Metro-Goldwyn-Mayer, Inc. v. Ross

• Decision Date: 13 January 1975
• Docket Number: INC,81,METRO-GOLDWYN-MAYE,Nos. 80,82,D,s. 80
• Parties: Fed. Sec. L. Rep. P 94,944 , Plaintiff-Appellant, v. Jerry ROSS and Arthur B. Ross, Defendants-Appellees. HERITAGE RECORDS, INC., et al., Plaintiffs-Appellants, v., et al., Defendants-Appellees. ockets 73--2271, 73--2306, 73--2686.
• Court: U.S. Court of Appeals — Second Circuit

Page 930

509 F.2d 930

Fed. Sec. L. Rep. P 94,944

METRO-GOLDWYN-MAYER, INC., Plaintiff-Appellant, v. Jerry ROSS and Arthur B. Ross, Defendants-Appellees.

HERITAGE RECORDS, INC., et al., Plaintiffs-Appellants, v. METRO-GOLDWYN-MAYER, INC., et al., Defendants-Appellees.

Nos. 80, 81, 82, Dockets 73--2271, 73--2306, 73--2686.

United States Court of Appeals, Second Circuit.

Argued Nov. 18, 1974.

Decided Jan. 13, 1975.

S. Hazard Gillespie, New York City (Davis Polk & Wardwell, New York City, on the brief, Daniel F. Kolb, Sue Ann Dillport, Mark L. Austrian, New York City, of counsel), for plaintiff-appellant Metro-Goldwyn-Mayer, Inc.

Arnold I. Rich, New York City (Hofer, Rich & Grubman, New York City, on the brief), for defendants-appellees Jerry Ross and Arthur B. Ross and plaintiffs-appellants Heritage Records, Inc., and others.

Before SMITH, HAYS and MANSFIELD, Circuit Judges.

HAYS, Circuit Judge:

Metro-Goldwyn-Mayer, Inc. filed a complaint in the United States District Court for the Southern District of New York alleging that the defendants, Jerry and Arthur Ross, had violated § 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a) (1970), § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) (1970), and SEC Rule 10b--5, 17 C.F.R. § 240.10b--5 (1974) by making misleading statements of material facts in connection with a stock exchange agreement with MGM and by omitting material facts necessary to make their statements to MGM not misleading. MGM also alleged that the Ross brothers had breached several of the warranties they had given in the agreement ¹ On these grounds, MGM demanded rescission of the agreement. The Ross brothers counterclaimed for damages for breach of a related loan agreement primarily on the ground that MGM had failed to provide the financing called for by that agreement. The district court dismissed MGM's claims for rescission and awarded the Ross brothers $200,000 in damages. ² Metro-Goldwyn-Mayer, Inc. v. Ross, 363 F.Supp. 23 (S.D.N.Y.1973). We reverse.

I.

Jerry Ross is a producer of records who prior to April 21, 1970, was the primary owner of Colossus Records, Inc. and a number of related record companies. When Michael Curb became president of MGM Records, a division of MGM, he set out to acquire the Ross companies for MGM in order to acquire the services of Jerry Ross, who had been responsible for a number of hit records.

On April 21, 1970, MGM and the Ross brothers signed a series of contracts, including an exchange agreement under which MGM was to receive an 80% interest in the Ross companies in exchange for 8,333 shares of MGM stock, valued for purposes of the agreement at $300,000. The Ross brothers were to receive additional annual payments of MGM stock over the next five years, depending on the earnings of the Ross companies. The exchange agreement was to be closed at a later date, and section 8(a) provided that all representations and warranties by the sellers would have the same force as though made on the closing date. In section 4(g) of the agreement, the Ross brothers warranted that all accounts receivable were valid, were subject to no offsets, and would be paid 'within six months from the date hereof.' In section 4(p) the sellers warranted that no statement of theirs to MGM contained or would contain any untrue statement of a material fact or an omission of a material fact necessary to make their statements as a whole not misleading.

Another contract signed on April 21 was a loan agreement, under which MGM was to provide financing of up to $500,000 for the Ross companies. The duty to provide financing was to become effective only if the board of directors of the Ross companies decided that such financing was necessary. The board was to consist of six members designated by MGM and three designated by the Ross brothers.

MGM engaged the certified public accounting firm of Arthur Andersen & Co. to conduct a 'purchase investigation' of the Ross companies before the closing. The Andersen report, submitted in September, 1970, reflected representations made by Ross employees that the Ross companies followed the common practice of providing to distributors three so-called free records for every 10 single records purchased and two free records for every 10 albums. In the case of the Ross companies that meant that they charged 45 cents each for the first 10 single records sold and 17 cents each for the next three, for an average price of 38.5 cents and $2.42 for the first 10 albums and nothing for the next two, for an average price of $2.01. In general, the report was a good deal more pessimistic about the companies' financial situation than the Ross companies' accountant, Ellis Elgart, had been in his audit of the May 31, 1970 Ross financial statements. In that audit Elgart certified the worth of the Ross companies to be $358,000, while Arthur Andersen concluded that it should have been $39,750.

On October 8, 1970, the April 21 agreements were closed, with some modifications not relevant here.

II.

In its claim for rescission, MGM relies primarily on the failure of the Ross brothers to inform it of some 70,000 records which the Ross companies had given to distributors free of charge, over and above the usual three on 10 and two on 10 arrangement, which MGM had been told was in force. Rejecting MGM's rescission claim, the district court held that although the distribution by the Ross companies of the additional 70,000 records was a material fact, 'MGM should have known and Jerry and Arthur Ross might reasonably have assumed MGM to know' the approximate number of such records. 363 F.Supp. at 29. We disagree.

The district court's conclusion that there had been no violation of a duty to disclose was based in large part on the fact that during the purchase investigation the Ross companies provided Arthur Andersen with inventory cards which, if explained and interpreted properly, could have revealed all but 12,500 of the 70,000 additional records. However, Rule 10b--5, as well as the terms of the exchange agreement, required the Ross brothers to state all material facts necessary to make other statements not misleading. See, e.g., SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968), cert. denied, 394 U.S. 976, 89 S.Ct. 1454, 22 L.Ed.2d 756 (1969). Such a duty is not discharged merely by giving the purchaser access to company records and letting him piece together the material facts if he can. Stier v. Smith, 473...