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Cramer v. General Telephone & Electronics Corp.

decided as amended august 8 1978.: July 18, 1978.



Before Gibbons, Rosenn and Hunter, Circuit Judges.

Author: Gibbons


This is an appeal from the termination of a shareholder's derivative suit brought by Harold Cramer*fn1 on behalf of the shareholders of General Telephone & Electronics Corporation (GTE). The defendants are Leslie H. Warner, Theodore F. Brophy, John J. Douglas, and William Bennett, directors of the corporation, and Arthur Andersen & Co., GTE's auditors. In his complaint, the plaintiff contends that the defendants (1) violated Sections 10(b), 12(b) (1), 13(a), and 14(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b), 78L (b)(1), 78m(a), & 78n(a), and the regulations promulgated thereunder, (2) defrauded the corporation in violation of state law, and (3) breached their common-law fiduciary duties to the corporation. Plaintiff's Complaint, P 10. The district court, 443 F. Supp. 516, granted the defendants' joint motion for summary judgment on the §§ 13(a) and 14(a) claims on the ground that such claims were barred by res judicata. The court dismissed the claims under § 10(b), Rule 10b-5, and § 12(a) for failure to state claims upon which relief could be granted. Fed.R.Civ.P. 12(b)(6). The state-law claims were dismissed on two grounds res judicata and lack of subject matter jurisdictions. Although we disagree somewhat with the reasons underlying the district court's decision, we affirm its judgment in all respects.*fn2


The thrust of the plaintiff's claim is that the corporation was injured by the making of illegal overseas payments by GTE subsidiaries to foreign governmental officials and to private persons. The plaintiff contends that the defendants participated both in the making of the payments and in the failure to disclose the payments in reports disseminated to GTE stockholders. Paragraph 14 of the complaint contains the major allegations:

14. During a period commencing at a time unknown to plaintiff, and continuing at least until November, 1975, defendants, in violation of the Exchange Act and the Rules and Regulations promulgated thereunder and in violation of the Common law in connection with General participated, and/or acquiesced in, and/or aided and abetted, and/or failed to discover when in the exercise of due diligence they would have discovered, devices, schemes and artifices to defraud General, to waste the assets of General, to utilize the assets of General for unlawful purposes, to falsify the records of General, to defraud the United States Government by falsifying tax returns; to make untrue statements of material facts and to omit to state material facts in reports disseminated to shareholders of General; and, in the case of the individual defendants, breached their fiduciary duties and obligations to General.

Cramer rests his allegations largely on the findings which appear in a report on a special investigation conducted by the Audit Committee of the Board of Directors of GTE. That report, which is incorporated by reference in paragraph 15 of the plaintiff's complaint, was distributed to the shareholders as part of the proxy statement prior to the stockholders' annual meeting on April 21, 1976. The Audit Committee, which consisted of four outside directors who had not been involved in the questionable transactions, had been authorized by the Board of Directors to determine whether between January 1, 1971, and December 31, 1975, GTE or any of its international subsidiaries had made "illegal political contributions, unlawful payments to domestic or foreign government officials or other payments which were otherwise improper or improperly recorded. . . ." Audit Committee Report (Exhibit A to Plaintiff's Complaint), at 13. The Committee was assisted by the Washington, D.C. law firm of Wilmer, Cutler and Pickering, which had never previously represented GTE, and by the accounting firm of Arthur Andersen, a defendant herein.

After investigating GTE's international operations for three months, the Audit Committee produced a 51-page report. That report, which was dated March 4, 1976, revealed that GTE and its subsidiaries had paid approximately $8 million to, or for the benefit of, foreign governmental officials. Most of these payments took the form of commercial kickbacks, rebates, or bribes to officials of private foreign customers. Another sum of approximately $21/2 million was paid pursuant to a pre-January 1, 1971 commission arrangement between GTE officials and officers of a single foreign company (called the "Customer" in the Audit Committee's report). This commission arrangement stemmed from GTE's sale of its substantial ownership interest in the Customer to a private investment company controlled by a group of foreign nationals (the "Group"). The foreign government itself had urged GTE to make the sale. Since the purchasing group did not have adequate financial resources to acquire GTE's interest, GTE agreed to finance part of the purchase price by paying the Group commissions on future GTE equipment sales to the Customer. After being told that a competitor would agree to such an arrangement if it declined to do so, GTE agreed to pay the commissions to a company designated by the purchasers and located in a third country.*fn3 Members of the Group became officers and directors of the Customer. Audit Committee Report, at 22.

The Audit Committee found that Warner, Brophy, Douglas, and Bennett, the defendants herein, had been involved, in varying degrees, "in the negotiation, formalization and implementation" of the commission arrangement described above. Id. at 28. Bennett was found to be at least aware of two other questionable financial transactions. However, the Committee concluded that none of these directors profited personally from these payments and that all of them believed they were acting in the best interests of the corporation. Id. at 28-29. The Committee's report did not discuss the possibility of litigation against these directors, and its recommendations to the Board did not include the pursuit of such litigation.*fn4

After the Audit Committee's report had been distributed to the GTE shareholders, three separate derivative suits were filed in different courts. The first of these was brought by Elias Auerbach, a GTE stockholder, against the same defendants as are named in the instant litigation. Auerbach's suit, which was filed in the Supreme Court of New York in Westchester County on March 16, 1976, alleged that the illegal payments constituted a waste of GTE's assets and that the defendants, by permitting such payments, had breached their fiduciary duties to the corporation. Two weeks later, Ralph Limmer filed another shareholder's derivative suit in the United States District Court for the Southern District of New York, charging that Warner, Brophy, Douglas, and Bennett had violated §§ 13(a) and 14(a) of the 1934 Act and had breached their fiduciary duties to the shareholders. Arthur Andersen was not made a defendant in that action. Finally, on June 18, 1976, Cramer commenced the present suit in the United States District Court for the Eastern District of Pennsylvania.

Cramer did not, before filing this suit, make a demand upon the GTE directors to institute the litigation. See Fed.R.Civ.P. 23.1. In paragraph 13 of his complaint, he alleges that such a demand would have been futile since the Audit Committee had not recommended litigation against the directors and since, in his opinion, the individual defendants dominated the Board of Directors.

On April 21, 1976, after the Auerbach and Limmer actions had been filed but before the instant action had been commenced, GTE's Board of Directors resolved to create a Special Litigation Committee to assess GTE's position with respect to the shareholders' derivative suits.*fn5 After Cramer had filed the instant lawsuit, the Board authorized the Committee to examine that suit too. The Committee consisted of three outside directors who had not been members of the Board of Directors at the time the events described in the Audit Committee's report occurred. Chief Judge Charles S. Desmond, now retired from the New York Court of Appeals, served as Special Counsel to the Committee.

After examining the work of the Audit Committee, the Special Litigation Committee made several findings and recommendations. The Committee found first that the investigation by the Audit Committee had been "complete, comprehensive and thorough." Special Litigation Committee Report, at 11. Judge Desmond informed the Committee members that in his opinion neither the state nor the federal claims were meritorious. The Special Litigation Committee advised GTE's General Counsel to take the position in Limmer and Cramer that the federal claims were meritless, that the state-law claims should be dismissed for lack of subject matter jurisdiction, and that the suits, even if meritorious, were not in the best interests of GTE or its shareholders and thus should not be prosecuted on GTE's behalf. The Committee recommended that the Auerbach action be opposed as being contrary to the best interests of GTE or its shareholders.*fn6

Relying on the conclusions of the Special Litigation Committee, the defendants moved to dismiss the complaints in Auerbach and Limmer. The state court dismissed Auerbach's complaint on the ground that this Committee's business judgment that the suit was not in GTE's best interests barred the prosecution of the suit. Auerbach v. Bennett, No. 572/77 (Sup.Ct. of New York, Westchester County, April 29, 1977). In Limmer, the district court dismissed the § 14(a) claim for failure to state a claim upon which relief could be granted. The § 13(a) claim was voluntarily withdrawn by the plaintiff and later dismissed with prejudice. Once the federal claims had been terminated, the district court dismissed the pendent state-law claims for lack of subject matter jurisdiction. Limmer v. General Tel. & Elec. Corp., 76 Civ. 1494 (S.D.N.Y. March 11, 1977).

The defendants also moved to dismiss the complaint in the present case. The defendants claimed that all the federal claims were barred, under principles of res judicata and collateral estoppel, by the district court's decision in Limmer. The district court below agreed that Cramer's §§ 13(a) and 14(a) claims were barred by res judicata. However, because claims under §§ 10(b) and 13(b)(1) require elements of proof different from those necessary under §§ 13(a) and 14(a), the court concluded that those claims were not barred by Limmer. Nevertheless, the court dismissed the § 10(b) and Rule 10b-5 claims on the grounds: (1) that the alleged fraud was not in connection with the purchase or sale of a security; (2) that GTE was not damaged by the fraudulent activities; and (3) that the plaintiff's complaint failed to allege that the defendants had intended to defraud the corporation. The § 12(b)(1) claim was dismissed because the plaintiff had not satisfied the standing requirements of § 18(a) of the 1934 Act, 15 U.S.C. § 78r(a).*fn7 The state-law claims were dismissed for two reasons. First, the court concluded that those claims were precluded by the res judicata effect of the New York judgment in Auerbach. Secondly, even assuming that the claims were not barred by res judicata, the district court declined to exercise its pendent jurisdiction over those claims. See United Mine Workers v. Gibbs, 383 U.S. 715, 86 S. Ct. 1130, 16 L. Ed. 2d 218 (1966). The plaintiff filed a timely notice of appeal from the district court's decision.*fn8


The doctrine of res judicata bars repetitious litigation of the same cause of action. As the Supreme Court has explained, the doctrine "rests upon considerations of economy of judicial time and public policy favoring the establishment of certainty in legal relations." Commissioner of Internal Revenue v. Sunnen, 333 U.S. 591, 597, 68 S. Ct. 715, 719, 92 L. Ed. 898 (1948). Once a court of competent jurisdiction has entered a final judgment on the merits of a particular cause of action, the parties to that action are bound not only by every matter which was offered and considered in reaching that judgment, but also by every other matter which could have been offered. Cromwell v. County of Sac, 94 U.S. 351, 352, 24 L. Ed. 195 (1876); Hubicki v. ACF Industries, Inc., 484 F.2d 519, 524 (3d Cir. 1973). Absent circumstances which would render inequitable the application of res judicata, a judgment on the merits will generally not be disturbed by a court in a subsequent suit involving the same parties.

We agree with the district court that the Limmer decision bars Cramer's § 14(a) claim against the directors. In Limmer, the district court granted the directors' motion to dismiss the plaintiff's § 14(a) claim. The court explained its decision as follows:

Section 14(a), after all, contemplates the prevention, or redress, of such injury as would be, or is, directly traceable to a transaction authorized by a corporate electorate in the partial light of a misleading proxy solicitation. . . . In the present case, by contrast, the damages claimed, if actually suffered, flow from breach of a fiduciary obligation owed as a director or officer, rather than from any shareholder vote obtained by false proxy solicitation materials.

Limmer Opinion, at 4. Before a judgment can be given res judicata effect, both the parties and the issues in the prior and subsequent suits must be identical. Expert Elec., Inc. v. Levine, 554 F.2d 1227, 1233 (2d Cir.), Cert. denied, 434 U.S. 903, 98 S. Ct. 300, 54 L. Ed. 2d 190 (1977). Both of these conditions are satisfied here. Limmer's and Cramer's claims arose out of the same transactions. All four directors named as defendants in the instant case were defendants in Limmer. In a shareholder's derivative suit, the substantive claim belongs to the corporation. See Ross v. Bernhard, 396 U.S. 531, 538-39, 90 S. Ct. 733, 24 L. Ed. 2d 729 (1970). Although different shareholders brought the two actions, the actual plaintiff on whose behalf the claims were brought is the identical corporation, GTE. Since the Limmer court's dismissal of ...

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