Citations
- 411 F. Supp. 133
Full opinion text
MURRAY M. SCHWARTZ, District Judge.
The instant case involves a challenge by several shareholders of E. I. Du Pont de Nemours and Company (“Du Pont”) to a contemplated merger between Du Pont and Christiana Securities Company (“Christiana”), a closed-end non-diversified management investment company registered under the Investment Company Act of 1940. 15 U.S.C. § 80a-l et seq. The plaintiffs, suing derivatively on Du Pont’s behalf seek, on three grounds, to enjoin the merger. They argue that the proposed merger will, when consummated, violate Delaware law because it is unfair to public shareholders of Du Pont. In addition, plaintiffs urge that the merger is violative of Rule lob-5, 17 C.F.R. § 240.10b-5 in two respects: first, the defendants have engaged in a scheme to defraud Du Pont’s public shareholders and second, that defendants have made material misstatements and non-disclosures with respect to the merger.
The defendants in this matter, Du Pont, Christiana and various individual directors and officers of Du Pont have countered plaintiffs’ claims, maintaining that the merger is fair under both Delaware and federal law and that Rule 10b-5 has not been violated. This matter having come on for trial this opinion will constitute the Court’s findings of fact and conclusions of law under Fed.R. Civ.Proc. 52(a). The legal arguments advanced by the parties will be considered below but it is first necessary to fully develop the factual background of the Du Pont-Christiana merger.
I. FACTS
A. The Merger Parties
Christiana is a closed-end non-diversified management investment company registered with the Securities Exchange Commission under the Investment Company Act of 1940. As of July 17, 1972, the date on which the respective Boards of Directors of Du Pont and Christiana approved the proposed merger terms, Christiana’s portfolio consisted of the following:
Christiana was organized in 1915 as a device both to guarantee the retention of control over Du Pont within the Du Pont family and to ensure that the family’s massive Du Pont holdings would be voted as a single unit. Although the original number of such stockholders was quite limited, by 1940 the number of such stockholders had risen in an amount sufficient to trigger the Investment Company Act registration requirement of 100 or more shareholders. However, 75% of Christiana’s outstanding securities are held by “affiliated persons” within the meaning of the ’40 Act and the Securities Exchange Act of 1934. Moreover, 95.5% of Christiana’s common stock is held by 338 persons and the Du Pont family itself still owns, albeit beneficially, three-quarters of the outstanding common stock. Therefore, despite the fact that Christiana’s securities are publicly traded in the over-the-counter market it has retained its character as a device for holding the Du Pont family’s block of Du Pont common stock.
Although both Christiana and Du Pont have consistently maintained that in actual fact Du Pont is not controlled by Christiana, the federal securities laws require a different statutory conclusion. By virtue of Christiana’s 28.3% holdings of Du Pont’s outstanding common stock Christiana is deemed to control Du Pont under Section 2(a)(9) of the Investment Company Act of 1940. 15 U.S.C. § 80a-2(a)(9). Similarly, under the Securities Exchange Act of 1934, Christiana’s Du Pont holdings, when added to the fact that the two companies have five common directors, require a presumption of control by Christiana.
Du Pont is far less a stranger to the public eye than its affiliated person Christiana. Its common and preferred stock are traded on the New York Stock Exchange and in 1971, the last full year preceding the merger negotiations, Du Pont had a net income of $356,500,-000 on net sales of approximately 3.85 billion dollars. This produced earnings per share of $7.33 of which $5.00 per share was distributed to shareholders in the form of dividends.
B. Market History of Christiana and Du Pont
Although a share of Christiana is, in essence, a share of Du Pont because over 98% of Christiana’s investment portfolio is Du Pont common, see, In the Matter of Christiana Securities Company — E. I. Du Pont de Nemours and Company at 9, Investment Company Act of 1940 Rel. No. 8615 (12/13/74), Christiana common has generally traded at a substantial discount from its net asset value. Over the two years preceding the April 28,1972 announcement that merger negotiations were to be undertaken by Du Pont and Christiana, Christiana common generally sold at a discount from net asset value ranging between 20 and 25%.
The discount is probably attributable to two significant factors. First, all dividend income received by Christiana as a result of its ownership of Du Pont common is subject to federal corporate income tax. The effective rate at which such dividend income is taxed is 7.2%. Thus, were Christiana removed as an intermediary between Du Pont and the current Christiana stockholders, the gross amount of dividends distributed directly to those shareholders would be increased by 7.2%. Secondly, Christiana common, which is traded over-the-counter in a fairly thin market, is relatively illiquid compared to the trading volume of Du Pont common. See, In the Matter of Christiana Securities, supra at 22, n. 51. The thinness of the market for Christiana despite the fact that some 11,-710,103 shares of Christiana are currently issued and outstanding seems attributable to two other phenomena: the extremely low or, in some cases, zero, tax basis of individual holders of Christiana which means that sales of Christiana would trigger huge capital gains tax liabilities on the part of selling shareholders and the historical control purpose of Christiana, a goal that would be ill-served by sales of stock belonging to Christiana’s control group.
Other less significant factors may also have had some effect upon the rate at which the market has chosen to discount Christiana’s net asset value. Christiana obviously costs something to operate and while it has consistently followed a practice of declaring dividends on its common stock in an amount nearly equal to its net earnings per share, whatever minimal operating expenses are incurred must be accounted for by further reducing Christiana’s gross after-tax dividend income. Moreover, Christiana’s historical procedure of distributing virtually all of its dividend income to its shareholders is not writ in stone and thus a further part of the market’s discount from net asset value may be attributable to the risk that Christiana one day might seek to retain some of its dividend income. Finally, it should be noted that the closed-end discount phenomenon is neither a recent development nor applicable solely to Christiana.
C. Merger Negotiations
Merger negotiations between Du Pont and Christiana were initiated in late April of 1972 when Christiana’s President, Irenée du Pont, Jr., sent a letter dated April 20, 1972, to C. B. McCoy (“McCoy”), then President and Board Chairman of Du Pont, suggesting that a merger between the two entities would be advantageous to both parties. As a result Du Pont agreed to consider such a merger.
Prior to the start of negotiations the Christiana and Du Pont boards took two basic steps prompted by the extremely close historical relationship and interlocking directorates of the two companies: The appointment of special negotiating committees composed of persons unconnected with the opposing negotiating party and the retention of three investment banking firms to provide financial advice with respect to valuations to be employed during negotiations and the fairness of any proposed merger terms.
The Du Pont board named McCoy and Irving S. Shapiro (“Shapiro”), then Senior Vice-President and a Director of Du Pont as its negotiating committee. Christiana similarly designated a two-man board composed of A. Felix du Pont, Jr., a Christiana Vice-President and Director, and E. B. du Pont, its Assistant Treasurer and also a Director. Du Pont and Christiana jointly retained Morgan Stanley & Co. (“Morgan Stanley”), an investment banking firm, as a financial advisor in connection with the merger. Morgan Stanley had previously assisted both of the merger parties. Christiana and Du Pont each then retained separate financial advisors, choosing Kidder, Peabody & Co., Incorporated (“Kidder Peabody”) and the First Boston Corporation (“First Boston”) respectively. Neither Kidder Peabody nor First Boston had any prior significant relationship with either of the merger parties.
The three financial advisors were asked to prepare reports for the special negotiating committees providing a financial analysis and evaluation of all factors believed relevant to the transaction. Moreover, they were requested to make recommendations as to a range of exchange ratios of Du Pont and Christiana common they considered to be fair, reasonable and consistent with the statutory standards rendered applicable by the Investment Company Act of 1940.
All three investment advisors considered the relative advantages and disadvantages of a merger to both parties and concluded that a merger involving exchange ratios within a certain range would provide advantages to both parties. Further, the investment advisors adopted the view that the proposed transaction essentially involved an exchange of Du Pont stock for Du Pont stock, placing emphasis both upon the extremely heavy weighting of Christiana’s portfolio towards Du Pont common, as well as the historical purposes of Christiana.
Despite the fact that Christiana had usually traded at a substantial discount 1from its underlying net asset value, neither Du Pont’s financial advisor nor Morgan-Stanley assigned any weight to that factor in calculating their recommended exchange ratios. Moreover, all three financial advisors took the position that market value was irrelevant when considering the merger of a non-diversified closed-end investment company into its operating affiliate. As an alternative to market value, Morgan Stanley and Kidder Peabody each employed Christiana’s net asset value as a device for assigning a valuation to Christiana in order to determine an appropriate range of potential exchange ratios. First Boston did not utilize net asset value, but instead approached the transaction from an earnings per share perspective. However, First Boston’s recommendations with respect to exchange ratios that would result in increments to Du Pont’s per share earnings were readily transformable into net asset value terms.
In late June of 1972 the three financial advisors prepared reports advising their respective clients on the range of exchange ratios they deemed fair, as well as articulating the bases both for their conclusions and their modes of analyzing the prospective transaction. On the evening of June 29, 1972 First Boston met with Du Pont’s special negotiating committee and discussed the issues covered in its report. The following morning both negotiating committees met jointly with all three financial advisors in order to more fully develop their understanding of the advisors’ recommendations and conclusions with respect to the proposed merger.
In the reports proffered up to this point by the financial advisors they posed the following recommended merger terms: Kidder Peabody (Christiana’s advisor) — an exchange of Du Pont shares valued at market equal to Christiana’s adjusted net asset value or a range covering a 1.7% premium over Christiana’s net asset value to a 1.7% discount from the adjusted net asset value; Morgan Stanley — a range of discounts from Christiana’s adjusted net asset value of .5% to 2.0%; First Boston — a range of exchange terms resulting in a 2