TSC INDUSTRIES, INC., Et al. v.

NORTHWAY, INC.

CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE SEVENTH CIRCUIT

No. 74-1471. Argued March 3, 1976-Decided June 14, 1976

Rule 14a-9, promulgated under § 14 (a) of the Securities Exchange Act of 1934, provides that no proxy solicitation shall be made "which... is false or misleading with respect to any material fact, or which omits to state any material fact necessary in order to make the statements therein not false or misleading." The dispute in this case centers on the acquisition of petitioner TSC Industries (TSC) by petitioner National Industries (National). National purchased 34% of TSC's voting securities from TSC's founder and principal shareholder and his family. The founder and his son promptly resigned from TSC's board of directors, and five National nominees were placed on the board, including National's president and executive vice president, who subsequently became, respectively, chairman of the board and chairman of TSC's executive committee. Thereafter, the TSC board approved a proposal to liquidate and sell all of TSC's assets to National by exchanging TSC common and preferred stock for National preferred stock and warrants to purchase National common stock. TSC and National then issued a joint proxy statement to their shareholders recommending approval of the proposal. The proxy solicitation was successful, TSC was placed in liquidation and dissolution, and the exchange of shares was effected. Respondent, a TSC shareholder, brought this action for damages, restitution, and other relief against TSC and National, claiming that their joint proxy statement was incomplete and materially misleading in violation of § 14 (a) and Rule 14a-9 in that it omitted material facts relating to the degree of National's control over TSC (i. e., it failed to disclose the positions in TSC held by National's president and executive vice president, and reports filed with the Securities and Exchange Commission by National and TSC indicating that National "may be deemed a 'parent' of TSC") and the favorability of the proposed acquisition to TSC shareholders (i. e., it failed to disclose certain unfavorable information about the proposal contained in a letter from an investment banking firm whose earlier favorable opinion of the

proposal was reported in the proxy statement, and also recent substantial purchases of National's common stock, suggestive of manipulation, by National and a mutual fund). The District Court denied respondent's motion for summary judgment, but the Court of Appeals reversed, holding that the claimed omissions of fact were material as a matter of law, and defining material facts as "all facts which a reasonable shareholder might consider important." Held:

1. The general standard of materiality best comporting with Rule 14a-9's policies is not the standard applied by the Court of Appeals but is as follows: An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. This standard is fully consistent with the general description of materiality as a requirement that "the defect have a significant propensity to affect the voting process." Mills v. Electric Auto-Lite Co., 396 U. S. 375, 384. It does not require proof of a substantial likelihood that disclosure of the omitted fact would have caused the reasonable investor to change his vote, but contemplates a showing of a substantial likelihood that, under all the circumstances, the omitted fact would have assumed actual significance in the reasonable shareholder's deliberations. Pp. 444–449.

2. The issue of materiality is a mixed question of law and fact, involving as it does the application of a legal standard to a particular set of facts, and only if the established omissions are "so obviously important to an investor that reasonable minds cannot differ on the question of materiality" is the ultimate issue of materiality appropriately resolved "as a matter of law" by summary judgment. P. 450.

3. Under the standard set forth in ¶ 1, supra, none of the omissions claimed to have been in violation of Rule 14a-9 in this case were, so far as the record reveals, materially misleading as a matter of law, and hence respondent was not entitled to summary judgment. Pp. 450-463.

512 F. 2d 324, reversed and remanded.

MARSHALL, J., delivered the opinion of the Court, in which all Members joined except STEVENS, J., who took no part in the consideration or decision of the case.

Joseph N. Morency, Jr., argued the cause for petitioners. With him on the briefs were James T. Otis,

Wesley S. Walton, Milton V. Freeman, and Werner J. Kronstein.

Harry B. Reese argued the cause for respondent. With him on the brief were Arnold I. Shure, Stanley B. Block, Willard J. Lassers, Charles R. Kaufman, and Alex Elson.*

MR. JUSTICE MARSHALL delivered the opinion of the Court.

The proxy rules promulgated by the Securities and Exchange Commission under the Securities Exchange Act of 1934 bar the use of proxy statements that are false or misleading with respect to the presentation or omission of material facts. We are called upon to consider the definition of a material fact under those rules, and the appropriateness of resolving the question of materiality by summary judgment in this case.

I

The dispute in this case centers on the acquisition of petitioner TSC Industries, Inc., by petitioner National Industries, Inc. In February 1969 National acquired 34% of TSC's voting securities by purchase from Charles E. Schmidt and his family. Schmidt, who had been TSC's founder and principal shareholder, promptly resigned along with his son from TSC's board of directors. Thereafter, five National nominees were placed on TSC's board; and Stanley R. Yarmuth, National's president and chief executive officer, became chairman of the TSC board, and Charles F. Simonelli, National's executive vice president, became chairman of the TSC executive committee. On October 16, 1969, the TSC board, with

*Solicitor General Bork and David Ferber filed a brief for the Securities and Exchange Commission as amicus curiae urging affirmance.

438

Opinion of the Court

the attending National nominees abstaining, approved a proposal to liquidate and sell all of TSC's assets to National. The proposal in substance provided for the exchange of TSC common and Series 1 preferred stock for National Series B preferred stock and warrants.1 On November 12, 1969, TSC and National issued a joint proxy statement to their shareholders, recommending approval of the proposal. The proxy solicitation was successful, TSC was placed in liquidation and dissolution, and the exchange of shares was effected.

This is an action brought by respondent Northway, a TSC shareholder, against TSC and National, claiming that their joint proxy statement was incomplete and materially misleading in violation of § 14 (a) of the Securities Exchange Act of 1934, 48 Stat. 895, 15 U. S. C. § 78n (a),' and Rules 14a-3 and 14a-9, 17 CFR §§ 240.14a-3, 240.14a-9 (1975), promulgated thereunder. The basis

3

1 Each share of TSC common stock brought .5 share of National Series B preferred stock and 12 National warrants. Each share of TSC Series 1 preferred stock brought .6 share of National Series B preferred stock and one National warrant. National Series B preferred stock is convertible into .75 share of National common stock. A National warrant entitles the holder to purchase one share of National common stock at a fixed price until October 1978. 2 Section 14 (a) provides:

"It shall be unlawful for any person, by the use of the mails or by any means or instrumentality of interstate commerce or of any facility of a national securities exchange or otherwise, in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors, to solicit or to permit the use of his name to solicit any proxy or consent or authorization in respect of any security (other than an exempted security) registered pursuant to section 781 of this title."

Northway also alleged in its complaint that National pursued a fraudulent plan to acquire TSC for less than its fair value in violation of § 10 (b) of the Securities Exchange Act, 15 U. S. C. § 78j (b),

Opinion of the Court

426 U.S. of Northway's claim under Rule 14a-3 is that TSC and National failed to state in the proxy statement that the transfer of the Schmidt interests in TSC to National had given National control of TSC. The Rule 14a-9 claim, insofar as it concerns us," is that TSC and National omitted from the proxy statement material facts relating to the degree of National's control over TSC

and Rule 10b-5, 17 CFR § 240.10b-5 (1975), promulgated thereunder. Northway has not pursued this claim in the proceedings that we are called upon to review. Northway also brought suit against Charles Schmidt and his family, charging them with aiding and abetting the corporate defendants in violation of § 10 (b) and Rule 10b-5. The District Court granted summary judgment to the Schmidt defendants, and the Court of Appeals affirmed. That aspect of the original suit is not before us.

* Rule 14a-3 (a) provides:

"No solicitation subject to this regulation shall be made unless each person solicited is concurrently furnished or has previously been furnished with a written proxy statement containing the information specified in Schedule 14A."

Schedule 14A, Item 5 (e), requires:

"If to the knowledge of the persons on whose behalf the solicitation is made a change in control of the issuer has occurred since the beginning of its last fiscal year, state the name of the person or persons who acquired such control, the basis of such control, the date and a description of the transaction or transactions in which control was acquired and the percentage of voting securities of the issuer now owned by such person or persons." 17 CFR § 240.14a101, Item 5 (e) (1975).

5 Northway also asserted a claim under Rule 14a-9 that the proxy statement was materially misleading in its assertion that the TSC board of directors had approved the proposed transaction. It contended, first, that the proposal was never legally approved under applicable state law; and, second, that the statement should have in any event disclosed that the proposal received only four affirmative votes, and that the National nominees were cautioned against voting by their legal advisers. The Court of Appeals did not reach the first contention, and it found summary judgment inappropriate on the second. Neither contention is before us.