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        Sidney B. Silverman, New York City, for plaintiff; Joan T. Harnes, Jewel H. Bjork, New York City, of counsel.

        Willkie, Farr & Gallagher, New York City, for Leasco Data; Anthony Phillips, L. Robert Griffin, New York City, of counsel.

        Simpson, Thacher & Bartlett, New York City, for Lehman Brothers; Rogers Doering, Charles Edelman, Dean C. Rohrer, New York City, of counsel.

        Shearman & Sterling, New York City, for White Weld; Robert F. Dobbin, Joseph McLaughlin, New York City, of counsel.

        WEINSTEIN, District Judge.

        This case raises the question of the degree of candor required of issuers of securities who offer their shares in exchange for those of other companies in take-over operations. Defendants' registration statement was, we find, misleading in a material way. While disclosing masses of facts and figures, it failed to reveal one critical consideration that weighed heavily with those responsible for the issuethe substantial possibility of being able to gain control of some hundred million dollars of assets not required for operating the business being acquired.

        Using a statement to obscure, rather than reveal, in plain English, the critical elements of a proposed business deal cannot be countenanced under the securities regulation acts. The defense that no one could be certain of precisely how much was involved in the way of releasible assets is not acceptable. The prospective purchaser of a new issue of securities is entitled to know what the deal is all about. Given an honest and open statement, adequately warning of the possibilities of error and miscalculation and not designed for puffing, the outsider and the insider are placed on more equal grounds for arms length dealing. Such equalization of bargaining power through sharing of knowledge in the securities market is a basic national policy underlying the federal securities laws.

        In this class action plaintiff seeks damages resulting from alleged misrepresentations and omissions in a registration statement prepared in conjunction with a 1968 offering of a "package" of preferred shares and warrants of Leasco Data Processing Equipment Corporation (Leasco) in exchange for the common stock of Reliance Insurance Company

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(Reliance). He is a former shareholder of Reliance who exchanged his shares for the Leasco package. Suit was commenced in October 1969 on behalf of all Reliance shareholders who accepted the exchange offer between August 19, and November 1, 1968.

        It is alleged that Leasco (1) failed to disclose an approximate amount of "surplus surplus" held by Reliance and (2) failed to fully and accurately disclose its intentions with regard to reorganizing Reliance or using other techniques for removing surplus surplus after it had acquired control. These failures, it is claimed, represented material misrepresentations or omissions in violation of Sections 11, 12(2), and 17(a) of the Securities Act of 1933 (15 U.S.C. §§ 77k, 77l(2), and 77q(a)), Sections 10(b) and 14(e) of the Securities Exchange Act of 1934 (15 U.S.C. §§ 78j(b), 78n(e)), and Securities and Exchange Commission Rule X-10B-5 (17 C.F.R. § 240.10b-5).

        Defendants are Leasco, the issuer; Saul P. Steinberg, Leasco's chief executive officer; Bernard L. Schwartz, Leasco's President; Robert B. Hodes, Leasco's general counsel and a director; and White, Weld & Co. and Lehman Brothers, the dealer-managers. In addition to denials, the answers raise a number of defenses.

        During the period August 19, through November 1, 1969 Leasco offered one share of convertible preferred stock and one-half warrant of Leasco in exchange for each share of Reliance common stock tendered. The preferred shares offered carried a $2.20 annual dividend and a conversion value of $55 if converted into common stock. The warrants permitted the holder to purchase Leasco common stock for $87 per share at any time up to June 4, 1978.

        Reliance common shares had a market value of approximately $30 in December of 1967. As word of an impending takeover attempt spread, the price rose gradually to a high of $99 7/8 during the tender offer period. The price of Leasco common shares was also rising during this period. On August 16, 1968, the last trading day before the exchange offer was effective, Leasco common stock closed at $87 5/8 while its warrants were listed at a high bid of $43. Reliance shares were then selling at $66.

        By September 13, 1968, 3,994,042 shares of Reliance, amounting to 72% of those outstanding, had been tendered and Leasco had obtained control of Reliance. Leasco ultimately acquired 97% of Reliance's common stock by the termination of the tender offer on November 1, 1968.

        Reliance's surplus surplus is the central element in this litigation. Leasco's desire to acquire it provided much of the original impetus for the exchange offer. Lack of disclosure of facts relating to the amount of surplus surplus and Leasco's intentions concerning its use, as well as the materiality of those omissions provide the basis of plaintiff's complaint. Finally, the method and difficulty of ascertaining its amount is critical to the defendants' affirmative defense. We cannot proceed without examining the concept.

        Reliance is a fire and casualty insurance company subject to stringent regulation by the Insurance Commissioner of Pennsylvania. Such a company is required by the regulatory scheme to maintain sufficient surplus to guarantee the integrity of its insurance operations. Such "required surplus" cannot be separated from the insurance business of the company. That portion of surplus not required in insurance operations has been referred to as surplus surplus. In a widely relied upon report to the New York Insurance Department, the matter was summed up as follows:

        "The `required surplus' is one that will be adequate to cover for a reasonable period of time any losses and expenses larger than those predicted and any declines

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in asset values, including all chance variations in the crucial factors of the operation. Any surplus beyond this cover is `surplus surplus' which, by definition, is unneeded; it may be treated quite differently in the process of regulation." State of New York Insurance Department, Report of the Special Committee on Insurance Holding Companies at 43 (Feb. 15, 1968) (hereinafter referred to as Insurance Department Report).

        Simply put, surplus surplus is the highly liquid assets of an insurance company which can be utilized in non-regulated enterprises. While the importance of the concept has only recently received full recognition the idea is not new; it was previously referred to as "redundant capital."

        Insurance companies are not generally permitted to engage in non-insurance business activities. If, therefore, surplus surplus is to be of any practical use it must be separated from the insurance operation with its concomitant regulatory restrictions.

        In 1967 Carter, Berlind & Weill undertook a study of fire and casualty companies. The result was a report by Edward Netter submitted in August 1967. It develops the concept of "The Financial Services Holding Company," envisioning modification of the corporate structure of the typical fire and casualty company to permit more flexible utilization of its resourcesparticularly surplus surplus. Netter postulated a one-stop, comprehensive financial institution servicing virtually all of the consumer's financial needs. Aggressive use of capital redundancy (surplus surplus) was a critical element in Netter's analysis. He estimated Reliance's capital redundancy at $80,000,000 as of December 31, 1966.

        Leasco's interest was aroused by the Netter Report. Michael Gibbs, Leasco's Vice President for Corporate Planning, subsequently prepared a "Confidential Analysis Of A Fire And Casualty Company" based "to a large extent" on Reliance. He worked from the Netter Report to illustrate the specific benefits to Leasco of increased earnings per share and leverage potential in acquiring and reorganizing a fire and casualty company with large surplus surplus. His initial idea was to establish a parent holding company to which the fire and casualty company (Reliance) could transfer its surplus surplusfreeing it from regulatory restrictionwhile continuing to operate as an insurance subsidiary. In his opinion such an acquisition was potentially extremely valuable to Leasco. As he noted:

        If Leasco could acquire control of an F & C * * * (3) large sums of capital for computer leasing would be available, (4) an aggressive acquisition and investment company (the holding company) would initially have a large sum of available capital in addition to potential debt leverage. * * (6) Leasco can create a true financial services company."

        Gibbs estimated Reliance's surplus surplus at $125,000,000 as of June 30, 1967 or $100,000,000 as of the end of 1967.

        These two documents, along with the Insurance Department Report, provided the impetus for Leasco's take-over bid. Steinberg considered surplus surplus "important to Leasco" and A. Addison Roberts, Reliance's President, came away from negotiations with the impression that "one important aspect of Reliance that commended itself to Leasco was Reliance's surplus surplus." Leasco protected its interest in the surplus surplus by including a provision in an August 1, 1968 agreement with Reliance requiring its management to provide the maximum amount then available to the holding company Leasco would form.

        The only statements in the prospectus with regard to surplus surplus appears on page five. It neither mentions the amounts that Leasco's management had

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in mind nor suggests the importance of Reliance's possible surplus surplus. It reads:

        "The Company [Leasco] believes that this Exchange Offer is consistent with the announced intention of the Reliance management to form a holding company to become the parent of Reliance. That intention was communicated to Reliance stockholders on May 15, 1968 by A. Addison Roberts, the president of Reliance, who wrote that the holding company concept would serve the interests of Reliance and all its stockholders `by providing more flexible operations, freedom of diversification and opportunities for more profitable utilization of financial resources.' The Company supports those objectives and intends to do all it can to promote their realization as soon as practicable. * * * Reliance will diligently pursue its previously announced intention to form a holding company which Reliance will provide with the maximum amount of funds legally available which is consistent with Reliance's present level of net premium volume. * * *"

        Plaintiff contends that anything as important to the overall transaction as the amount of surplus surplus should have been disclosed by some sort of approximation. He asserts that such a computation could, in fact, have been made by the techniques used by Netter and Gibbs with information in Leasco's possession or that sufficient additional data could have been obtained to arrive at a reliable estimate. He further claims that while Leasco disclosed its intention to form a holding company to make use of Reliance's resources, it should also have disclosed that Leasco was considering other plans for separating surplus surplus from the insurance operation by reorganization and liquidation of Reliance or by declaration of a special dividend.

        Defendants, in contrast, maintain that such omissions were not material because

        "* * * the stockholders who exchanged Reliance shares for the Leasco package would not have been deterred from doing so by an estimate of surplus surplus, but rather would have been made all the more anxious to tender."

        This belief stems from their perception that a large block of liquid assets in the hands of an aggressive acquisition-oriented company like Leasco would have made the Leasco package even more attractive than Reliance shares. They also assert that such an inclusion would have been "bullish" in violation of SEC standards it would have made the prospectus a selling document.

        Defendants' second principal argument is that surplus surplus could not have been calculated by Leasco because an accurate estimate required (1) access to Reliance's financial data, (2) the judgment of its management, and (3) the opinion of the insurance commissioner, all of which were denied Leasco by the hostility of Reliance's management and its attempts to obstruct the take-over bid.

        Finally, defendants contend that any other proposals for removing surplus surplus from Reliance were simply matters being considered by counsel. They never reached the level of a specific plan by Leasco during the pendency of the exchange offer.

        The problem and the variety of methods of determining surplus surplus were discussed in the New York Insurance Department Report in the context of how an insurance department should determine what is "required surplus." A variety of techniques were set out:

        "The `required surplus', which should be assured by regulation, is easy to state in the abstract, but difficult to implement in practice. It calls for analysis of the variables that the surplus

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to policyholders is expected to cover. Essentially they are three. First the surplus must absorb any basic insurance costs (losses and expenses) which are in excess of the premiums charged. Second, the surplus must absorb any under-valuation of loss or claim reserves. Third, the surplus must absorb any declines in asset values. To this should be added any surplus required to finance necessary growth.

        "Well-known rules-of-thumb for making approximations have been developed. The so-called `two-to-one' rule constitutes an approximation to the specification of required surplus, and can be applied in the absence of anything better. Under most circumstances it is surely too stringent when used as a test of solidity. The rule is based on a theory developed by a former New York Insurance Department Chief Examiner and was utilized in the first draft of the 1939 Recodification of the Insurance Law as a yardstick for payment of dividends.

        "A similarly rough, but probably much too liberal, approximation is found in the English statutes. A non-life insurer must have a surplus of at least 50,000 if the general premium income of the company in the previous year did not exceed 250,000, a fifth of that income if it exceeded 250,000 but not 2,500,000, or the aggregate of 500,000 and a tenth of the amount by which that income exceeded 2,500,000.

        "The insurance regulatory personnel of some states have concluded that premium writings of three times policyholders' surplus is safe but that four times is risky. Sometimes this is made a little more sophisticated by adding common stock investments to premium writings, in recognition of the fact that surplus must cover not only bad operational experience but also a stock market decline. In actual administration in a department as competent as New York's actual application can be still more refined and discriminating, though New York, like the others, relies more on judgment than on precise quantitative standards."

        The difficulties set out by the New York Insurance Department Report were also perceived as realistic problems by the insurance industry. Roberts, President of Reliance, and a cooperative witness of defendants was of the opinion that what needed consideration was: (1) the relationship of premium writings to surplus; (2) underwriting results; (3) investment policy of the company; (4) its re-insurance arrangements or treaties; (5) exposure to catastrophies; (6) adequacy of loss and premium reserves; (7) quality and characteristics of the agency plan or company; and (8) the quality of management. He indicated that some of the data pertaining to these criteria were not matters of public record.

        He concluded that the evaluation of these factors was largely a matter of judgment and nearly impossible without full access to company data.

        Similarly, Steinberg, Chief Executive Officer of Leasco, considered the rules of thumb method discussed by the Insurance Department Report and used in both the Netter and Gibbs memoranda to be "unreliable" methods of determining surplus surplus given the lack of access to Reliance management. Consequently, he considered the estimates contained in these documents to be inaccurate and undependable. He testified that he himself had never arrived at an estimate he considered accurate with any degree of certainty throughout the preliminary stages and even through the exchange offer period. Thus, he stated, when the question of including such an estimate in the prospectus arose it was decided on the advice of counsel not to include one.

        According to defendants, the result of this pervasive feeling of uncertainty about the accuracy of the estimates put forward by Netter and Gibbs, or any estimate, was that none of the principals in the exchange offer ever calculated surplus

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surplus, commissioned anyone to compute it, or even attempted to estimate it. Nor did the underwriters attempt at any time to obtain an estimate from Reliance. In fact, they did not even communicate with Reliance.

        This is not to suggest that no estimate of surplus surplus was available to Leasco during the negotiations and exchange offer periodthe Netter Report had estimated it at $80 million and Gibbs had indicated $100 and $125 million as his approximations. A range of $50-$125 million was discussed at meetings between Reliance and Leasco in October 1968. Leasco simply, according to defendants' testimony, considered these estimates speculative in light of their then state of knowledge of Reliance.

        Nor should it be inferred that an estimate could not have been obtained at least by Roberts, who was, of course, privy to Reliance's data. He stated bluntly that he could have made such a calculation "damn quickly" if given a reason to do it. He had not calculated it because he was never presented with a specific need to do so. No one from either Leasco or the underwriters ever asked him to calculate surplus surplus during the pendency of the exchange offer, but he could have done so if asked. Whether he might or would have is one of the subsidiary issues in this litigation.

        Following the submission of the Gibbs memorandum on January 11, 1968, Leasco developed an active interest in acquiring Reliance. By April 3rd of that year it had taken a substantial position in Reliance stock132,000 shares, roughly 3%, worth over four million dollars.

        As early as February 9, 1968 Roberts received word from a partner in a Philadelphia brokerage firm that Leasco was interested in buying Reliance. Accordingly, he sent a letter to his stockholders on May 15, 1968 indicating that Reliance intended to form a holding company to become the parent company of Reliance. This would benefit Reliance and its stockholders "* * * by providing more flexible operations, freedom of diversification and opportunities for more profitable utilization of financial resources through the Holding Company concept." While this document implies recognition of surplus surplus and indicates an intention to aggressively utilize it, the term itself was not used nor did Roberts calculate it because "[t]his was more or less a public relations maneuver" to demonstrate Reliance's progressive attitude and forestall a takeover bid. This letter was subsequently referred to by Leasco on page five of its prospectus, quoted above.

        Representatives of Leasco and Reliance met in early June, 1968 to discuss the possibility of a merger between the two companies. Steinberg tried to convince Roberts of the potential for creating new opportunities in the financial service company area. He believed that a merger of a sound insurance company with a company like Leasco which had a strong technological base "would make an exciting combination." Reliance was not particularly interested in the prospect, but Roberts said he would present any specific proposal to his board; none was suggested at that time. Because of the general nature of these discussions, surplus surplus was never specifically discussed and apparently no calculations were made.

        Leasco announced a tender offer for Reliance shares on June 22, 1968. At that time it offered one convertible debenture having a principal amount of $110 and paying annual interest of $4.00 and one warrant for every two Reliance shares tendered. The Reliance management wrote to its shareholders on June 24, advising them not to act in haste with regard to the offer.

        Hodes, a member of Leasco's board and a partner in its counsel's law firm, by telegram dated June 24, 1968 requested Reliance's cooperation in the preparation of a registration statement on SEC Form S-1 in conjunction with

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the registration of the Leasco shares into which the debentures were convertible and promised to promptly furnish Reliance with proofs of the registration statement for its comments. Roberts replied, by telegram dated July 1, 1968, that:

        "* * * the Reliance Executive and Finance Committee is studying Leasco's proposal. Reliance cannot incur the expense and potential liability of preparing and supplying the information requested until the Board of Directors has determined whether the Leasco proposal is in the best interests of Reliance and its stockholders."

        A copy of the preliminary registration statement filed with the SEC on July 8, 1968 was sent to Roberts on July 9, along with a request for advice as to its accuracy. Similarly, a copy of an actuarial consultant's report on Reliance was forwarded to Reliance with a request for comments on July 12. Roberts responded on July 15 that "[w]e are studying the requests made in your letter of July 9th and will advise you in due course." Reliance apparently never complied with these requests for information.

        During the greater part of July the posture of the Reliance officers toward the exchange offer and Leasco was one of hostility, apparently motivated by the conviction that the offer was not in the best interests of Reliance and its shareholders and further by its concern with regard to Leasco's intentions toward them personally should the offer succeed.

        Speaking of the first meeting between Leasco and Reliance in June, Roberts testified: "I was less than friendly about it because I was not interested, and they were pursuing it rather vigorously." He similarly characterized a subsequent meeting held in Philadelphia in late July:

        "* * * [T]he discussion was about whether we can make an amicable arrangement, an affiliate [sic] or merger, and discussion was rather abrasive. I guess I was the leading character in that respect." (emphasis added).

        Perhaps the best expression of this relationship was provided at trial by Saul Steinberg:

        "It is somewhat hard for me to characterize it, but, I think that Mr. Roberts viewedhe constantly has characterized this as he was a king and we were about to make him a baron, and the relationship was always on a personal basis, cordial, but I think that I certainly had a lot of respect for him and I still do * * *but it was cold. It * * * wasn't friendly, we were taking over his company." (emphasis added).

        Reliance filed a lawsuit against Leasco in mid-July, the purpose being "to inhibit the tender offer." Subsequently, on July 23, 1968, Roberts wrote a strong letter to his shareholders expressing opposition to the proposed exchange offer:

        "Your Board of Directors has very carefully weighed the pros and cons of the Leasco offer in the preliminary prospectus and strongly recommends that you reject the proposed exchange of Leasco Debentures and Warrants for your Reliance Stock." (emphasis in original).

        He listed the following as the reasons for not tendering: (1) the exchange was a taxable transaction; (2) Leasco was small and was spending large fees on the exchange offer itself; (3) the debentures would be subordinated to other debts; (4) Reliance stockholders would be contributing a disproportionate share of earnings and assets in the combined company; (5) Leasco common stock had never paid a dividend; (6) the debentures and warrants had no voting power; (7) any tender was irrevocable and eliminated the Reliance shareholder's ability to take advantage of favorable market changes during the exchange period; and (8) if earnings were to drop off the highly leveraged capitalization of Leasco might cause "financial stringencies."

        Indicating that the Board of Directors did not believe Leasco's long term prospects

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were as good as its high price-earnings ratio would suggest, he summed up management's position:

        "[W]e are recommending that you do not accept the Leasco paper. The other alternatives presently available are that you hold your investment or sell your shares on the open market."

        This document is particularly significant because of the insight it provides regarding the depth of opposition to the exchange offer as late as July 23. Viewed in conjunction with the failure to provide information and the filing of the law suit, it is clear that Roberts' group was prepared to employ a full panoply of defensive techniques in an attempt to bust the exchange offer. Such resolve in late July becomes crucial in light of conduct on and after August 1, 1968.

        The final paragraph of the July 23 letter relates directly to the problem of the alleged omissions to state an amount of surplus surplus. Reliance management informed its shareholders that Leasco might not be the only possible tenderor and impliedly suggested that they not accept the first offer made.

        "In considering these alternatives you should know that in the last several weeks Reliance management has negotiated with several other companies and has received a number of offers. In the judgment of your Board, all of these were, like Leasco's proposal, not sufficiently attractive to warrant recommendation to you at this time. We are continuing to have talks with several other interested companies and your management promises to take all possible steps to consummate an affiliation with an investment quality company and insure that your long term investment remains sound, secure and profitable."

        In short, they implied a better deal if the tender offer were frustrated.

        This promise to actively seek an alliance was made more credible by the fact that the Netter report had been distributed on Wall Street so that the attractiveness of fire and casualty companies was known to security analysts. Roberts' testimony was that many of his shareholders believed that the company was "going to be raided"; he was aware as early as May, 1968 that "many mutual funds were buying this stock" in anticipation of takeover bids.

        Shortly after this letter was sent to Reliance shareholders, its management once again met with Leasco to discuss a possible affiliation or merger. It was this meeting which was described as "abrasive" by Roberts. It accomplished nothing and the relationship between the two apparently did not improve until later in July when representatives of Leasco and Reliance met. They worked out the substance of an agreement which modified the offer somewhat and gave Reliance management very substantial personal benefits in exchange for withdrawal of active opposition to the exchange offer and assurances of cooperation in setting up a holding company. The results of these discussions were confirmed in a contract executed August 1, 1968.

        The August 1st agreement represents the end of open hostility, tacit acceptance of a Leasco takeover, and at least the beginning of a rapprochement between the two management groups. Thereafter, an effective working relationship commenced between what was to be parent and subsidiary. While the personal relationships may not have warmed immediately, the business associations improved considerably to the point that Reliance's management "co-operated with them within reason" after around mid-September and actively after October 18, 1968.

        The avowed purpose of entering into the August 1st agreement was that "Reliance has heretofore expressed opposition to Leasco's proposed Exchange Offer, and * * * Leasco desires that Reliance withdraw such opposition". Leasco agreed that if it should acquire a majority of Reliance shares it would

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nevertheless vote its shares for at least five years to maintain a majority of the existing Reliance Board of Directors. It bound itself not to elect more than one-third plus one of the directors of Reliance. In effect it reposed a voting trust in the old management.

        Roberts was guaranteed his position as director and chief executive officer of Reliance. His associates covenanted to cooperate in setting up a holding company to release from insurance operations "the maximum amount of funds available"i. e., Reliance's surplus surplus.

        As is apparent, a primary function of the agreement was to protect Leasco's interest in Reliance's surplus surplus. Because the voting trust arrangement denied Leasco day-to-day control of Reliance for five years, it required that Roberts and his associates do nothing to diminish profitability and thus limit its financial resources and that they form a holding company to make the maximum amount of surplus surplus available to the Leasco controlled holding company.

        The contract protected Reliance management from liability arising from the tender offer itself:

        "Nothing contained herein shall be deemed to require Reliance or its management or the stockholders to recommend to the stockholders of Reliance that they accept the Exchange Offer or to oblige Reliance to cooperate in the preparation of any Registration Statement in connection therewith or to assume or take any liabilities or responsibility in connection therewith."

        While Roberts was willing to withdraw his opposition and even cooperate, he clearly did not wish to incur any liability for a registration statement which he was not preparing. He thus avoided any affirmative duty to formally involve himself in the registration process and denied Leasco the use of his name on the registration statement.

        The critical significance of this document arises from the assurances it provided the Reliance management that (1) the ordinary insurance business of the company would not be interfered with by non-insurance interests and (2) there would be no major disruption of the prerogatives of Reliance's management team as a result of a successful exchange offer. Thus, the two principal reasons for anxiety and opposition by Reliance officials were resolved favorably.

        In addition to the security guaranteed by the August 1, 1968 contract, Roberts reaped a number of substantial personal benefits. His salary was increased from $80,000 to $100,000 a year shortly thereafter. He was granted an option to purchase 5,000 shares of Leasco at 30% of the market price when granted$27.15 which he exercised on October 23, 1968 when Leasco shares were selling at $114.25. Thus, during the pendency of the exchange offer Roberts was the recipient of an $87.10 per share discount, or a bonus of approximately $435,000. He also received a future option on 10,000 additional shares. Finally, he was accorded a position on the Leasco Board of Directors. Roberts took further pains to protect and preserve his own financial well being. He kept his substantial holdings of Reliance shares without tendering. Whatever happened to Reliance shareholders, he was to be well taken care of.

        Immediately after the August 1st reconciliation, Reliance withdrew the lawsuit it had filed against Leasco. It mailed its shareholders a letter stating that whether to exchange was a decision they would have to make and indicating that Leasco had increased the offer and granted management a voting trust. Roberts apparently also furnished Leasco with a stockholders list enabling it to transmit the prospectus and formal tender offer.

        Prior to the withdrawal of Reliance's opposition Leasco had offered one debenture and one warrant for each two Reliance shares tendered. Leasco finally offered one preferred share and one-half warrant for each share tendered. Whether the final package was in fact

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more advantageous than the original offer is not clear. What is clear, however, is that while the original package was taxable to the tenderor on an installment basis only as he realized gain, the final offer was taxable immediately.

        The Reliance management group realized the tax disadvantage to the Reliance shareholders, who might have to pay tax on the exchange before receiving any proceeds with which to pay it. Nevertheless, it dutifully maintained the neutrality bargained and paid for in the August 1st contract. Having accepted the imminent takeover on August 1st, Roberts was no longer concerned with details such as tax consequences to his own shareholders to whom he owed a fiduciary duty.

        Roberts' withdrawal of opposition, acceptance of Leasco's takeover, and subsequent cooperation during the pendency of the exchange offer, when viewed in light of his own poor opinion of the package offered, provides important insight into the state of his mindan issue critical to defendants' contention that he would not have cooperated in helping compute surplus surplus. True to his own evaluation of the merits of the Leasco exchange offer, Roberts refused to tender his own shares. It is clear that the neutral posture taken by Roberts after August 1, 1968 was not that of an elected corporate officer who believed that the exchange offer was necessarily in the best interests of his shareholders, but rather the stance of a pragmatic business man who perceived that a tender of shares at a premium over market price was likely to be successful and that it was better to acquiesceadvancing his personal fortune in the process than to incur the displeasure of the raiders.

        Roberts also made it clear that nothing occurred between July 23, and August 1, to change any of the eight specific reasons stated in his letter of opposition dated July 23. The August 1st agreement did not make these factors any less compelling.

        Shortly after the August 1st agreement was consummated, a revealing exchange of letters occurred between the Deputy Insurance Commissioner of Pennsylvania and Roberts. On August 2nd the Deputy Commissioner inquired about the Leasco takeover, the existence and extent of surplus surplus, and the position of Reliance's management on the takeover and its future course of action.

        Roberts' reply on August 6th expressed the belief that the activity in Reliance stock foretold a takeover bid and that "* * * the rumors had turned into reality in that we were receiving calls from companies interested in acquiring Reliance, commencing several months ago." He further stated that in his opinion Reliance did have surplus surplus which could be removed from the insurance operation but that it was very "difficult to measure with exactness"a somewhat disingenuous reply in view of his testimony at the trial that he could have computed it quickly. Most revealing, however, is his attitude toward the Leasco exchange offer.

        "The Reliance management did not seek the affiliation with Leasco. In fact, our Board of Directors much preferred that our Company not be owned by non-insurance interests; however, in the light of what has taken place we have accepted the fact that Leasco will probably obtain control of the Company. If so, we have agreed * * *

        "(b) That Leasco will receive our cooperation in forming a holding company with their having the right to withdraw any surplus funds of Reliance within the framework of satisfying the regulatory authorities that sufficient funds are kept in the business for it to be operated with at least its present premium income.

        "If the answers to these questions are not sufficient for your purpose, will you please advise us as we will be very happy to elaborate on any points or

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questions you might wish to present to us."

        At this date Roberts still had not expressed in writing a specific opinion regarding surplus surplus. He had, however, indicated his resignation to the Leasco takeover, his intention to cooperate with Leasco, and his willingness to answer any inquiry by the insurance department regarding surplus surplus and its disposition. Roberts' state of mind reflected that of other members of the Reliance board as of August 19, 1968 when the Leasco registration statement became effective and the exchange offer commenced.

        The exchange offer was so successful in the early days that by September 13, 72% of the shares had been tendered and Leasco had acquired control. The offer was extended for the second time on September 16, with a supplement to the prospectus indicating the success of the takeover. Between August 1, and mid-September, Roberts had, according to defendants' testimony, not been in direct contact with Leasco as he awaited the outcome of the exchange offer. But as it became certain that Leasco would be his employer, he abandoned his neutral stance.

        "Q Now then, Mr. Roberts, during the changeover period, you and other members of Reliance's management team cooperated with Leasco, did you not?

        "A Well, let's put it this way, August the first we stopped opposition of keeping the agreement [sic]. The next time I talked to people from Leasco or anyone in the Reliance management to my knowledge, there may have been other talks but I am not aware of them, the first time I did was the middle of December [sic] [September], when Leasco got control of over 80% of the stock. From that time we cooperated with them within reason.

        "Q * * * you and the management team cooperated in good faith after mid-September of 1968?

        "A That's correct."

        The exchange offer was extended four more times. As Roberts became more accustomed to the takeover his cooperation "within reason" became "active cooperation" by October 18the date of the last extension.

        On that date Roberts himself mailed a letter to the remaining Reliance shareholders describing the exchange offer, indicating the recent performance of Leasco securities on the market, and informing them that Leasco intended to declare a dividend of 48 cents on December 1, 1968 which they would not receive if they did not tender by November 1st. He concluded:

        "Although the Reliance management makes no recommendation as to the Leasco Exchange Offer, we do wish to point out that in view of Leasco's having over 90% of the Reliance stock, you will be a minority stockholder if you retain the Reliance stock. We strongly recommend that you reconsider you position and consult your financial advisor or broker as to whether you should accept the Leasco offer or take other possible courses of action."

        Roberts purpose in writing this letter was admittedly to induce intransigent stockholders to tender their shares though, as already noted, he himself never tendered.

        During the exchange period discussions were carried on between Hodes, Leasco's counsel, and Peter Korsan, counsel for Reliance, regarding methods of ultimately separating Reliance from its surplus surplus, and, if possible, effecting a tax savings for Leasco. Roberts was aware of these discussions. In the course of these meetings a range of $50-$125 million of surplus surplus was discussed. The figure was, however, apparently not Korsan's. During this period each of the principals was conducting an independent legal and factual investigation of reorganization schemes,

Page 560

holding company concepts, and tax consequences to Leasco. In at least one instance Korsan had discussions with the general counsel for the Pennsylvania Insurance Department in connection with formation of a holding company. In a memorandum to Roberts dated September 27, 1968 Korsan estimated the maximum surplus which could be distributed to a holding company by way of dividend under Pennsylvania law would be $125 million, but Leasco was not, according to defendants' testimony, made privy to this estimate.

        So far as relevant to this litigation, the major Leasco concern during this tender period was how Reliance might be reorganized to accomplish tax savings. While several legal variations were explored during September and October they remained merely matters for consideration by counsel and never rose to the level of corporate plans.

        Plaintiff, Dudley Feit, tendered his shares on October 14, 1968long after it was clear that the tender offer would be successful and after Roberts and his associate Korsan were actively cooperating with Leasco. At no time was the discussion of surplus surplus in the prospectus changed, despite the fact that a number of supplements were issued. The exchange offer terminated on November 1, 1968.

        After November 1, both management teams continued their studies of alternatives for reorganizing Reliance. Korsan met with a representative of the Insurance Department on November 14 and discussed a range of surplus surplus. On December 20, 1968, however, the Insurance Department was as yet uncertain as to how determination of surplus surplus related to actuarial studies. Reliance had not obtained approval for separation of a specific amount.

        A. The January 1969 Registration Statement

        Highly significant with respect to Leasco's claims that it could give no estimate of surplus surplus was the fact that it did just that a few months after the tender period ended. It did so with no more data than it had during the exchange offer period.

        Leasco filed a Form S-1 Registration Statement with the SEC on January 31, 1969 with a prospectus dated February 3, 1969. This registered various securities to be issued in the future among which were the common shares which could be obtained upon exercise of the warrants contained in the exchange package. The prospectus quite properly discussed Leasco's recently acquired insurance business and the plan for reorganizing Reliance to Leasco's benefit:

        "Reliance and the Company are in the process of seeking to cause a reorganization of Reliance, subject to regulatory approvals, the effect of which will be to eliminate minority interests and to make available to the Company, for use in its various business and acquisition activities, approximately $125,000,000 of excess surplus of Reliance. It is the opinion of Leasco that this amount represents funds which Reliance has on hand in excess of the legal requirements of its business. No assurance can be given that such excess funds will ultimately be made available to the Company in such amount or that if so made available that such funds will be profitably utilized by the Company." (emphasis added).

        This paragraph was also included in a draft of a preliminary prospectus prepared in June of 1969, but never made effective.

        Barely three months after the termination of the exchange offer when Leasco sought to sell its own shares, rather than acquire Reliance's, it included the type of qualified approximation of surplus surplus which plaintiff contends was material to the August 19, 1968 exchange offer. Leasco's lawyer, Hodes, sought to justify this surprising change in position by testifying that the inclusion resulted from the development of a "decent working relationship." He further testified that this new relationship had

Page 561

conferred previously denied access to Reliance and the Insurance Commissioner and that both were consulted before including the estimates.

        The Court has concluded, however, that Hodes' recollection is not accurate. Roberts was not consulted. He acquiesced after the paragraph on surplus surplus had been written by the same Leasco personnel who had participated in drafting the exchange offer prospectus. Roberts' deposition on the point was, at best, equivocal:

        "Q Who brought up the subject of surplus-surplus?

        A As I recall, I became aware of it because there was a $125 million figure put in the prospectus.

        Q What did you say about this?

        A I asked where the figure came from.

        Q Who did you ask?

        A One of the people who was working on the prospectus.

        `Q What did they say?

        A I don't recall that they had any definite answer. Maybe it came from Mike Gibbs. I don't know. Nobody knew. They haven't asked me about it. That's why I was rather curious."

        It is clear that the Insurance Commissioner had not been consulted about the use of this $125,000,000 figure.

        The dealer managers, White, Weld & Co. and Lehman Brothers, played a somewhat limited role in the exchange offer. Leasco's attorneys accepted primary responsibility for preparation of the registration statement with the brokerage houses performing only the "due diligence" function. This function as described by representatives of the firms Fred D. Stone of White, Weld and Sidney Kahn of Lehman Brothersincluded a line by line review of the prospectus accompanied by demands for documentation of particular statements included in the draft by Leasco as well as independent investigation of books and records. These "due diligence" meetings were held on June 28 and 29 and July 1, 2, 3, and 5, 1968 at Leasco's attorney's office in New York.

        White, Weld and Lehman are not precisely in pari materia in this case. White, Weld had representation on Leasco's board after June 17, 1968 and had participated in four prior offerings by Leasco, while this was Lehman's first experience with Leasco.

        White, Weld had accumulated data gathered as part of the prior offerings. They thoroughly reviewed Leasco's audit statements with Leasco's accountant, Touche, Ross & Company. They also examined the report of an actuary firm hired to examine Reliance.

        With regard to surplus surplus, Stone, for White, Weld, was well informed. As early as 1965 he worked with the concept then known as "redundant capital" in conjunction with staving off a tender offer and later, in 1968, he participated in forming a holding company. He received the Netter Report and the Gibbs Memorandum in January or February of 1968 and requested a copy of the New York Insurance Department Report sometime after June 22. When Leasco raised the question of including an estimate of surplus surplus, he concluded that surplus surplus could not be computed accurately because there was no factual basis for such a computation in the absence of access to Reliance's management and the insurance commissioner.

        Stone had in mind Leasco's requests for information and the lack of response when he gave this opinion. He was at no time disabused of the notion that Reliance would not provide data to assist in an approximation of surplus surplus. Since, based on his own experience, he had high regard for the competence of both Leasco's representatives and its law firm, there was no reason for him to suspect that they would be withholding relevant information. For this reason he relied on their representation, implied

Page 562

and actual, that the situations with regard to access to Reliance management remained unchanged. This accorded with his usual practice of relying upon the issuer or its counsel to produce relevant material from its files rather than to personally inquire into corporate developments such as negotiations between target and acquiring companies. Consequently, he made no effort to directly contact either Reliance or the Pennsylvania Insurance Commissioner about surplus surplus.

        Counsel for the dealer managers, Bell, Boyd, Lloyd, Haddad & Burns of Chicago, examined the corporate records of Leasco, its corporate minutes, director actions and basic contracts. Jack M. Whitney, II, a former SEC Commissioner, was the lawyer primarily in charge of the dealer manager's duties. He participated in the extensive "due diligence meetings" conducted in New York where the preliminary prospectus was examined. When the subject of Reliance's intention to form a holding company arose during these meetings Whitney became involved in a discussion of surplus surplus. He was admittedly uninformed about the concept and those present at the meeting, particularly Stone of White, Weld, undertook to edify him. Following intensive exploration of the concept and the limitations inherent in attempting to approximate it, he rendered an opinion that an estimate could not properly be included in the prospectus.

        On August 13, 1968barely six days before the registration statement became effectiveWhitney received yet further confirmation of his opinion of July in the form of a copy of a letter from Wilkie, Farr & Gallagher to the SEC. It reads:

        "Certified financial statements of Reliance Insurance Company are not included in the Amendment since that company has continued to refuse to cooperate in the making of the Exchange Offer. Although the Reliance Insurance Company management is not actively opposing the Exchange Offer they have expressly declined to support or recommend it and have accordingly declined to furnish information in connection with this Registration Statement." (Emphasis supplied.)

        On August 21 and September 18, 1969, Whitney sent a written favorable opinion to the dealer managers regarding the accuracy and completeness of the registration which became effective August 19, 1968.

        The position of the dealer-managers that surplus surplus should not be estimated was, the Court concludes, based upon information furnished by Leasco that Reliance continued to refuse to cooperate. This was not true. Roberts and Reliance had not been asked to confirm estimates after August 1st when the probabilities of a successful takeover became increasingly great. But the dealer-managers were not aware that such cooperation was available.

        Plaintiff seeks relief under three separate sections of the 1933 Securities Act. Section 11 creates civil liability for material misstatements and omissions contained in a registration statement. 15 U.S.C. § 77k. Section 12(2) imposes civil liability on a seller who uses such misrepresentations in any sale whether or not by registration statement. 15 U.S.C. § 77l(2). Section 17(a) makes it unlawful to sell securities by the use of an "untrue statement of a material fact" or any omission of a material fact (15 U.S. C. § 77q(a); civil liability is arguably also available to an injured buyer under this section, but the issue has not been definitely resolved. See Globus v. Law Research Service, 418 F.2d 1276, 1283-1284 (2d Cir. 1969), cert. denied, 397 U.S. 913, 90 S.Ct. 913, 25 L.Ed.2d 93 (1970); VI L. Loss, Securities Regulation 3913-3914 (1969).

        Plaintiff also asserts that the Securities Exchange Act of 1934 provides relief under both Section 10(b)pursuant to Rule X-10b-5and Section 14(e). 15 U.S.C. § 78j(b); 17 C.F.R. § 240.10b-5; 15 U.S.C. § 78n(e). The former makes it unlawful "to make any untrue statement of a material fact" in connection with the

Page 563

purchase or sale of "any security", while the latter creates the same illegality "in connection with any tender offer or request or invitation for tenders." Civil liability has been established for violation of Rule 10b-5. See SEC v. Texas Gulf Sulphur, 401 F.2d 833 (2d Cir. 1968), cert. denied sub nom, Coates v. SEC & Kline v. SEC, 394 U.S. 976, 89 S.Ct. 1454, 22 L.Ed.2d 756 (1969) (liability under Rule 10b-5); Fischman v. Raytheon, 188 F.2d 783 (2d Cir. 1951) (establishes civil remedy under Rule 10b-5). It also can be based on Section 14(e). See Mills v. Electric Auto-Lite Company, 396 U.S. 375, 90 S.Ct. 616, 24 L.Ed.2d 593 (1970) (Section 14(a) and Rule 14a-9 use the same operative language found in Section 14(e)); J. I. Case v. Borak, 377 U.S. 426, 84 S.Ct. 1555, 12 L.Ed.2d 423 (1964) (same).

        The case before us involves misrepresentations included in a registration statement. While liability might well lie under the other broader provisions urged by plaintiff, we will focus on Section 11. It deals exclusively with registration statements such as the one before us. Before turning to our discussion of Section 11 a few comments on the disclosure philosophy of the federal securities laws are necessary in order to establish the setting in which the requirements of Section 11 must be applied.

        The keystone of the Securities Act of 1933, and of the entire legislative scheme of the securities laws, is disclosure. Knauss, A Reappraisal of the Role of Disclosure, 62 Mich.L.Rev. 607 (1964). The 1933 Act is almost exclusively preoccupied with accurate disclosure of facts, favorable and unfavorable. Folk, Civil Liabilities Under the Federal Securities Acts: The BarChris Case, 1 Securities L.Rev. 3, 13, 16-17 (1969) (reprinted from 55 Va.L.Rev. 1 (1969)). "All the Act pretends to do is to require the `truth about securities' at the time of issue". Douglas and Bates, The Federal Securities Act of 1933, 43 Yale L.J. 171 (1933). See also F. Wheat, Disclosure to Investors 10, 46 (1969) (hereinafter referred to as The Wheat Report); Comment, BarChris: Due Diligence Refined, 68 Colum.L.Rev. 1411 (1968).

        "The emphasis on disclosure rests on two considerations. One relates to the proper function of Federal government to investment matters. Apart from the prevention of fraud and manipulation, the draftsmen of the '33 and '34 Acts viewed that responsibility as being primarily one of seeing to it that investors and speculators had access to enough information to enable them to arrive at their own rational decisions. The other, less direct, rests on the belief that appropriate publicity tends to deter questionable practices and to elevate standards of business conduct." The Wheat Report at 10.

        See Douglas and Bates, The Federal Securities Act of 1933, 43 Yale L.J. 171, 172 (1933).

        A primary objective is to place potential securities purchasers on a parity with their vendors to the extent practicable. Folk, Civil Liabilities Under the Federal Securities Acts: The BarChris Case, 1 Securities L.Rev. 3, 20 (1969) (reprinted from 55 Va.L.Rev. 1 (1969)). The Act's "fundamental purpose * * * was to substitute a philosophy of full disclosure for the philosophy of caveat emptor and thus to achieve a high standard of business ethics in the securities industry." SEC v. Capital Gains Research Bureau, 375 U.S. 180, 186, 84 S.Ct. 275, 280, 11 L.Ed.2d 237 (1963). See also In re Investors Management Company, et al., Sec.Exch.Act Release No. 9267, S.E.C. No. 3-1680, memorandum at 6-9 (SEC July 29, 1971). The focus on disclosure reflects the insight gained by experience that without complete, accurate and intelligible information about a company, investors cannot make intelligent investment decisions with regard to its securities. The Wheat Report conceives of the information requirement as an effort to assure

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the integrity of the free market for securities:

        "A classic statement of the purposes of provisions designed to inform the trading markets is found in the report of the House Committee on the '34 Act:

        `No investor, no speculator can safely buy and sell securities * * * without having an intelligent basis for forming his judgment as to the value of the securities he buys or sells. The idea of a free and open public market is built upon the theory that competing judgments of buyers or sellers as to the fair price of the security brings about a situation where the market price reflects as nearly as possible a just price. Just as artificial manipulation tends to upset the true function of an open market, so the hiding and secreting of important information obstructs the operations of the markets as indices of real value. There cannot be honest markets without honest publicity.'" The Wheat Report at 50.

        Another commentator views disclosure as a prerequisite to accurate determination of intrinsic value:

        "Because of the nature of securities, a buyer cannot make an immediate value judgment, as he would with tangible items. He must look behind the piece of paper and examine the merits of the company which has issued the security. The buyer must of necessity rely on the information given to him and on material generally available from the company. The less information available, the less the market price will be representative of the security's true value and the greater will be the opportunity for fraud." Knauss, A Reappraisal of the Role of Disclosure, 62 Mich.L.Rev. 607, 610 (1964).

        Cf. Ratner v. Chemical Bank New York Trust Company, 329 F.Supp. 270, 276 (S.D.N.Y.1971) ("Truth in Lending Act", 15 U.S.C. § 1601 et seq., requires disclosure of interest rates in order "to put the borrower in possession of the pertinent information before the plunge * * *").

        The secondand for our purposes less importantgoal of the full disclosure policy is deterrence. This consideration arose from excesses of the 1920's and the havoc subsequently wreaked on investors. The drafters accepted as an article of faith and common sense that if management must bare all on pain of civil and criminal liability its dirty intra-corporate linen will be cleaned before the registration statement is filed. Concomitantly, such disclosure has the prophylactic effect of promoting general business integrity.

        "Brandeis, to whom many give credit for being the strongest advocate for full disclosure, also directed his principal fire against the big companies. His famous quotation, `sunlight is said to be the best of disinfectants; electric light the most efficient policeman,' was made in relation to the amount of underwriting commissions received by J. P. Morgan & Co. for their role in selling securities of major companies." Knauss, A Reappraisal of the Role of Disclosure, 62 Mich.L.Rev. 607, 614 (1964).

        See also The Wheat Report at 50-51.

        The ultimate goal of the Securities Act is, of course, investor protection. Effective disclosure is merely a means. The entire legislative scheme can be frustrated by technical compliance with the requirements of the Securities and Exchange Commission's Form S-1 for preparation of registration statements in the absence of any real intent to communicate. It is for this reason that the SEC, through its rule making power, has consistently required "clearly understandable" prospectuses. The Wheat Report at 78.

        Unfortunately, the results have not always reflected these efforts. "[E]ven

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when an investor [is] presented with an accurate prospectus prior to his purchase, the presentation in most instances tend[s] to discourage reading by all but the most knowledgeable and tenacious." Knauss, A Reappraisal of the Role of Disclosure, 62 Mich.L.Rev. 607, 618-619 (1964). These documents are often drafted so as to be comprehensible to only a minute part of the investing public.

        "There are also the perennial questions of whether prospectuses, once delivered to the intended reader, are readable, and whether they are read. The cynic's answer to both questions is `No'; the true believer's is `Yes'; probably a more accurate answer than either would be: `Yes'by a relatively small number of professionals or highly sophisticated non-professionals; `No'by the great majority of those investors who are not sophisticated and, within the doctrine of SEC v. Ralston Purina Co. [346 U.S. 119, 73 S.Ct. 981, 97 L.Ed. 1494], are not `able to fend for themselves' and most `need the protection of the Act.'" Cohen, "Truth in Securities" Revisited, 79 Harv.L.Rev. 1340, 1351-1352 (1966).

        See also The Wheat Report at 77-78.

        In at least some instances, what has developed in lieu of the open disclosure envisioned by the Congress is a literary art form calculated to communicate as little of the essential information as possible while exuding an air of total candor. Masters of this medium utilize turgid prose to enshroud the occasional critical revelation in a morass of dull, andto all but the sophisticatesuseless financial and historical data. In the face of such obfuscatory tactics the common or even the moderately well informed investor is almost as much at the mercy of the issuer as was his pre-SEC parent. He cannot by reading the prospectus discern the merit of the offering.

        The instant case provides a useful example. Ignoring, for the moment, the alleged omissions which are the subject of the plaintiff's complaint, the passage in which Leasco's intentions with regard to surplus surplus are "disclosed" in the short excerpt set out at page 552, supra. This revelation, while probably technically accurate with regard to Leasco's then intentions respecting surplus surplus, was hardly calculated to apprise the owner of shares of Reliance common stock that Reliance held a large pool of cash or near-cash assets which were legally and practically unnecessary for the efficient operation of the insurance business, and that Leasco intended to remove those assets "as soon as practicable." More important, it does not reveal Leasco's estimates of the extent of those assets. A conscientious effort by the issuer and its counsel would have produced a more direct, informative and candid paragraph about Leasco's intended reorganization of Reliance. They might have effectively disclosed, in understandable proseas they did in January of 1969 the essence of the plan to the shareholders they were soliciting.

        The view that prospectuses should be intelligible to the average small investor as well as the professional analyist, immediately raises the question of what substantive standard of disclosure must be maintained. The legal standard is that all "material" facts must be accurately disclosed. But to whom must the fact have material significance?

        In an industry in which there is an unmistakable "trend toward a greater measure of professionalism * * * with the accompanying demand for more information about issuers" "a pragmatic balance must be struck between the needs of the unsophisticated investor and those of the knowledgeable student of finance." The Wheat Report at 9-10. There are three distinct classes of investors who must be informed by the prospectus: (1) the amateur who reads for only the grosser sorts of disclosures; (2) the professional advisor and manager who studies the prospectus closely and makes his decisions based on the insights he

Page 566

gains from it; and (3) the securities analyst who uses the prospectus as one of many sources in an independent investigation of the issuer.

        The proper resolution of the various interests lies in the inclusion of a clearly written narrative statement outlining the major aspects of the offering and particularly speculative elements, as well as detailed financial information which will have meaning only to the expert. Requiring inclusion of such technical data benefits amateurs, as well as experts, because of the advice many small investors receive and the extent to which the market reflects professional judgments. The Wheat Report at 52. Such "[e]xpert sifters, distillers, and weighers are essential for an informed body of investors". Cohen, "Truth in Securities" Revisited, 79 Harv.L.Rev. 1340, 1353 (1966).

        Mr. Justice Douglas, then teaching at Yale, commented in 1933 that:

        "[T]hose needing investment guidance will receive small comfort from the balance sheets, contracts, or compilation of other data revealed in the registration statement. They either lack the training or intelligence to assimilate them and find them useful, or are so concerned with a speculative profit as to consider them irrelevant. * * * [E]ven though an investor has neither the time, money, nor intelligence to assimilate the mass of information in the registration statement, there will be those who can and who will do so, whenever there is a broad market. The judgment of those experts will be reflected in the market price. Through them investors who seek advice will be able to obtain it." Douglas, Protecting The Investor, 23 Yale Rev. (N.S.) 508, 523-524 (1933) (quoted in The Wheat Report at 53).

        The Wheat Report further notes:

        "that a fully effective disclosure policy would require the reporting of complicated business facts that would have little meaning for the average investor. Such disclosures reach average investors through a process of filtration in which intermediaries (brokers, bankers, investment advisors, publishers of investment advisory literature, and occasionally lawyers) play a vital role." The Wheat Report at 52.

        "The significance of disclosures which have an initial impact at the professional level has been heightened by recent changes in the securities business. Most important of these is the enormous growth of intermediation in investment. The relative importance of such professional money managers as bank trust departments, pension fund managers, investment counseling firms and investment advisors to mutual funds and other investment companies is greater than ever before." The Wheat Report at 54.

        The significance of these observations is that the objectives of full disclosure can be fully achieved only by complete revelation of facts which would be material to the sophisticated investor or the securities professional not just the average common shareholder. But, at the same time, the prospectus must not slight the less experienced. They are entitled to have within the four corners of the document an intelligible description of the transaction.

        The Securities Act provides a full panoply of enforcement procedures.

        A considerable in terrorem effect is generated by the SEC's examination of registration statements and its use of orders refusing to permit registration statements to become effective (15 U.S. C. § 77h(b)) and stop orders when uncorrected misrepresentations appear (15 U.S.C. § 77h(d)). "A stop order may not be merely a death warrant for the particular financing; it may also be a severe or even fatal blow to the registrant and, at very least, is likely to touch off the civil liability provisions if securities have been sold." Cohen, "Truth In Securities" Revisited, 79 Harv.L.Rev. 1340, 1355 (1966). Section 20(b) of the 1933

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Act authorizes injunctive relief against any person who is about to violate any of the provisions of the Actin this context anyone who proposes to distribute a prospectus containing material misstatements or omissions. 15 U.S.C. § 77t(b). Furthermore, the Commission may transmit evidence of such violation to the Attorney General for criminal prosecution (15 U.S.C. § 77t(b)) and anyone who wilfully violates the disclosure requirements of the statute or SEC rules is subject to a $5000 fine or five years imprisonment or both. 15 U.S.C. § 77x. "Moreover, the SEC may suspend or expel those who violate the securities acts or suspend trading in a particular stock." Globus v. Law Research Service, 418 F. 2d 1276, 1285 (2d Cir. 1969), cert. denied, 397 U.S. 913, 90 S.Ct. 913, 25 L.Ed.2d 93 (1970).

        But this power of the SEC to intercede is, as a practical matter, limited to more flagrant misstatements and omissions obvious on the face of the prospectus or from other information at hand. To expect the hard pressed SEC staff to conduct an independent field study of every prospectus is unrealistic. Cf. Douglas and Bates, The Federal Securities Act of 1933, 43 Yale L.J. 171, 212 (1933).

        The civil liability sections of the 1933 Act, when properly applied, act as independent and effective enforcement provisions. A "class action under Fed.R.Civ. P. 23 could be particularly effective and appropriate in remedying violations of the securities acts * * * compensatory damages, especially when multiplied in a class action, have a potent deterrent effect." Globus v. Law Research Service, 418 F.2d 1276, 1285 (2d Cir. 1969), cert. denied, 397 U.S. 913, 90 S.Ct. 913, 25 L.Ed.2d 93 (1970). Cf. Ratner v. Chemical Bank New York Trust Company, 329 F.Supp. 270, 280 (S.D.N.Y. 1971) (private attorney general in "Truth in Lending Act"). The principal purpose of civil liability in the 1933 Act is, in fact, deterrent rather than compensatory.

        "There is a danger in discussing civil liability in connection with the Securities Act that both the purpose of the Act and the emphasis of the discussion will be misunderstood. It is not the object of the Act simply to provide a legal remedy for the investor who has bought securities upon a false representation, to compensate him for a loss incurred. Even the provisions for civil liability are calculated to be largely preventive rather than redressive. Both in the extent of liability imposed the variety of persons to whom the liability is attached, the bases of the liability, and the persons in whose favor it runsand in the limitation of the amounts recoverable, the in terrorem function of the Act is evidenced. But even this purpose of securing preventive vigilance and caution on the part of the persons concerned is only coordinate with, or probably subordinate to, another object. The Act seeks not only to secure accuracy in the information that is volunteered to investors, but also, and perhaps more especially, to compel the disclosure of significant matters which were heretofore rarely, if ever, disclosed. Civil liability is imposed largely as one appropriate means of accomplishing these ends, not as the end itself, or, on the other hand, as the only means. While, then, discussion of the Act may properly be directed to the different provisions separately, it is apt to be misleading, and more covertly disingenuous, if the principal objectives are not constantly pushed to the front." Shulman, Civil Liability and the Securities Act, 43 Yale L.J. 227 (1933).

        The Second Circuit has recently adopted this early view of the in terrorem function of Section 11:

        "Civil liability under section 11 and similar provisions was designed not so much to compensate the defrauded purchaser as to promote enforcement of the Act and to deter negligence by providing a penalty for those who fail in their duties." Globus v. Law Research

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Service, 418 F.2d 1276, 1288 (2d Cir. 1969), cert. denied, 397 U.S. 913, 90 S.Ct. 913, 25 L.Ed.2d 93 (1970).

        See also III L. Loss, Securities Regulation 1831 (1969); Cohen, "Truth in Securities" Revisited, 79 Harv.L.Rev. 1340, 1355 (1966); Douglas and Bates, The Federal Securities Act of 1933, 43 Yale L.J. 171, 173 (1933); Comment, BarChris: Due Diligence Refined, 68 Colum. L.Rev. 1411 (1968).

        Criminal liability is necessarily predicated on proof of specific intent to violate the Act, while civil liability is established after a showing of failure to exercise reasonable care in preparing registration statements. Only primary reliance on civil liability can protect investors from the "climate of laxity" or "lethargy" which has characterized the preparation of some registration statements. Folk, Civil Liabilities Under the Federal Securities Acts: The BarChris Case, 1 Securities Law Rev. 3, 8-9 (1969) (reprinted from 55 Va.L.Rev. 1 (1969)).

        The courts face a dual responsibility when presented with a claim for civil relief. They must adjudicate the particular claim for relief presented by the plaintiff, and simultaneously vindicate the full disclosure policy of the Securities Act for the protection of the entire investing public.

        Section 11(a) of the Securities Act of 1933 provides for civil liability for misstatements and omissions in a registration statement. 15 U.S.C. § 77k(a). It reads:

        "(a) In case any part of the registration statement, when such part became effective, contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, any person acquiring such security (unless it is proved that at the time of such acquisition he knew of such untruth or omission) may, either at law or in equity, in any court of competent jurisdiction, sue"

        (1) Failure to Disclose Methods of Reorganization Other Than the Holding Company Concept

        During the exchange offer period several memoranda and letters were exchanged between Hodes, Leasco's counsel, and various other attorneys for Reliance and Leasco. It is apparent that various methods of reorganization were being seriously investigated by a number of attorneys for Leasco and Reliance. Leasco's president, Schwartz, was kept apprised of the progress of these inquiries by Hodes.

        Despite this research activity, none of these investigations ever crystallized during the exchange offer period sufficiently to be characterized as "plans" of Leasco. They were never presented to the Leasco Board nor were they even discussed in any detail with members of Leasco's management. They were, rather, merely possible alternatives for consideration by counsel. Such preliminary contingency planning need not be included in the prospectus under the circumstances of this case.

        (2) Failure to Include an Estimate of Surplus Surplus

        The failure to include an estimate of surplus surplus raises a more serious question. There is no doubt that Leasco had in its possession at least three estimates of Reliance's surplus surplus $80,000,000 as of December 31, 1966 contained in the Netter Report and $125,000,000 or $100,000,000, at June 30th and December 31, 1967 respectively, both approximated in the Gibbs Memorandum. In addition they had available the rules of thumb for calculation contained in the New York Insurance Department Report. Leasco could have used these estimates or commissioned an independent computation based on public information. This figure could have been included with the sort of qualifying statement included

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in the January, 1969 prospectus. Whether the failure to do so places liability on the defendants under Section 11 is the question now presented.

        Only if the omission complained of is "material" within the meaning of Section 11 can liability be found. The SEC has defined the term by looking to what a reasonably prudent investor reasonably ought to know before buying a security. It reads:

        "The term `material', when used to qualify a requirement for the furnishing of information as to any subject, limits the information required to those matters as to which an average prudent investor ought reasonably to be informed before purchasing the security registered." 17 C.F.R. § 230.405(l).

        Speaking of this definition in one of the few reported Section 11 cases, Judge McLean summed the matter up succinctly by emphasizing the need to know "facts which have an important bearing upon the nature or condition of the issuing corporation or its business." Escott v. BarChris Construction Corp., 283 F.Supp. 643, 681 (S.D.N.Y.1968).

        Judge McLean quite properly placed emphasis on the need to disclose those facts which revealed the "condition" of the issuer because the facts omitted in BarChris related to the stability of the issuing company and the continuing security of the investment. It is clear, however, that facts other than the condition of the issuer bearing on the value, qua price, of the securities in question must be disclosed with the same scrupulousness. The issuer must disclose any fact "which in reasonable and objective contemplation might affect the value of the corporation's stock or securities". Kohler v. Kohler Co., 319 F.2d 634, 642 (7th Cir. 1963) (emphasis added). See Chasins v. Smith, Barney & Co., 438 F.2d 1167, 1171 (2d Cir. 1971); SEC v. Texas Gulf Sulphur, 401 F.2d 833, 849 (2d Cir. 1968), cert. denied sub nom. Coates v. SEC and Kline v. SEC, 394 U.S. 976, 89 S.Ct. 1454, 22 L. Ed.2d 756 (1969); List v. Fashion Park, 340 F.2d 457, 462 (2d Cir.), cert. denied sub nom. List v. Lerner, 382 U.S. 811, 86 S.Ct. 23, 15 L.Ed.2d 60 rehearing denied, 382 U.S. 933, 86 S.Ct. 305, 15 L.Ed.2d 344 (1965). BarChris cannot be read as permitting exclusion of important facts merely because they involve the condition of the company being taken over rather than the issuer since these facts will bear on the relative value of the issuer's securities.

        Some probability that the investor's decision would be affected by disclosure is a prerequisite to a finding of materiality. The degree of probability that it would have such an impact has been differently stated by the courts. They have focused on the effect on the reasonable purchaser, variously asking whether he "might" or "would" or "might well have been" affected by the information; they have asked whether it is "reasonably certain" that the information would have had a "substantial effect" or whether it "might" have had a "significant propensity" to affect him.

        List v. Fashion Park, 340 F.2d 457 (2d Cir.), cert. denied sub nom. List v. Lerner, 382 U.S. 811, 86 S.Ct. 23, 15 L. Ed.2d 60, rehearing denied, 382 U.S. 933, 86 S.Ct. 305, 15 L.Ed.2d 344 (1965), the Second Circuit used the word "would" to suggest the applicable level of probability.

        "The basic test of `materiality' * * * is whether `a reasonable man would attach importance [to the fact misrepresented] in determining his choice of action in the transaction in question.'" List, supra at 462 (quoting from Restatement, Torts § 538(2) (a)) (emphasis added).

        "The proper test is whether the plaintiff would have been influenced to act differently * * *." List, supra at 463 (emphasis added).

        See SEC v. Great American Industries, Inc., 407 F.2d 453, 459-460 (2d Cir.

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1968), cert. denied, 395 U.S. 920, 89 S.Ct. 1770, 23 L.Ed.2d 237 (1969); III L. Loss, Securities Regulation 1431 (1969). This test implies a fairly high probability.

        Subsequently, in the leading case of SEC v. Texas Gulf Sulphur, 401 F.2d 833 (2d Cir. 1968), cert. denied sub nom. Coates v. SEC and Kline v. SEC, 394 U.S. 976, 89 S.Ct. 1454, 22 L.Ed.2d 756 (1969), the Second Circuit used several different verbal formulations of materiality. Discussing an "insider's" obligation to disclose under Rule 10b-5, it indicated that the duty

        "arises only in `those situations which are essentially extraordinary in nature and which are reasonably certain to have a substantial effect on the market price of the security * * *.'" SEC v. Texas Gulf Sulphur, supra at 848 (emphasis added).

        The Court also mentions the tests quoted above from List and Kohler v. Kohler, 319 F.2d 634, 642 (7th Cir. 1963). It shifted from the "would" of List to the standard of "may":

        "Thus, material facts include not only information disclosing the earnings and distributions of a company but also those facts which affect the probable future of the company and those which may affect the desire of investors to buy, sell, or hold the company's securities.

        "In each case, then, whether facts are material within Rule 10b-5 when the facts relate to a particular event and are undisclosed by those persons who are knowledgeable thereof will depend at any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the event in light of the totality of the company activity." SEC v. Texas Gulf Sulphur, supra, 401 F.2d at 849 (emphasis added).

        Discussing materiality in the context of Section 14(a) of the Securities Exchange Act of 1934 the Supreme Court utilized an even less stringent test than Texas Gulf, indicating that a "material fact" was one

        "of such a character that it might have been considered important by a reasonable shareholder who was in the process of deciding how to vote. This requirement [is] that the defect have a significant propensity to affect the voting process * * *" Mills v. Electric Auto-Lite Company, 396 U.S. 375, 384, 90 S.Ct. 616, 621, 24 L.Ed.2d 593 (1970) (emphasis added in part).

        The use of "propensity" in the context of a proxy situation is particularly significant to the instant case since the Reliance shareholders were, in effect, being asked to "vote" a merger with Leasco by accepting the exchange offer.

        Just this year the Second Circuit has once again employed "might" as the applicable standard of probability, further reducing the force of the word by adding to it "well have." Applying the test articulated in List, Kohler, Texas Gulf Sulphur, and Mills v. Electric Auto-Lite, the court held that "the question of materiality becomes whether a reasonable man in [the investor's] position might well have acted otherwise than to purchase if he had been informed * * *." Chasins v. Smith, Barney & Co., 438 F.2d 1167, 1171 (2d Cir. 1971) (emphasis added). The issue, it was said, is whether the disclosure "could well influence" the decision of the investor. Id. at 1172. See also Gilbert v. Nixon, 429 F.2d 348, 355-356 (10th Cir. 1970); Johns Hopkins University v. Hutton, 422 F.2d 1124, 1128-1129 (4th Cir. 1970); Demarco v. Edens, 390 F.2d 836, 840-841 (2d Cir. 1968).

        Most recently the Securities and Exchange Commission indicated that certain information "was material because it `was of such importance that it could be expected to affect the judgment of investors whether to buy, sell or hold * * * stock [and, i]f generally known, * * * to affect materially the market price of the stock.'" In re Investors Management Company, et al., Sec. Exch. Act Release No. 9267, S.E.C. No. 3-1680,

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memorandum at 9 (SEC July 29, 1971) (emphasis added).

        While these verbal formulations by the courts and the SEC taken individually fail to prescribe a precise standard, they do evince a trend toward broadening the definition of materiality and concomitantly raising the requirement of disclosure where the law requires full disclosure. Cf. Wiesen, Disclosure of Inside InformationMateriality and Texas Gulf Sulphur, 1 Securities L.Rev. 267, 288-290, 310-311 (1969) (reprinted from 28 Md.L.Rev. 189 (1968)); 2 A. Bromberg, Securities Law; Fraud SEC Rule 10b-5 § 8.3, p. 199 (1970) ("Rule is applied to subtler or milder cases").

        Commentators have not been much more successful than the courts in precisely defining the concept of materiality. Thus, an early writer concluded that "a material fact is any piece of information having fairly predictable results either on the value of the securities or on the outsider's estimate of that value." Comment, The Prospects for Rule X-10B-5: An Emerging Remedy for Defrauded Investors, 59 Yale L.J. 1120, 1145 (1950) (emphasis added). It was later suggested that materiality "be limited to those situations which are essentially extraordinary in nature and which are reasonably certain to have a substantial effect on the market price of the security if disclosed." Fleischer, Securities Trading and Corporate Information Practices: The Implications of the Texas Gulf Sulphur Proceeding, 51 Va.L.Rev. 1271, 1289 (1965) (emphasis added).

        What is called for is "[s]ome sort of reasonable-man, objective test of investment, judgment, intrinsic value, or (in the case of a publicly traded security) significant market effect". 2 A. Bromberg, Securities Law: Fraud SEC Rule 10b-5 § 8.3, p. 199 (1970).

        A fair summary of the rule stated in terms of probability is that a fact is proved to be material when it is more probable than not that a significant number of traders would have wanted to know it before deciding to deal in the security at the time and price in question. What is statistically significant will vary with the legal situation. Cf. Rosado v. Wyman, 322 F.Supp. 1173, 1180-1181 (E.D.N.Y.1970), aff'd, 437 F. 2d 619 (2d Cir. 1970). Being a formal and legally required document, a prospectus must satisfy a high standard of disclosure i.e., disclosure is required when only a relatively small percentage of traders would want to know before making a decision. Anything in the order of 10% of either the number of potential traders or those potentially making 10% of the volume of sales would seem to more than suffice.

        Putting the test in mathematical terms may, perhaps, be useful in permitting surveys and quantification of results in future litigation. But even if mathematical models buttressed by valid sampling techniques for determining trader reactions were possible and economically feasible in litigations of this sort, no such approach was attempted by the parties in this case.

        Since no data except the unpersuasive suppositions of opposing experts were produced at the trial to show how potential traders would have viewed the information at issue, we are forced to analyze the facts in terms of alternative courses of conduct available to a hypothetical reasonably prudent shareholder constructed by the Court. In nonquantitative terms a fact is "material" in a registration statement whenever a rational connection exists between its disclosure and a viable alternative course of action by any appreciable number of investors. Materiality is then a question of fact to be determined in the context of a particular case. Cf. SEC v. Texas Gulf Sulphur, 401 F.2d 833, 849 (2d Cir. 1968), cert. denied sub nom. Coates v. SEC and Kline v. SEC, 394 U.S. 976, 89 S.Ct. 1454, 22 L.Ed.2d 756 (1969); Escott v. BarChris Construction Corp., 283 F.Supp. 643, 682 (S.D.N.Y.1968); Painter, Inside Information: Growing Pains for the Development of Federal Corporation Law Under Rule 10b-5, 65 Colum. L.Rev. 1361, 1379 (1965); Fleischer, Securities

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Trading and Corporate Information Practices: The Implications of the Texas Gulf Sulphur Proceeding, 51 Va.L.Rev. 1271, 1289-1290 (1965); Ruder, Pitfalls in the Development of a Federal Law of Corporations by Implication Through Rule 10b-5, 59 Nw.U.L.Rev. 185, 195 (1964).

        The information with respect to the availability of tens of millions of dollars of surplus surplus is so significant that under any test proposed it is material. A substantial percentage of the reasonable