King v. Kansas City Southern Industries, Inc.
| Decision Date | 19 June 1975 |
| Docket Number | Nos. 74-1191,74-1192,s. 74-1191 |
| Parties | Fed. Sec. L. Rep. P 95,213 Jordan Jay KING and Dorothy King, Plaintiffs-Appellants, v. KANSAS CITY SOUTHERN INDUSTRIES, INC., et al., Defendants-Appellees. |
| Court | U.S. Court of Appeals — Seventh Circuit |
Abraham L. Pomerantz, New York City, Harry Schulman, A. Bradley Eben, Lowell E. Sachnoff, Chicago, Ill., for plaintiffs-appellants.
Lynne E. McNown, Joan M. Hall, Edward Hatton, Chicago, Ill., Marvin Schwartz, New York City, Arthur Susman, Chicago, Ill., Landon H. Rowland, Kansas City, Mo., for defendants-appellees.
Before CLARK, Associate Justice, * and PELL and SPRECHER, Circuit Judges.
Jordan Jay King and Dorothy King, shareholders in Technology Funds, Inc., appeal orders denying them class action status and approving a settlement of all claims arising from the merger of Supervised Investors Services, Inc. and Kemperco, Inc. The Kings with Melvin Stoller (the Kings) brought this action as representatives of four mutual funds (the Funds); Technology Fund, Inc. (Technology), Balanced Income Fund, Inc. (Balanced), Supervised Investors Summit Fund, Inc. (Summit), and Supervised Investors Growth Fund, Inc. (Growth). Their complaint named as defendants Kansas City Southern Industries, Inc. (KCSI) and the principal shareholders and officers of Supervised Investors Services, Inc. (SIS), John Hawkinson, Russell Matthias, Courtenay Davis, John Porter, Jr., J. Milburn Smith and Chester Tripp.
The Kings claimed defendants violated Sections 15 1 and 20(a) 2 of the Investment Company Act of 1940, Sections 10(b) 3 and 14(a) 4 of the Securities Exchange Act of 1934, Rule 10b-5 5 of the rules and regulations of the Securities and Exchange Commission, and their common law fiduciary obligations to the Funds and their shareholders. The plaintiffs sought $18 million in damages and injunctive relief.
The Funds are open-end diversified investment companies registered and regulated under the Investment Company Act of 1940. 6 Virtually all their assets are invested in securities listed and traded on national securities exchanges. By 1971 Summit held securities worth $52 million, Balanced, $14 million, Growth, $197 million, and Technology, $715 million. As is the case with mutual funds, the Funds merely held title to these securities. SIS, the Funds' creator, principal underwriter and investment advisor, controlled all trading in them. In return for this service SIS received an annual management fee based on the total of the Funds assets. In 1969, SIS's advisory fees were $3.5 million and their underwriting commission.$1.2 million. SIS's net assets amounted to approximately $1.5 million. Finally, SIS was controlled in turn by KCSI which owned 54 percent of outstanding SIS common stock.
During 1969 and 1970 the individual defendants staffed the Funds, SIS and KCSI. John Hawkinson was president and Russell Matthias the secretary-treasurer of all four Funds as well as SIS. Both were directors and shareholders in the Funds and SIS, and Hawkinson was a director of KCSI. Chester Tripp was a director of each of the Funds and a director and stockholder of SIS. Courtenay Davis, John Porter and Milburn Smith were the remaining directors and shareholders of SIS.
On November 6, 1969, SIS entered into a merger agreement with Kemperco. SIS agreed to transfer its business, assets and liabilities to a subsidiary of Kemperco bearing the same name, Supervised Investors Services, Inc. Kemperco in return agreed to issue to SIS's shareholders for each share of SIS stock 0.8 shares of Kemperco common stock and 0.2 warrants to purchase Kemperco common stock. During the period the merger agreement was negotiated, Kemperco stock was trading from a low of $19.50 to a high of $27.50. Since such a merger, however, would by operation of law (15 U.S.C. § 80a-15(a)(4) ) automatically terminate the advisory and underwriting contracts between SIS and the Funds, SIS promised further to recommend to Funds shareholders approval of new advisory and underwriting contracts between the Funds and the new SIS. Clearly, gaining shareholders' approval was a crucial preliminary to merger. Meetings were called for Balanced and Technology shareholders for January 15 and for Summit and Growth shareholders for February 19, 1970, and proxy materials were mailed to them.
In a covering letter Hawkinson, citing the recommendations of the SIS management and the Boards of Directors of the four Funds, urged acceptance of the proposed service contracts. Hawkinson's signed letter reads in part:
With this letter you will find a notice and proxy statement with regard to the annual meeting of shareholders. . . . Before you read the proxy statement, I would like to inform you of a major new development affecting the manager of your fund. Supervised Investors Services, Inc., the Fund's investment adviser and underwriter, and Kemperco, Inc., a Chicago based insurance and financial services holding company, have jointly announced a proposed merger of Supervised Investors Services, Inc. into Kemperco, Inc. and the operation of Supervised Investors Services, Inc. as a wholly owned subsidiary of Kemperco, Inc.
The proposed merger, which is described in detail in the attached proxy statement, is subject to certain conditions, including approval by the shareholders of the Fund of new investment advisory and underwriting agreements with Supervised Investors Services, Inc.
Before going further, I want to emphasize that:
1. The proposed merger does not contemplate any changes in your Fund. Your Fund will not be merged. It will retain its separate identity.
2. The name, investment policies and objectives of your Fund will not be changed.
3. Supervised Investors Services, Inc., as a subsidiary of Kemperco, Inc., will continue to operate as an autonomous corporation; and there will be no changes in its management or personnel.
4. Supervised Investors Services, Inc. will continue to be responsible for investment advice and management of your Fund and the distribution of its shares.
The management of Supervised Investors Services, Inc. believes that the proposed merger with Kemperco, Inc. will be beneficial to it and to the shareholders of the Fund in providing a more complete package of financial services and continuous highly qualified management for the future.
The Board of Directors of the Fund approves the continuation of Supervised Investors Services, Inc. as the Fund's investment adviser, manager and underwriter, and recommends approval of the new contracts described and set forth in the attached proxy statement.
Hawkinson did not mention that SIS and the Funds were bound by the proposed merger contract to recommend approval of the new service contracts nor did he indicate the financial advantage he and the other defendants would gain from the merger. The Funds shareholders voted their approval by an overwhelming majority.
In May 1970, the merger went through. SIS and Kemperco's shareholders approved the merger agreement. On May 22, 1970, the transfers of stock took place and the merger was formally completed.
Within two years, six different groups of plaintiffs commenced actions in the Northern District of Illinois challenging the SIS-Kemperco merger. The Kings' case was one of these and was brought with both shareholder derivative and shareholder class action claims. Four suits were brought as straightforward shareholder derivative actions on behalf of the Funds. Rifken v. KCSI, 71 C 2116 (N.D.Ill., Jan. 14, 1974); Simonson v. Hawkinson, 72 C 12 (N.D.Ill., Jan. 14, 1974); Herman v. SIS, 72 C 14 (N.D.Ill., Jan. 14, 1974); Schwartz v. Hawkinson, 72 C 13 (N.D.Ill., Jan. 14, 1974). Finally, the Funds themselves brought a direct action in the same federal district. Technology v. KCSI, 71 C 2349.
All the plaintiffs alleged substantially the same claims. First, they asserted defendants sent Funds shareholders false and misleading proxy statements to secure approval of the SIS-Kemperco merger. They further contended that the new investment advisory and underwriting contracts were thus void. Second, they asserted the SIS-Kemperco merger breached a fiduciary duty owed to the Funds and the Funds shareholders. Arguing that the merger was in reality a sale of fiduciary office, they contended the value of Kemperco stock and warrants transferred in excess of the book value of SIS stock was an unlawful succession fee. Plaintiffs based the first set of claims on the Holding Company Act of 1940, the Securities Exchange Act of 1934 and the rules and regulations of the Securities Exchange Commission. The second set of claims proceeded on a theory of liability recognized by the Second Circuit in Rosenfeld v. Black, 445 F.2d 1337 (2d Cir. 1971). In Rosenfeld an investment advisor to a mutual fund was held personally liable for profiting from the appointment of a new advisor on his recommendation.
Unlike the other shareholder plaintiffs, the Kings moved pursuant to Rule 23, Fed.R.Civ.P., for designation of their action as a class action. They claimed to be a true class representing those persons who held stock in the Funds when the new contracts were voted on and approved. Jordan King and Dorothy King jointly held at that time 200 shares of Summit common stock and Melvin Stoller held 200 shares of Technology common stock. The defendants with the Funds opposed the motion, and Funds moved for dismissal of all pending derivative suits. Finding substantial procedural problems with proper definition of the class and notice, the district court denied the Kings class status. King v. Kansas City Southern Industries, 56 F.R.D. 96 (N.D.Ill.1972). 7 The court, however, refusing to dismiss the derivative actions stayed them and allowed the Funds' direct action alone to proceed.
The Kings were not put off for long. On September 11, 1972, they moved to intervene in the Funds' direct action. The...
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