Matter of Hawaii Corp.

• Decision Date: 24 March 1983
• Docket Number: Civ. No. 79-0037.,Bankruptcy No. 76-0512
• Citation: 567 F. Supp. 609
• Parties: In the Matter of The HAWAII CORPORATION, Debtor. John T. GOSS, Trustee of the Estate of The Hawaii Corporation, Plaintiff, v. Randolph CROSSLEY, et al., Defendants.
• Court: U.S. District Court — District of Hawaii

567 F. Supp. 609

In the Matter of The HAWAII CORPORATION, Debtor John T. GOSS, Trustee of the Estate of The Hawaii Corporation, Plaintiff, v. Randolph CROSSLEY, et al., Defendants.

Bankruptcy No. 76-0512, Civ. No. 79-0037.

United States District Court, D. Hawaii.

March 24, 1983.

COPYRIGHT MATERIAL OMITTED

Loren R. Rothschild, Robert M. Turner, James L. Marable, Fogel, Rothschild, Feldman & Ostrov, Los Angeles, Cal., R. Charles Bocken, Kenneth R. Kupchak, Diane D. Hastert, Damon, Key, Char & Bocken, Honolulu, Hawaii, for plaintiff.

George L.T. Kerr, Paul M. Ganley, Chun, Kerr & Dodd, Honolulu, Hawaii, G. Richard Doty, McCutchen, Black, Verleger & Shea, Los Angeles, Cal., W. Sidney Davis, Jr., Marc J. Schiller, Sharon L. Fishman, Maria A. Fulgieri, Davis, Markel, Dwyer & Edwards, New York City, for defendant Peat, Marwick, Mitchell & Co.

OPINION AND ORDER

PANNER, District Judge, Sitting by Designation.

INTRODUCTION

Plaintiff John T. Goss is trustee in the Chapter X Reorganization of The Hawaii Corporation (THC). He seeks to recover damages of approximately $22,000,000 allegedly suffered by THC as a result of accounting work done by defendant Peat, Marwick, Mitchell & Company (PMM) in connection with the reorganization of THC and American Pacific Group (APG).

Plaintiff's original complaint asserted claims against former officers, directors and auditors of THC. As a result of prior proceedings, PMM is the only remaining defendant. All references in this opinion to "defendant" are to PMM.

Plaintiff alleges he is entitled to recover as THC's successor-in-interest for: (1) violations of the federal and State of Hawaii securities laws; (2) professional malpractice and negligence; (3) breach of contract; and (4) common law fraud.

On July 21, 1982, United States District Judge Martin Pence granted plaintiff's motion for summary judgment on defendant PMM's amended counterclaim. The parties then filed cross motions for summary judgment on the remaining issues. I reserved ruling on the motions until trial because of the age of the case, its complexity and the fact that an imminent trial date had been set when I was assigned the case. At the end of the trial, I took the matter under advisement. I DENY the cross motions for summary judgment and find for the defendant.

BACKGROUND

The Von Hamm-Young Company was incorporated in 1899. It developed from a family-owned business into one of Hawaii's larger corporations. By 1964, when the company changed its name to "The Hawaii Corporation," it was active in construction, merchandising, real estate, laundry, and consumer finance services. THC's revenues grew from approximately $49 million in 1965 to $87 million in 1971. Retained earnings increased during this period from $2.7 million to $8.6 million. It had a long history of uninterrupted quarterly dividends to shareholders. However, by the late 1960s, the officers, directors and financial associates of THC became concerned about its future and began planning for external expansion through acquisitions and mergers.

American Pacific Group was formed in 1959 as Hawaii National Insurance Company. It was primarily a holding company whose subsidiaries, other than THC, were for the most part unprofitable and unseasoned enterprises.

Peat, Marwick, Mitchell & Co. is a partnership engaged in the practice of public accounting. PMM's Honolulu office served as the accountants for APG and THC during the reorganization and until approximately one year afterwards. PMM's Los Angeles office served as the accountants for Falcon Capital Corporation (FCC), a subsidiary of APG until THC acquired FCC in September, 1972.

In May 1967, APG acquired 39% of the THC stock and by February 1968, controlled approximately 50.5% of THC's stock. By 1969, APG had nominated five of the seven THC directors. By August 1970, APG owned approximately 54% of THC's outstanding capital stock. Randolph Crossley was president of APG from 1966 to 1969 and in April 1969, he became president of THC.

APG had, as its goal, consolidation with THC. During 1968-69, THC and APG management representatives and directors discussed the possibility of a merger of the two companies. In November 1970, Crossley stated publicly that APG intended to pursue a merger with THC, after which the survivor would seek a listing on the New York Stock Exchange.

From November 1970 until March 3, 1972, when the reorganization was concluded, the THC and APG Boards of Directors discussed the desirability and the terms of their agreement. Both Boards were composed of experienced, capable businessmen who reviewed extensive evaluations and financial information.

In November of 1970, the THC Board requested that PMM provide pro forma financial statements reflecting the reorganization of APG and THC. The Board also asked PMM to express opinions as to the most advantageous means of combining APG and THC and whether or not the transaction should be accounted for by the "pooling of interests" or by the "purchase" method of accounting.

On December 11, 1970, PMM delivered the pro forma statements accounting for the combination on the basis of purchase accounting with THC as the acquiring company and APG as the acquired company. Two investment companies prepared reports for THC and APG with respect to valuations and exchange ratios. THC, APG, and their subsidiaries had their own internal financial personnel who prepared interim financial statements and cash flow projections.

In its June 30, 1971 report to THC, duPont Glore Forgan, THC's investment banker, concluded that although the reorganization was ultimately in the best interests of the stockholders of THC, the advantages at that time were outweighed by the disadvantages. DuPont Glore Forgan recommended that the reorganization be deferred until APG and THC could satisfy certain conditions.

THC and APG Board members disagreed among themselves as to the validity of the duPont Glore Forgan report. They directed the managements of THC and APG to prepare further reports and analyses for review by the Bank of America and presentation to the boards. The Bank recommended the reorganization. On August 20, 1971, the THC directors approved the merger of THC and APG, with an exchange ratio to be negotiated by a committee of directors from both companies.

The plan of reorganization was executed on September 22, 1971. It provided that APG would transfer its assets and liabilities, including 926,000 shares of THC stock, to THC. THC would then transfer back 818,963 shares of THC stock to APG. APG would then distribute the 818,963 THC shares to its stockholders on the basis of one THC share for each 2.65 APG shares. APG would then dissolve. Before the reorganization, APG as a corporation owned approximately 55% of THC's common stock. After the reorganization, the former APG shareholders owned approximately 52.7% of THC's stock.

A condition precedent to the reorganization was a comfort letter from PMM stating that, on the basis of a limited review, nothing had come to PMM's attention which caused it to believe that there had been any material adverse changes in the consolidated financial position or results of operations of APG or its subsidiaries.

After an exchange of correspondence among APG, PMM, and the SEC about the method of accounting for the transaction, the SEC by inaction permitted the filing of the proxy statement with the plan of reorganization and the attached materials including pro forma financial statements.

PLAINTIFF'S CONTENTIONS

Plaintiff contends that defendant acted negligently and recklessly in performing the accounting services for THC in connection with the reorganization and the subsequent accounting treatment of certain corporate transactions. He alleges that defendant did not comply with Generally Accepted Accounting Principles and Generally Accepted Auditing Standards as follows:

(1) In failing to apply purchase accounting to the reorganization with APG as the acquirer and THC as the acquired.

(2) In issuing the comfort letter as it did in spite of APG's alleged material adverse changes in financial position or results of operation from June 30, 1971 to February 29, 1972 (the comfort period).

(3) In failing to revise the accounting for the APL-FCC Continental sale of insurance transaction as recorded by the companies involved.

(4) In treating the net operating loss carryforward of APG as a current asset on the combined balance sheet after the reorganization.

(5) In failing to revise the accounting for amortization of the New Ventures, Ltd. (an APG subsidiary) cost in excess of net book value.

Plaintiff alleges this conduct violated federal and State of Hawaii securities laws and constituted negligence, breach of contract, and fraud.

RULE 10b-5 CLAIM

Plaintiff contends that PMM recklessly performed its accounting and auditing services in violation of Section 10(b) of the Securities and Exchange Commission Act of 1934, 15 U.S.C. § 78j(b) and Rule 10b-5 of the Securities and Exchange Commission, 15 C.F.R. § 240.10b-5.¹ There is no contention of intentional fraud. Plaintiff asserts that THC was both a purchaser and a seller of securities within the meaning of Rule 10b-5. PMM denies plaintiff's assertion.

Standing to bring a private damage action under Rule 10b-5 is limited to actual "purchasers" or "sellers" of "securities." Birnbaum v. Newport Steel Corporation, 193 F.2d 461 (2d Cir.1952); Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 95 S.Ct. 1917, 44 L.Ed.2d 539 (1975).

A "sale" includes "every contract of sale or disposition of a security or interest in a security, for value." 15 U.S.C. § 77b(3). A "security" is defined as including stocks, bonds and investment contracts. 15 U.S.C. § 77b(1). These broad statutory terms do not include certain instruments if "the context otherwise requires." 15 U.S.C. § 77b. In enacting the securities laws, Congress did not intend to provide a broad federal remedy for all...