally accepted auditing procedures and by willfully withholding information of improper payments from the shareholders, the New York Stock Exchange, and the SEC.

In addition to demanding that defendants account to Burroughs for the amount of the illegal payments and expenses incurred as a result of the payments, plaintiffs demand that the election of the directors be set aside for the years 1971-1976, and that Price Waterhouse return all fees paid to it.

The Motions

Burroughs and the four individual director defendants who have been served have filed these motions for summary judgment with regard to all claims in Count II alleged against them, or, alternatively, for dismissal of the federal securities law claims. They contend that they are entitled to summary judgment as to all claims, whether based on state common law or federal law, because the Special Litigation Committee has made a good faith business judgment that these claims should not be pursued in the form of a derivative action on behalf of the corporation. In the alternative, they contend that the cause of action based on § 14(a) fails to state a claim upon which relief can be granted and should be dismissed pursuant to F.R.Civ.P. 12(b)(6).

Price Waterhouse moves for summary judgment on the basis of the Special Litigation Committee's good faith business judgment that the derivative claim should not be maintained against them as a non-director third party defendant. It also argues that the complaint fails to state a claim upon which relief can be granted, that there are no genuine issues as to any material fact, and that Price Waterhouse is entitled to summary judgment as a matter of law.

II.

In Burks v. Lasker, 441 U.S. 471, 99 S.Ct. 1831, 60 L.Ed.2d 404 (1979), the Supreme Court addressed the question of when the business judgment rule can be used to dismiss a shareholder derivative action based on violation of a federal statute. In Burks, the Court was faced with the question in the context of a business...