USCA1 Opinion
United States Court of Appeals
For the First Circuit
____________________
No. 95-1995
MERRY LOU SHAW, ET AL.,
Plaintiffs, Appellants,
v.
DIGITAL EQUIPMENT CORP., ET AL.,
Defendants, Appellees.
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No. 95-1996
LEONARD WILENSKY, ET AL.,
Plaintiffs, Appellants,
v.
DIGITAL EQUIPMENT CORP., ET AL.,
Defendants, Appellees.
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APPEALS FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. Joseph L. Tauro, U.S. District Judge]
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____________________
Before
Torruella, Chief Judge,
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Cyr and Lynch, Circuit Judges.
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Sanford P. Dumain, with whom David J. Bershad, James P.
__________________ _________________ _________
Bonner, Milberg, Weiss, Bershad, Hynes & Lerach, Glen DeValerio,
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Kathleen Donovan-Maher, Berman, DeValerio & Pease, Richard
_______________________ _____________________________ _______
Schiffrin, Schiffrin & Craig, Ltd., Joseph D. Ament, and Much,
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Shelist, Freed, Denenberg, Ament, Bell & Rubenstein, P.C., were
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on brief, for the Shaw appellants.
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Thomas G. Shapiro, with whom Edward F. Haber, Shapiro,
___________________ ________________ ________
Grace, Haber & Urmy, Glen DeValerio, Kathleen Donovan-Maher,
_____________________ _______________ _______________________
Berman, DeValerio & Pease, Fred Taylor Isquith, Peter C. Harrar,
_________________________ ___________________ _______________
Wolf, Haldenstein, Adler, Freeman & Herz, L.L.P., Richard
_______________________________________________________ _______
Bemporad, and Lowey, Dannenberg, Bemporad & Selinger, P.C., were
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on brief, for the Wilensky appellants.
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Edmund C. Case, with whom Jordan D. Hershman, Deborah S.
_______________ ___________________ ___________
Birnbach, Testa, Hurwitz & Thibeault, John D. Donovan, Jr.,
________ ____________________________ ______________________
Randall W. Bodner, Daniel J. Klau, and Ropes & Gray were on
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brief, for the Shaw appellees.
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Edmund C. Case, with whom Jordan D. Hershman, Deborah S.
_______________ ___________________ __________
Birnbach, Testa, Hurwitz & Thibeault, John D. Donovan, Jr.,
________ ____________________________ ______________________
Randall W. Bodner, Daniel J. Klau, Ropes & Gray, Gerald F. Rath,
_________________ ______________ _____________ ______________
Robert A. Buhlman, Bingham, Dana & Gould, Michael J. Chepiga,
_________________ ______________________ ___________________
Daniel A. Shacknai, and Simpson, Thacher & Bartlett were on
___________________ _____________________________
brief, for the Wilensky appellees.
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May 7, 1996
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LYNCH, Circuit Judge. Plaintiffs, purchasers of the
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securities of Digital Equipment Corp., appeal from the district
court's dismissal of two consolidated class actions alleging
violations of the federal securities laws. Both complaints
assert that there were misleading statements and nondisclosures
in the registration statement and prospectus prepared in
connection with a public offering of stock. That offering
commenced on March 21, 1994, just 11 days prior to the close of
the quarter then in progress, and about three weeks prior to
the company's announcement of an unexpectedly negative earnings
report for that quarter. One of the complaints further alleges
that defendants made fraudulently optimistic statements to the
public in the period leading up to the offering. The district
court found that neither complaint identified any statements or
omissions actionable under the securities laws and dismissed
both for failure to state a claim. We agree that many of the
alleged misstatements and omissions do not provide a legally
cognizable basis for the plaintiffs' claims, but we also
conclude that a limited set of allegations in both complaints
relating to the registration statement and prospectus for the
March 1994 offering does state a claim. We further find that
the surviving portions of the complaints satisfy the pleading
requirements of Fed. R. Civ. P. 9(b). Accordingly, we affirm
the district court's decision in part, reverse in part, and
remand for further proceedings.
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I.
Background
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Digital Equipment Corporation ("DEC") is one of the
world's largest suppliers of computer hardware, software and
services. Founded in 1957, it first became a publicly held
company in 1966. By the early 1990's, the company's success
had burgeoned into $14 billion in yearly revenues. The
company's success story, however, would not last forever. By
1992, the company had fallen on hard times. In January 1992 it
reported its first-ever quarterly operating loss of $138.3
million. Faced in the ensuing months with operating losses in
the range of $30 million to $311 million per quarter, the
company decided to engage in radical surgery, cutting loose
some 35,000 employees over the course of 15 months in the
process, including its founder and CEO. To cover the costs of
these actions, the company accumulated "restructuring" charges
totalling close to $3.2 billion in fiscal years 1990-1992
combined.
In the midst of its financial woes, however, the company
took some steps to restore its health. In February 1992, DEC
had introduced a new product, the "Alpha" chip. The Alpha chip
was hailed as a technological advance that could potentially
restore the company's fortunes. In mid-1992, the company
installed a new CEO, Robert B. Palmer. He took the helm in the
fall of that year, as the company continued to implement
strategies to help its Alpha technology gain acceptance in the
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marketplace and to bring the company back to financial
vitality. At the time Palmer took over, the company had
absorbed over $3 billion in losses for the prior three years
and had been losing money at the rate of approximately $3
million per day. Under the new management, it appeared that
the company's financial hemorrhaging had finally begun to slow.
On January 14, 1993, DEC reported a loss for the second
quarter of fiscal year 1993 that was far smaller than had been
anticipated by analysts. That promising result was followed by
another quarter of losses, but within Wall Street's
expectations. Then, on July 28, 1993, the company announced
its first profitable quarter since before the 1992 fiscal year,
reporting a net profit of $113.2 million for the fourth quarter
of fiscal year 1993. That result was slightly below analysts'
expectations, but a stark improvement over the operating loss
of $188.1 million (and overall loss of $2 billion) reported for
the comparable quarter in the prior year.
Still, on October 20, 1993, DEC announced a loss of
$83.1 million for the first quarter of 1994, an improvement
over the $260.5 million loss for the same quarter the prior
year, but worse than analysts had been predicting. On January
19, 1994, the company announced another setback, reporting
losses for the second quarter of fiscal year 1994, ending
January 1, 1994, of $72 million. The loss was worse than
analysts had expected and was virtually identical to the losses
for that period the prior year.
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It was against this backdrop that DEC, on January 21,
1994, filed with the SEC a "shelf" registration statement
giving the company the option to issue up to $1 billion in
various classes of debt and equity securities. Two months
later, DEC through its underwriters conducted an offering of
$400 million in depositary shares of preferred stock, pursuant
to the "shelf" registration, a prospectus dated March 11, 1994,
and a prospectus supplement dated March 21, 1994. The offering
commenced on the date of the prospectus supplement and closed
one week later on March 28, 1994, four days before the end of
the third fiscal quarter. All 16 million depositary shares of
preferred stock were sold, at an offering price of $25. DEC
raised a badly needed $387.4 million.1
Less than three weeks later, on April 15, 1994, DEC
announced an operating loss of over $183 million for the
quarter that had ended on April 2, 1994. This third quarter
loss was far greater than analysts had been expecting, and the
largest that the company had reported since the first quarter
of fiscal 1993. It bucked the positive trend of reduced losses
under the company's new management. The announcement sent the
price of the newly distributed preferred stock tumbling from
the offering price of $25 to $20.875 by the close of trading on
April 15. The common stock fell from $28.875 to $23 during the
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1. Because the offering was conducted pursuant to a "firm
commitment" underwriting arrangement, DEC sold all of the
offered shares to the underwriters at a discount, who then in
turn sold the shares to the public. Thus, DEC's proceeds were
less than the total offering amount.
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same period, and to $21.125 by the close of the next trading
day.
In its April 15 announcement, the company also disclosed
that it had decided to "accelerate [its] on-going restructuring
efforts" and "also consider further restructuring." This was
despite a representation in the March 21 prospectus supplement
that "[t]he Corporation believes that the remaining
restructuring reserve of $443 million is adequate to cover
presently planned restructuring actions." Eventually,
following the close of fiscal year 1994, DEC announced on July
14, 1994 that it would cut almost one-fourth of its remaining
workforce and take an additional charge of $1.2 billion for
fiscal year 1994 (beyond the $443 million remaining in reserve
as of March 21) to cover the costs of additional restructuring
activities.
II.
Description of the Actions
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These two lawsuits were filed on Tuesday, April 19,
1994, two business days after the company's announcement of
April 15, 1994. One, the Wilensky action, brought on behalf of
________
all persons who purchased shares in the March 1994 public
offering, asserts claims under Sections 11, 12(2), and 15 of
the Securities Act of 1933 ("Securities Act") against DEC, its
Chief Executive Officer (Robert B. Palmer), its Chief Financial
Officer (William Steul), and seven underwriting or investment
banking firms, representing a purported defendant class of 65
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underwriters who participated in the offering. The second, the
Shaw action, advances claims under Sections 10(b) and 20(a) of
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the Securities Exchange Act of 1934 ("Exchange Act") and Rule
10b-5, and a pendent claim of common law negligent
misrepresentation, on behalf of all purchasers of DEC common
stock between January 19 and April 15, 1994 (the "Class
Period").
At the heart of both complaints are two sets of claims.
First, plaintiffs assert that DEC management had knowledge of
material facts concerning the large losses developing during
the third fiscal quarter of 1994, and that the defendants were
under a duty to disclose such material information to the
market in connection with the public offering conducted on
March 21, 1994. Second, both the Wilensky and Shaw plaintiffs
________ ____
contend that the representation made in the March 21 prospectus
supplement concerning the "adequacy" of the then-remaining
"restructuring reserve" was materially misleading. The Shaw
____
plaintiffs allege, additionally, that throughout the Class
Period, the defendants made fraudulently optimistic statements
to the public concerning DEC's future prospects in order
artificially to inflate the market value of DEC shares, and
that these statements were actionably false or misleading.
The defendants filed motions to dismiss under Fed. R.
Civ. P. 9(b) and 12(b)(6). The district court consolidated the
cases, stayed all discovery, and then dismissed both actions.
The district court ruled, inter alia, that defendants had
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violated no duty to disclose and that the defendants'
statements were not misleading, bespoke caution, or were
otherwise not actionable as a matter of law. The court granted
the defendants' motions to dismiss under Rule 12(b)(6), without
reaching whether the complaints satisfied the pleading
requirements of Rule 9(b). These appeals followed. We affirm
in part and reverse in part. For clarity, we discuss each of
the two actions in turn.
III.
The Section 11 and 12(2) Claims
_______________________________
(Wilensky Action)
________
Sections 11 and 12(2) are enforcement mechanisms for the
mandatory disclosure requirements of the Securities Act of
1933. Section 11 imposes liability on signers of a
registration statement, and on underwriters, if the
registration statement "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." 15 U.S.C. 77k. Section 12(2) provides that
any person who "offers or sells" a security by means of a
prospectus or oral communication containing a materially false
statement or that "omits to state a material fact necessary to
make the statements, in the light of the circumstances under
which they were made, not misleading," shall be liable to any
"person purchasing such security from him." 15 U.S.C.
77l(2).
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The Wilensky plaintiffs assert claims under Sections 11,
________
12(2), and 15,2 alleging that the registration statement and
prospectus filed in connection with the March 1994 public
offering contained materially false statements and omitted to
state material information required to be provided therein.
The thrust of the Wilensky complaint is that defendants knew as
________
of the March 21 date of the 1994 public offering, of material
facts portending the unexpectedly large losses for the third
quarter of fiscal 1994 that were announced later, and that
failure to disclose these material facts in the registration
statement and prospectus violated Section 11. Additionally,
the Wilensky plaintiffs contend that the statement in the
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registration statement and prospectus characterizing as
"adequate" the company's then-remaining "restructuring reserve"
of $443 million was materially false and misleading, in
violation of both Sections 11 and 12.
The defendants parry by attempting to reduce plaintiffs'
claims to an argument that the company was required to disclose
its internal forecasts about the outcome of the third quarter.
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They argue that the plaintiffs' position is untenable because
the securities laws impose no duty upon a company to disclose
internal projections, estimates of quarterly results, or other
forward-looking information. They also say that the statement
concerning the adequacy of the company's restructuring reserves
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2. Section 15 imposes derivative liability upon persons who
"control" those liable under Section 11 or 12. See 15 U.S.C.
___
77o.
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is not actionably misleading when considered in context.
Finally, defendants contend that the complaint fails to allege
sufficient facts establishing that DEC and the underwriter
defendants were statutory "sellers" subject to liability under
Section 12(2). We evaluate each set of arguments separately.
A. Actionability of Alleged Nondisclosures Under Section 11
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The proposition that silence, absent a duty to disclose,
cannot be actionably misleading, is a fixture in federal
securities law. See, e.g., Backman v. Polaroid Corp., 910 F.2d
___ ____ _______ ______________
10, 13 (1st Cir. 1990) (en banc). Equally settled is that
accurate reports of past successes do not themselves give rise
to a duty to inform the market whenever present circumstances
suggest that the future may bring a turn for the worse. See
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Serabian v. Amoskeag Bank Shares, Inc., 24 F.3d 357, 361 (1st
________ ___________________________
Cir. 1994); Capri Optics Profit Sharing v. Digital Equip.
_____________________________ _______________
Corp., 950 F.2d 5, 7-8 (1st Cir. 1991). In short, the mere
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possession of material nonpublic information does not create a
duty to disclose it. See Roeder v. Alpha Indus., Inc., 814
___ ______ ___________________
F.2d 22, 26 (1st Cir. 1987) (citing Chiarella v. United States,
_________ _____________
445 U.S. 222, 235 (1980)).
To focus here on a duty to disclose in the abstract,
however, would be to miss the obvious in favor of the obscure.
This action arises out of an allegedly defective registration
statement and prospectus filed in connection with a public
stock offering. The obligations that attend the preparation of
those filings embody nothing if not an affirmative duty to
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disclose a broad range of material information. Cf. Herman &
___ ________
MacLean v. Huddleston, 459 U.S. 375, 381-82 (1983). Indeed, in
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the context of a public offering, there is a strong affirmative
duty of disclosure.3 See Ernst & Ernst v. Hochfelder, 425
___ ______________ __________
U.S. 185, 195 (1976) (the Securities Act "was designed to
provide investors with full disclosure of material information
concerning public offerings").
The question here is not whether defendants were under
an abstract duty to disclose information -- clearly, they were.
The issue, rather, is whether the defendants had a specific
obligation to disclose information of the type that the
plaintiffs complain was omitted from the registration statement
and prospectus. The task of deciding whether particular
information is subject to mandatory disclosure is not easily
separable from normative judgments about the kinds of
information that the securities laws should require to be
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disclosed, which depend, in essence, on conceptions of
materiality. See generally Victor Brudney, A Note On
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____________________
3. In Roeder, this court alluded to three situations that
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could give rise to a duty to disclose material facts: (i) when
an insider trades in the company's securities on the basis of
material nonpublic information; (ii) when a statute or
regulation requires disclosure; and (iii) when the company has
previously made a statement of material fact that is false,
inaccurate, incomplete, or misleading in light of the
undisclosed information. Roeder, 814 F.2d at 27; see also In
______ _________ __
re Time Warner, Inc. Sec. Litig., 9 F.3d 259, 267 (2d Cir.
__________________________________
1993), cert. denied, 114 S. Ct. 1397 (1994); Backman, 910 F.2d
_____ ______ _______
at 12-13; Greenfield v. Heublein, Inc., 742 F.2d 751, 758 (3d
__________ ______________
Cir. 1984), cert. denied, 469 U.S. 1215 (1985). We do not
____________
decide here whether these three situations are the only ones
that could trigger a duty of disclosure, or whether they
necessarily would do so in every case.
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Materiality and Soft Information Under the Federal Securities
_______________________________________________________________
Laws, 75 Va. L. Rev. 723, 728 (1989). For our purposes, it
____
suffices to say that the determination of whether the alleged
nondisclosures in this case provide a legally sufficient basis
for the plaintiffs' claims cannot be severed from consideration
of the basic policies underlying the disclosure obligations of
the applicable statutes and regulations.
We conclude that we cannot say that DEC was not required
to disclose material information concerning its performance in
the quarter in progress at the time of the March 21, 1994
public offering. Nor can we conclude, as a matter of law and
on these pleadings, that DEC was not in possession of such
material nonpublic information at the time of the offering.
1. The Insider Trading Analogy
__ ___________________________
In understanding the nature of the disclosure
requirements attending a public offering of stock, it is
helpful to conceptualize DEC (the corporate issuer) as an
individual insider transacting in the company's securities, and
to examine the disclosure obligations that would then arise.
There is no doubt that an individual corporate insider
in possession of material nonpublic information is prohibited
by the federal securities laws from trading on that information
unless he makes public disclosure. He must disclose or abstain
from trading. See SEC v. Texas Gulf Sulphur Co., 401 F.2d 833,
___ ___ ______________________
848 (2d Cir. 1968) (en banc), cert. denied, 394 U.S. 976
_____________
(1969); see also SEC v. MacDonald, 699 F.2d 47, 50 (1st Cir.
________ ___ _________
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1983) (en banc). A central justification for the "disclose or
abstain" rule is to deny corporate insiders the opportunity to
profit from the inherent trading advantage they have over the
rest of the contemporaneously trading market by reason of their
superior access to information. See Shapiro v. Merrill Lynch,
___ _______ ______________
Pierce, Fenner & Smith, Inc., 495 F.2d 228, 235 (2d Cir. 1974);
____________________________
SEC v. Texas Gulf Sulphur Co., 401 F.2d 833, 848 (2d Cir. 1968)
___ ______________________
(en banc).4 The rule eliminates both the incentives that
insiders would otherwise have to delay the disclosure of
material information, and minimizes any efficiency losses
associated with the diversion of resources by insiders to
"beating the market." See Robert C. Clark, Corporate Law
___ ______________
8.2, at 273-75 (1986); Frank H. Easterbrook & Daniel R.
Fischel, The Economic Structure of Corporate Law 288 (1991)
_________________________________________
("The lure of trading profits may induce people to spend a lot
of effort and other resources "beating the market"; . . . [T]he
prompt disclosure of information by the affected firm will
extinguish the trading opportunity. When everyone knows the
truth, no one can speculate on it."5).
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4. See also Brudney, supra, at 735 (noting that the other
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major justification for requiring trading insiders to disclose
is to increase the quality and quantity of information
available to investors, thereby facilitating efficiency in the
allocation of capital).
5. Judge Easterbrook and Professor Fischel ultimately reject
this beating-the-market concern as a justification for
mandatory disclosure. They argue that companies normally will
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voluntarily disclose material bad news, because, among other
reasons, if a company consistently fails to make such
disclosure, the market will discount the value of the company's
securities by the increased probability that it is in
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The policy rationale for the "disclose or abstain" rule
carries over to contexts where a corporate issuer, as opposed
to an individual, is the party contemplating a stock
transaction. Courts, including this one, have treated a
corporation trading in its own securities as an "insider" for
purposes of the "disclose or abstain" rule. See, e.g.,
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McCormick v. Fund American Cos., Inc., 26 F.3d 869, 876 (9th
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Cir. 1994) (collecting cases) ("[T]he corporate issuer in
possession of material nonpublic information, must, like other
insiders in the same situation, disclose that information to
its shareholders or refrain from trading with them."); Rogen v.
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Ilikon Corp., 361 F.2d 260, 268 (1st Cir. 1966); Kohler v.
_____________ ______
Kohler Co., 319 F.2d 634, 638 (7th Cir. 1963); Green v.
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Hamilton Int'l Corp., 437 F. Supp. 723, 728-29 (S.D.N.Y. 1977);
____________________
VII Louis Loss & Joel Seligman, Securities Regulation 1505 (3d
_____________________
ed. 1991) ("When the issuer itself wants to buy or sell its own
securities, it has a choice: desist or disclose."); 18 Donald
C. Langevoort, Insider Trading: Regulation, Enforcement &
______________________________________________
Prevention 3.02[1][d], at 5 (3d rel. 1994) ("Issuers
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themselves may buy or sell their own securities, and have long
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possession of undisclosed material negative information,
thereby increasing the company's long-run costs of raising
capital. Id. at 288-89. However, as the authors also
___
recognize, the argument for voluntary disclosure becomes
considerably weaker in contexts where the short-term interests
of the company's managers differ from its long-term interests,
for example, where management is under pressure to engineer a
rapid turnaround in the company's financial performance. See
___
id. at 169 (discussing the "agency" problem in the context of
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tender offers).
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been held to an obligation of full disclosure . . . .
Conceptually, extending the insider trading prohibition to
instances of issuer insider trading makes perfect sense.").
Just as an individual insider with material nonpublic
information about pending merger or license negotiations could
not purchase his company's securities without making
disclosure, the company itself may not engage in such a
purchase of its own stock, if it is in possession of such
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undisclosed information. See, e.g., Rogen, 361 F.2d at 268.
___ ____ _____
By extension, a comparable rule should apply to issuers engaged
in a stock offering. Otherwise, a corporate issuer selling its
________
own securities would be left free to exploit its informational
trading advantage, at the expense of investors, by delaying
disclosure of material nonpublic negative news until after
completion of the offering. Cf. Ian Ayres, Back to Basics:
___ ________________
Regulating How Corporations Speak to the Market, 77 Va. L. Rev.
_______________________________________________
945, 959-60 (1991) (describing the argument that securities
laws impose needed discipline, because companies do not always
internalize the costs of failing to provide the market with
accurate information that would lower stock prices).
2. The Statutory and Regulatory Scheme
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Analogizing a corporate issuer to an individual insider
subject to the "disclose or abstain" rule of insider trading
law illustrates the policy reasons supporting a comparably
strong disclosure mechanism in the context of a public
offering. We look to the explicit statutory and regulatory
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framework to determine whether the Securities Act provides such
a mechanism, and whether the Wilensky complaint states a
________
legally cognizable claim for nondisclosure under Section 11.
Section 11 by its terms provides for the imposition of
liability if a registration statement, as of its effective
date: (1) "contained an untrue statement of material fact"; (2)
"omitted to state a material fact required to be stated
therein"; or (3) omitted to state a material fact "necessary to
make the statements therein not misleading." 15 U.S.C.
77k(a). The plaintiffs' claim of nondisclosure relies on the
second of these three bases of liability. That predicate is
unique to Section 11; neither Section 12(2) of the Securities
Act nor Section 10(b) or Rule 10b-5 under the Exchange Act
contains comparable language. It is intended to ensure that
issuers, under pain of civil liability, not cut corners in
preparing registration statements and that they disclose all
material information required by the applicable statutes and
regulations. See Huddleston, 459 U.S. at 381-82; Harold S.
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Bloomenthal et al., Securities Law Handbook 14.08, at 663
________________________
(1996 ed.) ("Congress . . . devised Section 11 of the
Securities Act as an in terrorem remedy that would . . .
encourage careful preparation of the registration statement and
prospectus.").
The information "required to be stated" in a
registration statement is spelled out both in Schedule A to
Section 7(a)of the Securities Act, 15 U.S.C. 77g(a), 77aa,
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and in various regulations promulgated by the SEC pursuant to
its statutory authority.6 Those rules and regulations are no
less essential to the statutory scheme than the general
outlines of the statute itself. Cf. Touche Ross & Co. v. SEC,
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609 F.2d 570, 580 (2d Cir. 1979).
In this case, DEC conducted its March 1994 public
offering pursuant to a registration statement on SEC Form S-3.
Item 11(a) of the instructions to Form S-37 requires that the
issuer (registrant) describe in the portion of the registration
statement comprising the prospectus:
any and all material changes in the registrant's
_________________________________________________
affairs which have occurred since the end of the
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latest fiscal year for which certified financial
statements were included in the latest annual
report to security holders and which have not
been described in a report on Form 10-Q or Form
8-K filed under the Exchange Act.
Instructions to Form S-3, Item 11(a) (emphasis added).
To understand the scope of the "material changes"
disclosure requirement, it is helpful to understand the nature
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6. Section 7(a) of the Securities Act provides that the
"registration statement shall contain such other information,
and be accompanied by such other documents, as the Commission
may by rules or regulations require as being necessary or
appropriate in the public interest or for the protection of
investors." 15 U.S.C. 77g(a); see also 15 U.S.C. 77j(d)
________
(granting SEC similar authority with respect to prospectuses);
15 U.S.C. 77s(a) (granting SEC broad authority to "make,
amend, and rescind such rules and regulations as may be
necessary to carry out the provisions of this [Act], including
rules and regulations governing registration statements and
prospectuses").
7. The provisions of the registration forms prescribed by the
SEC constitute an integral part of the regulatory disclosure
framework. See 17 C.F.R. 230.400, 230.401, 239.0-1 et seq.
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of Form S-3. Form S-3 is a streamlined registration form
available only to certain well-capitalized and widely followed
issuers about which a significant amount of public information
is already available.8 A registrant on Form S-3 accomplishes
disclosure in part by incorporating in the prospectus by
reference its most recent Form 10-K and Forms 10-Q filed
pursuant to the Exchange Act. See Instructions to Form S-3,
___
Item 12(a). Unlike registrants on more broadly available forms
(such as S-1), a Form S-3 registrant is not required separately
to furnish in the prospectus the information required by Item
303(a) of Regulation S-K, 17 C.F.R. 229.303(a) ("Management's
discussion and analysis of financial condition and results of
operations"),9 because that information is presumed to be
contained in the Exchange Act filings that Form S-3
incorporates by reference, which are themselves subject to the
requirements of Regulation S-K.10 The primary purpose of the
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8. To be eligible to register on Form S-3, an issuer must have
been subject to public reporting requirements for at least one
year, filed all reports required under the Exchange Act (such
as Forms 10-Q and 10-K) timely during the past year, and must
meet certain other requirements relating to financial strength
and stability. See 17 C.F.R. 239.13; see also Bloomenthal et
___ ________
al., supra, 5.05[1][b], at 212-13.
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9. Item 303(a) requires the disclosure, among other
information, of "any known trends or uncertainties that have
had or that the registrant reasonably expects will have a
material favorable or unfavorable impact on net sales or
revenues or income from continuing operations." 17 C.F.R.
229.303(a)(3)(ii).
10. By contrast, a registrant on Form S-1 (which does not
permit incorporation by reference) must independently furnish
in the prospectus the information required by Item 303 of
Regulation S-K. See Instructions to Form S-1, Item 11(h).
___
-19-
"material changes" disclosure requirement of Item 11(a), then,
is to ensure that the prospectus provides investors with an
update of the information required to be disclosed in the
______
incorporated Exchange Act filings, including the information
provided in those filings concerning "known trends and
uncertainties" with respect to "net sales or revenues or income
from continuing operations." 17 C.F.R. 229.303(a)(3)(ii).
In this case, the date of the final prospectus for the
March 1994 offering and the effective date of the registration
statement was March 21, 1994.11 Prior to that date, the end
of DEC's latest fiscal year was July 3, 1993 (fiscal year
1993), and the last Form 10-Q filed by the company was for the
quarter that had ended on January 1, 1994 (DEC's second fiscal
quarter). The question, then, is whether the complaint
contains sufficient allegations that defendants failed to
disclose in the registration statement any information
regarding "material changes" in DEC's "affairs" as of March 21,
1994, that had occurred since July 3, 1993 and had not been
reported in the Form 10-Q filed for the second quarter of
fiscal year 1994. If the Wilensky complaint adequately so
________
alleges, then the complaint sets forth a cognizable claim of
nondisclosure under Section 11, namely, that defendants failed
____________________
11. The effective date of the registration statement for
purposes of Securities Act liability is the "speaking date" of
the final prospectus. See Bloomenthal et al., supra,
___ _____
5.05[2][f] at 216. The parties do not dispute that March 21,
1994 was the effective date of the registration statement.
-20-
to include in the registration statement information "required
to be stated therein."
3. The Alleged Nondisclosures
__ __________________________
Plaintiffs argue that defendants failed to comply with
Item 11(a) by omitting three categories of information from the
registration statement and prospectus. First, plaintiffs
contend that defendants failed to disclose that DEC had
embarked on a risky marketing strategy that involved slashing
prices and sacrificing profit margins in the hopes of
increasing "market penetration" of the company's Alpha chip
products. Second, plaintiffs assert that defendants failed to
disclose that under the company's compensation scheme, its
sales representatives were being paid "double commissions,"
again to the detriment of the company's profit margins. Third,
and most centrally, plaintiffs allege that, by the date of the
March 21 offering, defendants were in possession of, yet failed
to disclose, material knowledge of facts indicating that the
third fiscal quarter would be an unexpectedly disastrous one.
We dispose of the first two claims of nondisclosure, and then
focus our discussion on the third.
a. Marketing Strategy
__ __________________
The defendants provide a decisive rejoinder to the
plaintiffs' claim of nondisclosure concerning the "marketing
strategy": the relevant aspects and consequences of the
strategy were in fact prominently disclosed, both in the text
-21-
of the prospectus and in documents incorporated by
reference.12 For example, in its Form 10-Q filing for the
quarter ending October 2, 1993 (the first quarter of fiscal
year 1994), the company explained its reported decline in gross
profit margins as follows:13
The decline in product gross margin resulted from
the decrease in product sales, a continued shift
in the mix of product sales toward low-end
systems which typically carry lower margins,
competitive pricing pressures and unfavorable
currency fluctuations, partially offset by
manufacturing cost efficiencies.
The Corporation has adopted an aggressive,
competitive price structure for its Alpha AXP
systems. Given this pricing, as well as the
factors described in the preceding paragraph, the
Corporation expects to experience continued
downward pressure on product gross margins.
This statement, in conjunction with related disclosures found
elsewhere in the prospectus and incorporated filings relating
to "competitive pricing pressures," declining gross profit
margins, "competitive pricing actions taken by the
Corporation," an "industry trend toward lower product gross
____________________
12. As required by Item 12 of the instructions to Form S-3,
the March 11, 1994 prospectus specifically incorporated by
reference the company's Form 10-K filing for fiscal year 1993
(as amended by Form 10-K/A dated March 11, 1994), and its Form
10-Q filings for the quarterly periods that ended on October 2,
1993 and January 1, 1994.
13. Since the complaint alleges nondisclosures in the
registration statement and prospectus, the court may look to
the text of those materials and the incorporated SEC filings to
determine whether the plaintiffs' allegations are well founded.
See Kramer v. Time Warner, Inc., 937 F.2d 767, 774 (2d Cir.
___ ______ __________________
1991). We discuss more fully later the circumstances in which
a court may look outside the four corners of a complaint in
deciding a motion to dismiss.
-22-
margins," and "persistent intense pricing competition,"
together obviate the plaintiffs' claim that defendants failed
to disclose the company's adoption of a price-cutting strategy
to boost the "market penetration" of its Alpha-based systems.
b. "Double Commissions"
__ ____________________
The plaintiffs' claim of a failure to disclose "double
commissions" also fails to make out a Section 11 violation. To
the extent that the claim comprises allegations of
mismanagement,14 it is not cognizable under the securities
laws. See Santa Fe Indus., Inc. v. Green, 430 U.S. 462, 477-80
___ _____________________ _____
(1977); In re Craftmatic Sec. Litig., 890 F.2d 628, 638-39 (3d
____________________________
Cir. 1989) (stating that plaintiffs cannot circumvent Santa Fe
________
by simply pleading a mismanagement claim as a failure to
disclose management practices); see also Hayes v. Gross, 982
_________ _____ _____
F.2d 104, 106 (3d Cir. 1992). Otherwise, the claim fails for
lack of any allegations establishing a plausible theory of
materiality.
The complaint does not allege that "double commissions"
have some intrinsic significance to investors. Plaintiffs
complain, rather, that DEC failed to tell the market that the
commission-based compensation scheme, instead of boosting sales
as it was supposed to do, was contributing to the company's
losses. This argument is problematic. As the complaint itself
acknowledges, DEC publicly announced the switch from a salary-
____________________
14. The complaint's assertion that "DEC implemented its
commission program and set sales quotas without careful
evaluation" is an example of such an allegation.
-23-
based compensation scheme to the incentive-based model that
produced the double commissions. Furthermore, according to the
complaint, the switch was made not during the third fiscal
___
quarter of 1994, but some two years earlier, in 1992. The
____
plaintiffs do not allege that any material changes to the
compensation scheme were implemented after that time. Whatever
the bearing of DEC's incentive-based compensation scheme on the
company's expenses in relation to its revenues, the investing
public had at least a year's worth of hard financial data
(through the second quarter of fiscal 1994) to evaluate whether
the commission system was working to increase gross
margins,15 or instead, as plaintiffs allege, to shrink them.
Plaintiffs do not allege that there were any material changes
in the payment of commissions between the time of the March
public offering and the last prior Form 10-Q filed by the
company (for the second fiscal quarter of 1994), and so on
their own theory the claim that DEC failed to disclose the
payment of "double commissions" amounts to naught.
c. Operating Results Prior to End of Quarter
__ _________________________________________
We turn to the complaint's central, overarching claim
that defendants failed, in connection with the March public
offering, to disclose material factual developments foreboding
disastrous quarter-end results. In evaluating this claim, we
____________________
15. The payments made to sales representatives constituted a
component of the company's quarterly expenses, and the
aggregate effect of such payments could have been determined by
examining the company's quarterly earnings data, as disclosed
in the required SEC filings.
-24-
accept arguendo the complaint's allegations16 that DEC had in
________
its possession as of the March 21 offering date nonpublic
information concerning the company's ongoing quarter-to-date
performance, indicating that the company would suffer
unexpectedly large losses for that quarter. We ask, then,
whether there was a duty to disclose such information in the
registration statement and prospectus under the rubric of
"material changes" under Item 11(a) of Form S-3. We focus upon
the defendants' primary legal arguments on this point: that DEC
was under no duty to disclose "intra-quarterly" results or any
other information concerning its third quarter performance
until after the quarter ended; and that defendants had no duty
as of March 21, 1994 to disclose any internal projections or
predictions concerning the expected outcome of the quarter.
A central goal underlying the disclosure provisions of
the securities laws is to promote fairness and efficiency in
the securities markets. See Central Bank of Denver, N.A. v.
___ _____________________________
First Interstate Bank of Denver, N.A., 114 S. Ct. 1439, 1445
_______________________________________
(1994) ("Together, the Acts embrace a fundamental purpose . . .
to substitute a philosophy of full disclosure for the
philosophy of caveat emptor." (internal quotation omitted)); In
__
re LTV Sec. Litig., 88 F.R.D. 134, 145 (N.D. Tex. 1980). The
___________________
disclosure of accurate firm-specific information enables
____________________
16. As discussed below, based on the character of the
allegations in the Wilensky complaint, the plaintiffs' claims
________
under the Securities Act are not subject to the pleading
requirements of Fed. R. Civ. P. 9(b).
-25-
investors to compare the prospects of investing in one firm
versus another, and enables capital to flow to its most
valuable uses. LHLC Corp. v. Cluett, Peabody & Co., 842 F.2d
__________ _____________________
928, 931 (7th Cir.), cert. denied, 488 U.S. 926 (1988); cf.
_____ ______ ___
Acme Propane, Inc. v. Tenexco, Inc., 844 F.2d 1317, 1323 (7th
__________________ _____________
Cir. 1988) (securities laws aim at ensuring the availability to
the investing public of information not otherwise in the public
domain). The availability of reliable firm-specific
information is also essential to the market's ability to align
stock price with a security's "fundamental value." See Marcel
___
Kahan, Securities Laws and the Social Costs of "Inaccurate"
_______________________________________________________
Stock Prices, 41 Duke L. J. 977, 988-89 (1992).
____________
The need for issuers to disclose material information is
crucial in the context of a public offering, where investors
typically must rely (unless the offering is "at the market") on
an offering price determined by the issuer and/or the
underwriters of the offering. See Kahan, supra, at 1014-15
___ _____
(explaining the heightened need to target disclosure
requirements to companies engaged in public offerings).
Accordingly, the disclosure requirements associated with a
stock offering are more stringent than, for example, the
regular periodic disclosures called for in the company's annual
Form 10-K or quarterly Form 10-Q filings under the Exchange
Act. See id. at 1014-15 & n.163.
___ ___
The need for complete and prompt disclosure is
particularly keen when a corporation issues stock pursuant to a
-26-
"shelf registration" under SEC Rule 415(a), as DEC did in its
public offering of March 1994. See 17 C.F.R. 230.415(a)
___
(permitting registration of securities to be issued on a
"continuous" or "delayed" basis). The shelf registration rule
permits a company to file a single registration statement
covering a certain quantity of securities (register securities
"for the shelf"), and then over a period of up to two
years,17 with the appropriate updates of information,18
issue installments of securities under that registration
statement (take the securities "down from the shelf") almost
instantly, in amounts and at times the company and its
underwriters deem most propitious. See Clark, supra, at 751
___ _____
(explaining that the shelf registration process enables firms
to pinpoint the timing of offerings to the issuer's advantage);
see generally Jeffrey N. Gordon & Lewis A. Kornhauser,
______________
Efficient Markets, Costly Information, and Securities Research,
______________________________________________________________
60 N.Y.U. L. Rev. 761, 819-20 (1985).
____________________
17. A shelf registration under Rule 415 may only cover an
amount of securities that "is reasonably expected to be offered
and sold within two years from the initial effective date of
the registration." 17 C.F.R. 230.415(a)(2).
18. For example, Rule 415(a)(3) requires that a shelf
registrant comply with Item 512(a) of Regulation S-K, 17 C.F.R.
229.512(a)(ii), which requires that a registrant file a post-
effective amendment to an initial registration statement "[t]o
reflect in the prospectus any facts or events arising after the
effective date of the registration statement . . . which,
individually or in the aggregate, represent a fundamental
change in the information set forth in the registration
statement."
-27-
The social benefit of the shelf registration rule is
that it can enable an issuer to decrease its costs of raising
capital. See Clark, supra, at 751. The concomitant risk is
___ _____
that, by permitting securities to be offered on a "delayed"
basis, the rule may adversely affect the quality and timeliness
of the disclosures made in connection with the actual issuance
of securities. See Shelf Registration, SEC Release Nos. 33-
___
6499, 34-20384, 35-23122, 1983 WL 35832 (SEC), *2 ("Shelf Reg.
Rel."); see also I Loss & Seligman, supra, at 355 ("The
_________ _____
rationale for limiting the time during which registered
securities may be sold is that investors need current
information when considering an offering. To permit
'registration for the shelf' runs the risk that investors
subsequently will be offered securities on the basis of
outdated or stale information."). In response to these
concerns, the SEC, in adopting Rule 415 in its current form,
assured that "[p]ost-effective amendments [to the initial
registration statement] and prospectus supplements [would]
serve to ensure that investors are provided with complete,
accurate and current information at the time of the offering or
sale of securities." Shelf Reg. Rel., supra, 1983 WL 35832
_____
(SEC), *9. The SEC explained that registrants would not be
permitted "to use the shelf registration rule as a basis for
omitting required information from their registration
statements when they become effective." Id., 1983 WL 35832
___
(SEC), *10.
-28-
Based on concerns about Rule 415's effect on the
adequacy and timeliness of disclosure, the SEC chose to limit
the availability of the rule, in the context of primary stock
offerings, to the widely-followed companies (like DEC) that are
eligible to register securities on SEC Form S-3.19 See 17
___
C.F.R. 230.415(a)(1)(x); SEC Rel. No. 33-6499, 1983 WL 35832
(SEC) at *5; I Loss & Seligman, supra, at 361 & n.90. The
_____
theory was that the concerns about adequacy of disclosure were
less prominent in the case of "S-3" registrants, because those
companies are precisely the ones that in the ordinary course of
their businesses "provide a steady stream of high quality
corporate information to the marketplace and whose corporate
information is broadly disseminated[] . . . and is constantly
digested and synthesized by financial analysts." Shelf Reg.
Rel., supra, 1983 WL 35832 (SEC), *5.
_____
Defendants assert here that the disclosure requirements
of the Securities Act and regulations, including Item 11(a) of
Form S-3, should be interpreted so that they would never
_____
mandate the provision of current information about a company's
performance in the quarter in progress at the time of a public
offering, so long as the company satisfies its quarterly and
annual periodic disclosure obligations under the Exchange Act.
That argument cuts severely against the very reason the shelf
____________________
19. As an exception to the Form S-3 limitation, the SEC also
made the shelf registration rule available in certain other
limited circumstances not relevant here. See 17 C.F.R.
___
230.415(a)(1)(i)-(ix); Bloomenthal et al., supra, 5.12[1]
_____
at 235-36; I Loss & Seligman, supra, at 362-63.
_____
-29-
registration rule was made available to issuers like DEC: that
"S-3" companies would provide the market with a continuous
stream of high quality corporate information. The rule permits
offerings to be made on a "continuous" or "delayed" basis
because it envisions "continuous" disclosure. It would be
inconsistent with this rationale to permit an issuer to take
refuge in its periodically-filed Forms 10-Q or 10-K to avoid
the obligation to disclose current material facts in its shelf
offering prospectus.
Absent some mechanism requiring a registrant to disclose
internally known, material nonpublic information pertaining to
a quarter in progress, the shelf registration procedure, by
enabling the issuer to pinpoint the timing of its offering,
would give a company anticipating a negative earnings
announcement the ability to time its offerings of securities
from the shelf to be completed prior to the public release of
the known negative news. This would allow companies to exploit
what amounts to a naked informational trading advantage. Cf.
___
Gordon & Kornhauser, supra, at 819-20. Item 11(a) of Form S-3,
_____
by requiring the issuer to disclose current information
concerning "material changes" from previously reported data,
provides a mechanism -- comparable in effect to the "disclose
or abstain" rule governing insider trading -- to prevent such
strategic behavior.20
____________________
20. Of course, if the issuer desires not to disclose the
information prior to quarter's end, then the flexibility of the
shelf registration procedure permits the issuer to "delay" a
-30-
In the face of these concerns, DEC argues that the
plaintiffs' claims of nondisclosure are without merit, because
they seek to impose liability upon DEC for a failure to
disclose its internal projections about the outcome of the
___________
third quarter of fiscal 1994. The federal securities laws
impose no obligation upon an issuer to disclose forward-looking
information such as internal projections, estimates of future
performance, forecasts, budgets, and similar data. See, e.g.,
___ ____
In re Verifone Sec. Litig., 11 F.3d 865, 869 (9th Cir. 1993);
___________________________
In re Convergent Technologies Sec. Litig., 948 F.2d 507, 516
__________________________________________
(9th Cir. 1991). Plaintiffs, however, insist that their
Section 11 claim is concerned not with the nondisclosure of
projections, but of current information that DEC allegedly had
in its possession as of March 21, 1994 about "losses" the
company was incurring in the ongoing quarter. Defendants
respond, in turn, that under a system of quarterly reporting,
"losses" cannot be realized until a quarter has ended, and that
because the quarter in question did not end until April 2,
1994, whatever information DEC had as of March 21 concerning
that quarter necessarily must have been forward-looking, in the
nature of a projection or forecast, which it had no obligation
to disclose.
DEC's argument elevates form over substance. DEC's
assertion that companies do not realize "losses" as such until
____________________
planned offering until after the quarter is completed and the
results from the quarter are publicly reported.
-31-
a quarter has ended is, of course, largely unexceptionable.
But it does not follow that DEC's only information concerning
the ongoing quarter as of March 21 must have been forward-
looking. That contention relies on two faulty components.
First, it assumes that plaintiffs could not adduce adequate
evidence that defendants were actually in possession of
material information about the ongoing quarter at the relevant
time. Second, it assumes that the potential unreliability of
inferences that could be drawn from current information about
operating results as of eleven days before the end of a quarter
absolutely protects that information from mandatory disclosure.
The first premise is inconsistent with the standards governing
a Rule 12(b)(6) motion to dismiss. The second confuses the
issue of materiality with the duty to disclose.
Defendants posit, in essence, that there can never be a
duty to disclose internally known, pre-end-of-quarter financial
information, because any inferences about the quarter that
might be drawn from such information could be rendered
unreliable by later developments in the same quarter, such as a
sudden surge of profitable sales. This position does not
withstand scrutiny. Present, known information that strongly
implies an important future outcome is not immune from
mandatory disclosure merely because it does not foreordain any
particular outcome. The question whether such present
information must be disclosed (assuming the existence of a
duty), poses a classic materiality issue: given that at any
-32-
point in a quarter, the remainder of the period may not mirror
the quarter-to-date, is there a sufficient probability that
unexpectedly disastrous quarter-to-date performance will carry
forward to the end of the quarter, such that a reasonable
investor would likely consider the interim performance
important to the overall mix of information available?
As desirable as bright-line rules may be, this question
cannot be answered by reference to such a rule. To try to do
so would be contrary to Basic, Inc. v. Levinson, 485 U.S. 224
___________ ________
(1988). The Supreme Court there refused to adopt a bright-line
approach to determine at what stage preliminary merger
discussions create a sufficient probability of actual
consummation to become material. See id. at 237-39 (rejecting
___ ___
"agreement-in-principle" test). So here. We decline to adopt,
as defendants would have us do, a hard and fast rule that
current information concerning a company's operating experience
is never subject to disclosure until after the end of the
quarter to which the information pertains. Rather, the
question is whether the nondisclosure of interim facts rendered
the prospectus materially incomplete. An issuer's compliance
with the periodic disclosure requirements of the Exchange Act
does not per se preclude such undisclosed facts from being
_______
material.
By the same token, we reject any bright-line rule that
an issuer engaging in a public offering is obligated to
disclose interim operating results for the quarter in progress
-33-
whenever it perceives a possibility that the quarter's results
may disappoint the market. Far from it. Reasonable investors
understand that businesses fluctuate, and that past success is
not a guarantee of more of the same. There is always some risk
that the quarter in progress at the time of an investment will
turn out for the issuer to be worse than anticipated. The
market takes this risk of variability into account in
evaluating the company's prospects based on the available facts
concerning the issuer's past historical performance, its
current financial condition, present trends and future
uncertainties. But, strong-form efficient market theories
aside, the ability of market observers to evaluate a company
depends upon the information publicly available to them. If,
as plaintiffs allege here, the issuer is in possession of
nonpublic information indicating that the quarter in progress
at the time of the public offering will be an extreme departure
from the range of results which could be anticipated based on
currently available information, it is consistent with the
basic statutory policies favoring disclosure to require
inclusion of that information in the registration statement.
We do not mean to imply, however, that nondisclosure
claims similar to those asserted by plaintiffs here can never
be disposed of as a matter of law. In many circumstances, the
relationship between the nonpublic information that plaintiffs
claim should have been disclosed and the actual results or
events that the undisclosed information supposedly would have
-34-
presaged will be so attenuated that the undisclosed information
may be deemed immaterial as a matter of law. Cf. Verifone, 11
___ ________
F.3d at 867-70 (affirming dismissal of claim that registration
statement allegedly failed to disclose information concerning
development that came to light six months later); Krim v.
____
BancTexas Group, Inc., 989 F.2d 1435, 1439, 1449-50 (5th Cir.
_____________________
1993) (affirming summary judgment disallowing claim that
prospectus failed to disclose information of developments that
matured four months later); Convergent, 948 F.2d at 509-11,
__________
515-16 (same, where prospectuses in March and August 1983
allegedly failed to disclose negative developments announced in
February 1984); Zucker v. Quasha, 891 F. Supp. 1010, 1012, 1018
______ ______
(D.N.J. 1995) (dismissing complaint based on alleged
nondisclosure in March 31 registration statement of information
relating to results of period ending July 2), aff'd, __ F.3d __
_____
(3d Cir. 1996) (table, No. 95-5428). In such circumstances,
where the allegedly undisclosed information is sufficiently
remote in time or causation from the ultimate events of which
it purportedly forewarned, the plaintiff's claim of
nondisclosure may be indistinguishable from a claim that the
issuer should have divulged its internal predictions about what
would come of the undisclosed information. Cf. Verifone, 11
___ ________
F.3d at 869 (characterizing plaintiffs' claims of nondisclosure
of "adverse material facts and trends" as of March 13 as claims
that defendants failed to disclose forecasts of news actually
released to public on September 17).
-35-
Here, however, the prospectus in question was filed 11
days prior to the end of the quarter in progress. The results
for that quarter turned out to be, by all accounts, the product
of more than a minor business fluctuation. Accepting, as we
must, the plaintiffs' allegation that DEC, by March 21, 1994,
was in possession of information about the company's quarter-
to-date performance (e.g., operating results) indicating some
____
substantial likelihood that the quarter would turn out to be an
extreme departure from publicly known trends and uncertainties,
we cannot conclude as a matter of law and at this early stage
of the litigation that such information was not subject to
mandatory disclosure under the rubric of "material changes" in
Item 11(a) of Form S-3. We conclude, accordingly, that the
Wilensky plaintiffs' complaint as to this theory states a
________
legally cognizableclaim under Section11 of theSecurities Act.21
____________________
21. It bears reemphasizing that the plaintiffs' claim is
sustainable only to the extent it relates to the nondisclosure
of "hard" material information, as opposed to "soft"
information in the nature of projections. See In re Verifone
___ _______________
Sec. Litig., 784 F. Supp. 1471, 1482 (N.D. Cal. 1992), aff'd,
___________ _____
11 F.3d 865 (9th Cir. 1993); see generally 2 Loss & Seligman,
_____________
supra, at 622 n.66. Although DEC had no obligation to disclose
_____
a forecast of results for the quarter in progress at the time
of the offering, it was permitted to do so. If it had chosen
to disclose such a forward-looking projection, and if the
projection was made with reasonable basis and in good faith, it
would have been protected by the SEC's safe harbor provision.
See SEC Rule 175, 17 C.F.R. 230.175; see also Arazie v.
___ ________ ______
Mullane, 2 F.3d 1456, 1468 (7th Cir. 1993); Searls v. Glasser,
_______ ______ _______
64 F.3d 1061, 1066 (7th Cir. 1995); cf. Private Securities
___
Litigation Reform Act of 1995, Pub. L. No. 104-67, 102, 109
Stat. 737, 749-55 (creating expanded statutory protection for
forward-looking statements). Furthermore, had DEC chosen to
disclose projected results, such a disclosure (if reasonable)
could very well have rendered the "hard" interim information
underlying the projection immaterial as a matter of fact or of
-36-
B. Actionability of Statement Concerning Restructuring
__ _________________________________________________________
Reserves
________
The Wilensky plaintiffs also allege that the
________
registration statement and prospectus for the March 21 offering
contained a materially false and misleading statement
actionable under both Sections 11 and 12(2). They contend that
the statement of DEC's "belie[f]" as to the "adequacy" of the
then-remaining $443 million restructuring reserve "to cover
presently planned restructuring actions" was false and
misleading, in light of information contemporaneously known to
the company.
1. Background
__ __________
The "restructuring reserve" referred to in the
prospectus supplement originated as a $1.5 billion charge taken
by DEC at the close of its fiscal year 1992 (ended June 27,
1992) as part of the company's ongoing efforts to streamline
the company "to achieve a competitive cost structure." The
reserve was intended to cover the anticipated costs of employee
separations, facilities consolidations, asset retirements,
relocations, and related expenses. The company had absorbed
similar restructuring charges of $1.1 billion and $550 million
in fiscal years 1991 and 1990, respectively.
____________________
law, unless the market would have had some reason to discredit
the projection, thereby creating a substantial likelihood that
a reasonable investor might still have found the underlying
information important to the total mix of information
available.
-37-
During fiscal year 1993, DEC took a number of actions
consistent with the $1.5 billion dollar reserve recorded at the
end of fiscal year 1992. By the end of the fiscal year (July
3, 1993), the remaining reserve was reported to be
approximately $739 million. During the first two quarters of
the next fiscal year, the company continued to draw from the
reserve, so that by the end of the second quarter (January 1,
1994), the reserve stood at approximately $443 million. In its
Form 10-Q for that quarter, dated February 4, 1994 (and
incorporated by reference into the registration statement and
prospectus at issue here), DEC stated its belief that the $443
million reserve was "adequate" to cover restructuring
activities planned at that time. This statement was repeated
in the prospectus supplement dated March 21, 1994. The full
statement, with its immediately surrounding context, was as
follows:
While spending for R&E [research & engineering]
and SG&A [selling, general & administrative] is
declining, the Corporation believes its cost and
expense levels are still too high for the level
and mix of total operating revenues. The
Corporation is reducing expenses by streamlining
its product offerings and selling and
administrative practices, resulting in reductions
in employee population, closing and consolidation
of facilities and reductions in discretionary
spending. The Corporation believes that the
remaining restructuring reserve of $443 million
is adequate to cover presently planned
restructuring actions. The Corporation will
continue to take actions necessary to achieve a
level of costs appropriate for its revenues and
competitive for its business.
-38-
As events turned out, additional restructuring charges
were in fact taken later in fiscal year 1994. At the time of
the company's announcement on April 15, 1994 of the $183
million loss for the third fiscal quarter of 1994, defendant
Palmer stated that he had already instructed management to
"accelerate [the company's] on-going restructuring efforts" and
that the company would "consider further restructuring to
achieve [its] goals." In line with these statements, the
company announced on July 20, 1994 (just after the close of
fiscal year 1994) that it had decided to take an additional
restructuring charge of $1.2 billion in fiscal year 1994 (ended
June 30, 1994).
2. Whether the Statement Was Misleading
__ ____________________________________
Although defendants were required to disclose the size
of the remaining restructuring reserve in the registration
statement and prospectus as affecting the company's liquidity
and capital resources,22 the characterization of the reserve
as adequate was arguably voluntary. But whether voluntary or
________
not, DEC's description of its belief as of March 21, 1994 that
the remaining $443 million reserve was "adequate" carried with
it an obligation to ensure that the representation was not
____________________
22. Item 303(a) of Regulation S-K requires the registrant to
include in its Exchange Act filings (e.g., Forms 10-Q and 10-
____
K), which in turn are incorporated by reference into
registration statements on Form S-3, a description of "trends
or any known demands, commitments, events or uncertainties"
affecting the registrant's liquidity, and of the registrant's
"material commitments for capital expenditures." 17 C.F.R.
229.303(a)(1)-(2).
-39-
misleading. See Roeder, 814 F.2d at 26; cf. Serabian v.
___ ______ ___ ________
Amoskeag Bank Shares, Inc., 24 F.3d 357, 365 (1st Cir. 1994)
___________________________
("[I]f a defendant characterizes . . . reserves as 'adequate'
or 'solid' even though it knows they are inadequate or
unstable, it exposes itself to possible liability [under the
securities laws]." (quoting Shapiro v. UJB Financial Corp., 964
_______ ___________________
F.2d 272, 282 (3d Cir.), cert. denied, 506 U.S. 934 (1992)));
_____ ______
cf. also In re Wells Fargo Sec. Litig., 12 F.3d 922, 930 (9th
________ ______________________________
Cir. 1993), cert. denied, 115 S. Ct. 295 (1994). Plaintiffs
_____ ______
assert that defendants failed to meet that obligation.
The undeniable purport of the "adequacy" statement is
that DEC had no plans as of the date of the prospectus
supplement to engage in actions that would require the taking
of a restructuring charge beyond the $443 million then
remaining in "reserve." This was false or misleading,
plaintiffs say, because DEC knew as of March 21, 1994 that
further restructuring actions would be necessary to put the
company back on the right track after its impending third
quarter setback, and that these actions would deplete the
remaining reserve and require further restructuring charges to
be taken. Defendants reply, as the district court noted, that
whatever the natural implication of the "adequacy" statement,
its context sufficiently "bespeaks caution" to render any
misleading inference from the statement immaterial as a matter
of law. We do not agree.
-40-
The "bespeaks caution" doctrine "is essentially
shorthand for the well-established principle that a statement
or omission must be considered in context." In re Donald J.
_______________
Trump Casino Sec. Litig., 7 F.3d 357, 364 (3d Cir. 1993), cert.
________________________ _____
denied, 114 S. Ct. 1219 (1994); see also Rubinstein v. Collins,
______ ________ __________ _______
20 F.3d 160, 167 (5th Cir. 1994). It embodies the principle
that when statements of "soft" information such as forecasts,
estimates, opinions, or projections are accompanied by
cautionary disclosures that adequately warn of the possibility
that actual results or events may turn out differently, the
"soft" statements may not be materially misleading under the
securities laws.23 See Romani v. Shearson Lehman Hutton, 929
___ ______ ______________________
F.2d 875, 879 (1st Cir. 1991); see also Harden v.
__________ ______
Raffensperger, Hughes & Co., 65 F.3d 1392, 1404 (7th Cir.
_____________________________
1995); In re Worlds of Wonder Sec. Litig., 35 F.3d 1407, 1413-
__________________________________
14 (9th Cir. 1994) (collecting cases), cert. denied, 116 S. Ct.
_____ ______
185 (1995); Rubinstein, 20 F.3d at 166-68; In re Trump, 7 F.3d
__________ ____________
at 371-72; I. Meyer Pincus & Assocs. v. Oppenheimer & Co., 936
_________________________ _________________
F.2d 759, 763 (2d Cir. 1991). In short, if a statement is
couched in or accompanied by prominent cautionary language that
clearly disclaims or discounts the drawing of a particular
inference, any claim that the statement was materially
misleading because it gave rise to that very inference may fail
as a matter of law. In re Trump, 7 F.3d at 364.
___________
____________________
23. The doctrine has been codified in the Securities
Litigation Reform Act, supra, Pub. L. No. 104-67, 102, 109
_____
Stat. at 750.
-41-
Here, however, the bespeaks caution doctrine does not
preclude a claim that the reserve "adequacy" statement was
materially misleading. The "adequacy" statement has both a
forward-looking aspect and an aspect that encompasses a
representation of present fact. In its forward-looking aspect,
the statement suggests that DEC would take no further
restructuring charges in the near-term future. In its present-
oriented aspect, it represents that as of March 21, 1994, DEC
had no current intent to undertake activities that would
require any such further restructuring charges to be taken. To
the extent that plaintiffs allege that the reserve "adequacy"
statement encompasses the latter representation of present
_______
fact, and that such a representation was false or misleading
____
when made, the surrounding cautionary language could not have
rendered the statement immaterial as a matter of law. See
___
Harden, 65 F.3d at 1405-06 (explaining that the bespeaks
______
caution doctrine cannot render misrepresentations of "hard"
fact nonactionable).24
Furthermore, to the extent that plaintiffs allege that
the "adequacy" statement implies a hiatus on new restructuring
charges for the near future, we do not think that the
surrounding context warns against such an implication with
sufficient clarity to be thought to bespeak caution. See Fecht
___ _____
____________________
24. Cf. also Securities Litigation Reform Act, supra, Pub. L.
________ _____
No. 104-67, 102, 109 Stat. at 750 (providing safe harbor to
statements couched in cautionary language only if the
statements are identified as forward-looking).
-42-
v. Price Co., 70 F.3d 1078, 1082 (9th Cir. 1995), cert. denied,
_________ _____ ______
64 U.S.L.W. 3688 (1996). The prospectus supplement does state
that DEC will "continue to take actions," but it is at best
ambiguous whether those "actions" refer to any restructuring
activities other than those "presently planned." Thus, one
might easily interpret the purportedly cautionary statement,
especially in light of the "adequacy" characterization, to mean
that the company's ongoing "actions" will continue to be
covered by the existing restructuring reserve. If it was true,
as plaintiffs allege, that defendants knew as of March 21, 1994
that DEC's performance in the third quarter would precipitate
actions on a scale and schedule that would necessitate the
taking of additional restructuring charges, the "adequacy"
statement may well have been materially misleading.
We cannot conclude, as a matter of law and on these
pleadings, that the actionability of the "reserve adequacy"
statement is precluded by a context that bespeaks caution. The
cautionary statements to which defendants point did not provide
an unambiguous warning of the possibility that DEC might take
additional restructuring charges in the near future -- as it
turned out, a charge of $1.2 billion in the fiscal year then in
progress. See id. at 1082 (bespeaks caution doctrine provides
___ ___
basis for dismissal as matter of law "only when reasonable
minds could not disagree as to whether the mix of information
___
in the [allegedly actionable] document is misleading" (emphasis
in original)); Rubinstein, 20 F.3d at 167-68 (stating that
__________
-43-
questions of whether disclosures were sufficiently cautionary
may not always be resolved as a matter of law). Accordingly,
we hold that the district court erred in concluding that the
plaintiffs' allegations pertaining to the prospectus
supplement's description of the restructuring reserve as
"adequate" fail to state a claim under Sections 11 and
12(2).25
C. Whether Defendants Are Statutory "Sellers"
__ __________________________________________
As an alternative basis for affirming the district
court's dismissal of the Section 12(2) claim, defendants argue
that the Wilensky plaintiffs have failed adequately to allege
________
their status as statutory "sellers."26 We conclude that the
complaint adequately alleges "seller" status only as to the
underwriter defendants. The dismissal of the Section 12(2)
claim as to the other defendants will accordingly be affirmed.
____________________
25. Defendants argue that, as a matter of fact, the market was
well aware in January 1994 or earlier that DEC might eventually
be forced to take further restructuring charges in fiscal year
1994. This, however, does not address whether the disclosures
in the prospectus supplement themselves "bespeak caution" as a
matter of law. Moreover, the evidence cited by defendants on
this point goes far beyond the allegations of the complaint.
While evidence of actual market knowledge might be proper grist
for the summary judgment mill on the question of materiality,
it cannot properly be considered in evaluating whether the
plaintiffs' complaint is legally sufficient to survive a motion
to dismiss under Rule 12(b)(6).
26. The district court, having dismissed the plaintiffs'
claims on other grounds, did not reach this issue. We may, of
course, affirm the district court's dismissal on any
independently sufficient ground. See Crellin Technologies,
___ ______________________
Inc. v. Equipmentlease Corp., 18 F.3d 1, 13 (1st Cir. 1994).
____________________________
-44-
In Pinter v. Dahl, 486 U.S. 622 (1988), the Supreme
______ ____
Court described in detail the class of defendants who may be
sued as "sellers" under Section 12(1) of the Securities Act.
See id. at 641-44. Section 12(2) defines the persons who may
___ ___
sue and be sued thereunder in language identical to the
language used in Section 12(1). Thus, Pinter's analysis of
______
"seller" for purposes of Section 12(1) applies with equal force
to the interpretation of "seller" under Section 12(2). See,
___
e.g., Ackerman v. Schwartz, 947 F.2d 841, 844-45 (7th Cir.
____ ________ ________
1991); In re Craftmatic Sec. Litig., 890 F.2d 628, 635 (3d Cir.
____________________________
1989); Moore v. Kayport Package Express, Inc., 885 F.2d 531,
_____ ______________________________
536 (9th Cir. 1989); Wilson v. Saintine Exploration & Drilling
______ ________________________________
Corp., 872 F.2d 1124, 1125-26 (2d Cir. 1989); Dawe v. Main St.
_____ ____ ________
Management Co., 738 F. Supp. 36, 37 (D. Mass. 1990).
______________
A person who "offers or sells" a security may be liable
under Section 12 to any person "purchasing such security from
__________ ____
him." 15 U.S.C. 77l(2) (emphasis added). Although the
"purchasing from" language in the statute literally appears to
contemplate a relationship between defendant and plaintiff "not
unlike traditional contractual privity," Pinter, 486 U.S. at
______
642, the Pinter Court held that Section 12 liability is not
______
limited to those who actually pass title to the suing
purchaser. See id. at 645. This is so because even "[i]n
___ ___
common parlance," a person may "offer or sell" property without
actually passing title. Id. at 642. For example, a broker or
___
agent who solicits a purchase "would commonly be said . . . to
-45-
be among those 'from' whom the buyer 'purchased,' even though
the agent himself did not pass title." Id. at 644.
___
Furthermore, because "solicitation is the stage at which an
investor is most likely to be injured," id. at 646, the Court
___
found it consistent with the policies of the statute to permit
imposition of liability on a non-owner of securities who
"successfully solicits"27 the plaintiff's purchase of the
securities, provided that the solicitor is "motivated at least
in part by a desire to serve his own financial interests or
those of the securities owner." Id. at 647.28
___
The Pinter Court limited its holding in ways that govern
______
the result here. The Court held that the "purchasing . . .
from" requirement of Section 12 limits the imposition of
liability to "the buyer's immediate seller" and thus, "a buyer
cannot recover against his seller's seller." Pinter, 486 U.S.
______
at 643 n.21 (citations omitted). Second, the Court stated that
proof the defendant caused a plaintiff's purchase of a security
______
is not enough to establish that the defendant "solicited" the
sale for Section 12 purposes. See id. at 651 (explaining that
___ ___
____________________
27. Section 2(3) of the Securities Act defines "sale" or
"sell" to include, among other notions, "every . . .
solicitation of an offer to buy, a security or interest in a
security, for value." 15 U.S.C. 77b(3); see Pinter, 486 U.S.
___ ______
at 643.
28. The Court reasoned that where a person's motivation in
persuading another to purchase securities is solely to benefit
the buyer, it would be "uncommon to say that the buyer
'purchased' from him," and that such motivation makes it
difficult to characterize the person's act as "solicitation."
Pinter, 486 U.S. at 647.
______
-46-
"[t]he 'purchase from' requirement of 12 focuses on the
defendant's relationship with the plaintiff-purchaser" and
rejecting use of a test under which defendant could qualify as
a seller if he was a "substantial factor" in causing the
transaction to take place). Finally, the Court indicated that
a person's "remote" involvement in a sales transaction or his
mere "participat[ion] in soliciting the purchase" does not
subject him to Section 12 liability. See id. at 651 n.27. A
___ ___
defendant must be directly involved in the actual solicitation
of a securities purchase in order to qualify, on that basis, as
a Section 12 "seller." See In re Craftmatic, 890 F.2d at 636;
___ ________________
Capri v. Murphy, 856 F.2d 473, 478-79 (2d Cir. 1988); Dawe, 738
_____ ______ ____
F. Supp. at 37.
We apply these principles to the Wilensky complaint.
________
The March 1994 public offering was made pursuant to a "firm
commitment" underwriting, as disclosed in the registration
statement and prospectus supplement. The plaintiffs do not
contend otherwise. In a firm commitment underwriting, the
issuer of the securities sells all of the shares to be offered
to one or more underwriters, at some discount from the offering
price. Investors thus purchase shares in the offering directly
from the underwriters (or broker-dealers who purchase from the
underwriters), not directly from the issuer. In fact, the
March 21, 1994 prospectus supplement represented that "[DEC]
has agreed not to, directly or indirectly, sell, offer or enter
-47-
into any agreement to offer or sell, shares of [the offered
stock]."
Because the issuer in a firm commitment underwriting
does not pass title to the securities, DEC and its officers
cannot be held liable as "sellers" under Section 12(2) unless
they actively "solicited" the plaintiffs' purchase of
securities to further their own financial motives, in the
manner of a broker or vendor's agent. See Pinter 486 U.S. at
___ ______
644-47. Absent such solicitation, DEC can be viewed as no more
than a "seller's seller," whom plaintiffs would have no right
to sue under Section 12(2). See id. at 644 n.21; PPM Am., Inc.
___ ___ _____________
v. Marriott Corp., 853 F. Supp. 860, 874-75 (D. Md. 1994);
______________
Louis Loss & Joel Seligman, Fundamentals of Securities
_____________________________
Regulation 1000-01 (3d ed. 1995) ("[I]t seems quite clear that
__________
12 contemplates only an action by a buyer against his or her
__________
immediate seller. That is to say, in the case of the typical
_________________
'firm-commitment underwriting,' the ultimate investor can
recover only from the dealer who sold to him or her." (emphasis
in original; footnotes omitted)).
The factual allegations in the complaint supporting the
purported status of DEC and the individual defendants as
Section 12(2) sellers are sparse, and all pertain to those
defendants' involvement in preparing the registration
statement, prospectus, and other "activities necessary to
effect the sale of the[] securities to the investing public."
Under Pinter, however, neither involvement in preparation of a
______
-48-
registration prospectus nor participation in "activities"
relating to the sale of securities, standing alone,
demonstrates the kind of relationship between defendant and
___________________________________
plaintiff that could establish statutory seller status. See
_________ ___
Pinter, 486 U.S. at 651 & n.27; Shapiro, 964 F.2d at 286.
______ _______
Although the complaint also contains a conclusory allegation
that each defendant "solicited and/or was a substantial factor
in the purchase by plaintiffs" of securities in the offering,
the Supreme Court specifically rejected a proposed test under
which a defendant's being a "substantial factor" in bringing
about a sale could establish statutory seller status. See
___
Pinter, 486 U.S. at 651. Furthermore, the term "solicitation"
______
is a legal term of art in this context. In deciding a motion
to dismiss under Rule 12(b)(6), a court must take all well-
pleaded facts as true, but it need not credit a complaint's
"bald assertions" or legal conclusions. Washington Legal
_________________
Found. v. Massachusetts Bar Found., 993 F.2d 962, 971 (1st Cir.
______ ________________________
1993) (quoting United States v. AVX Corp., 962 F.2d 108, 115
_____________ _________
(1st Cir. 1992)). Here it is undisputed that the public
offering was conducted pursuant to a firm commitment
underwriting, and plaintiffs' bald and factually unsupported
allegation that the issuer and individual officers of the
issuer "solicited" the plaintiffs' securities purchases is not,
standing alone, sufficient.
While, on a different set of allegations, an issuer
involved in a firmly underwritten public offering could be a
-49-
"seller" for purposes of Section 12(2), we hold that the
Wilensky complaint does not contain sufficient non-conclusory
________
factual allegations which, if true, would establish that DEC or
the individual defendants qualify as such. However, the
complaint does adequately allege that the underwriter
defendants directly sold securities to the plaintiffs (in the
literal sense of passing title), consistent with the
underwriting arrangements disclosed in the prospectus
supplement of March 21, 1994. We conclude that the plaintiffs
have adequately alleged statutory seller status as against the
underwriter defendants, but not against DEC or the individual
defendants.
IV.
The Section 10(b) Claims
________________________
(Shaw Action)
____
The plaintiffs in the Shaw action assert claims under
____
Sections 10(b) and 20(a)29 of the Securities Exchange Act of
1934, 15 U.S.C. 78j(b), 78t(a), and Rule 10b-5 promulgated
thereunder, 17 C.F.R. 240.10b-5. The implied right of
private action under Section 10(b) and Rule 10b-530
____________________
29. Section 20(a) provides for derivative liability of persons
who "control" others found to be primarily liable under the
Exchange Act.
30. Section 10(b) proscribes the "use or employ[ment], in
connection with the purchase or sale of any security, . . . any
manipulative or deceptive device or contrivance in
contravention of such rules and regulations as the Commission
may prescribe." 15 U.S.C. 78j(b). Rule 10b-5 makes it
unlawful "[t]o make any untrue statement of a material fact or
to omit to state a material fact necessary in order to make the
-50-
complements the civil enforcement function provided by Sections
11 and 12(2) of the Securities Act by reaching beyond
statements and omissions made in a registration statement,
prospectus, or in connection with an initial distribution of
securities, to create liability for false or misleading
statements or omissions of material fact in connection with
trading in the secondary market. See Central Bank of Denver,
___ _______________________
114 S. Ct. at 1445; Eckstein v. Balcor Film Investors, 8 F.3d
________ ______________________
1121, 1123-24 (7th Cir. 1993), cert. denied, 114 S. Ct. 883
_____ ______
(1994).
In addition to proving that the defendant made a
materially false or misleading statement or omitted to state a
material fact necessary to make a statement not misleading, a
Rule 10b-5 plaintiff, unlike a plaintiff asserting claims under
Section 11 or 12(2) of the Securities Act, must establish that
the defendant acted with scienter, and that the plaintiff's
reliance on the defendant's misstatement caused his injury.
See Holmes v. Bateson, 583 F.2d 542, 551 (1st Cir. 1978); see
___ ______ _______ ___
also San Leandro Emergency Medical Group Profit Sharing Plan v.
____ _______________________________________________________
Philip Morris Cos., Inc., 75 F.3d 801, 808 (2d Cir. 1996). The
________________________
same standard of materiality, however, applies to claims under
Section 10(b) and Rule 10b-5 as to claims under Sections 11 and
12(2) of the Securities Act. See Lucia v. Prospect St. High
___ _____ __________________
Income Portfolio, Inc., 36 F.3d 170, 172 n.3 (1st Cir. 1994).
______________________
____________________
statements made, in the light of the circumstances under which
they were made, not misleading . . . in connection with the
purchase or sale of any security." 17 C.F.R. 240.10b-5(b).
-51-
Finally, a plaintiff asserting securities fraud must plead the
alleged "circumstances constituting fraud . . . with
particularity." Fed. R. Civ. P. 9(b).
The Shaw plaintiffs advance the same claims of
____
nondisclosure and misstatement championed by the Wilensky
________
plaintiffs. They allege further that those alleged
nondisclosures and misstatements were made with fraudulent
intent, that defendants' conduct artificially inflated the
market price of DEC common stock, and that this fraud on the
market caused the plaintiffs to suffer damages. The Shaw
____
plaintiffs also allege that defendants committed actionable
fraud by making optimistic statements to the public (outside of
any SEC filing) concerning the company's prospects throughout
the Class Period,31 even though they knew or recklessly
disregarded nonpublic information indicating that the company
was then in dire straits, as was ultimately disclosed on April
15, 1994. The defendants respond that they were under no duty
to disclose the information identified by plaintiff, and that
none of the statements attributed to them was materially false,
misleading, or otherwise actionable.
A. Nonactionability of Loosely Optimistic Statements
__ _________________________________________________
____________________
31. The Class Period (here, January 19 through April 15, 1994)
constitutes the time period during which members of the
putative plaintiff class purchased shares of DEC common stock.
We limit our analysis of the Shaw plaintiffs' claims of
____
affirmative misrepresentation to the statements allegedly made
by defendants within the Class Period. See In re Clearly
___ ______________
Canadian Sec. Litig., 875 F. Supp. 1410, 1420 (N.D. Cal. 1995).
____________________
-52-
The Shaw plaintiffs allege that the defendants made a
____
number of fraudulently optimistic statements about DEC through
media outlets (e.g., newspapers and trade publications) and
____
press releases issued by the company. The district court,
after analyzing each of the statements identified by the
plaintiffs, held as a matter of law that none was sufficiently
material to support a claim of securities fraud. We agree.
In most circumstances, disputes over the materiality of
allegedly false or misleading statements must be reserved for
the trier of fact. See Basic, 485 U.S. at 236; Lucia, 36 F.3d
___ _____ _____
at 176. But not every unfulfilled expression of corporate
optimism, even if characterized as misstatement, can give rise
to a genuine issue of materiality under the securities laws.
See Lucia, 36 F.3d at 176 (leaving open possibility that some
___ _____
materiality determinations may be made as a matter of law). In
particular, courts have demonstrated a willingness to find
immaterial as a matter of law a certain kind of rosy
affirmation commonly heard from corporate managers and
numbingly familiar to the marketplace -- loosely optimistic
statements that are so vague, so lacking in specificity, or so
clearly constituting the opinions of the speaker, that no
reasonable investor could find them important to the total mix
of information available.32 See, e.g., San Leandro, 75 F.3d
___ ____ ____________
____________________
32. Under the common law of fraud, courts typically would find
such statements to be mere "puffing" or sales talk upon which
no reasonable person could rely, and thus to be legally
insufficient to support a claim. See, e.g., Greenery
___ ____ ________
Rehabilitation Group, Inc. v. Antaramian, 628 N.E.2d 1291, 1293
__________________________ __________
-53-
at 807, 811 (holding not actionable statement that the company
"expect[ed] . . . another year of strong growth in earnings per
share"); Hillson Partners Ltd. Partnership v. Adage, Inc., 42
__________________________________ ___________
F.3d 204, 213 (4th Cir. 1994) (similar, where alleged
fraudulent statement was: "[the company] is on target toward
achieving the most profitable year in its history"); In re
______
Caere Corporate Sec. Litig., 837 F. Supp. 1054, 1057-58 (N.D.
___________________________
Cal. 1993) ("[The company is] 'well-positioned' for growth.");
Colby v. Hologic, Inc., 817 F. Supp. 204, 211 (D. Mass. 1993)
_____ _____________
("Prospects for long term growth are bright.").
Review of vaguely optimistic statements for
immateriality as a matter of law may be especially robust in
cases involving a fraud-on-the-market theory of liability. In
such cases, the statements identified by plaintiffs as
actionably misleading are alleged to have caused injury, if at
all, not through the plaintiffs' direct reliance upon them, but
by dint of the statements' inflating effect on the market price
of the security purchased. See Basic, 485 U.S. at 241-47; Rand
___ _____ ____
v. Cullinet Software, Inc., 847 F. Supp. 200, 205 (D. Mass.
________________________
1994). When the truth is disclosed and the market self-
corrects, investors who bought at the inflated price suffer
losses. Those losses can be deemed to have been caused by the
defendants' statements, even absent direct reliance by
____________________
(Mass. App. Ct. 1994), rev. denied, 417 Mass. 1103 (1994); Webb
____ ______ ____
v. First of Mich. Corp., 491 N.W.2d 851, 853 (Mich. App. 1992);
____________________
Rodio v. Smith, 587 A.2d 621, 624 (N.J. 1991); Hauter v.
_____ _____ ______
Zogarts, 14 Cal. 3d 104, 111-12 (1975) (en banc).
_______
-54-
plaintiffs, because the statements were presumptively absorbed
into and reflected by the security's price. See Basic, 486
___ _____
U.S. at 243-44 (quoting In re LTV, 88 F.R.D. at 143).
_________
This presumption of investor reliance on the integrity
of stock prices has the primary effect of obviating the need
for plaintiff purchasers to plead individual reliance. But by
its underlying rationale, the presumption also shifts the
critical focus of the materiality inquiry. In a fraud-on-the-
market case the hypothetical "reasonable investor," by
reference to whom materiality is gauged, must be "the market"
itself, because it is the market, not any single investor, that
determines the price of a publicly traded security. See In re
___ ______
Verifone Securities Litigation, 784 F. Supp. 1471, 1479 (N.D.
_______________________________
Cal. 1992) ("The fraud-on-the-market theory thus shifts the
inquiry from whether an individual investor was fooled to
whether the market as a whole was fooled."), aff'd, 11 F.3d 865
_____
(9th Cir. 1993); see also In re Apple Computer Sec. Litig., 886
________ ________________________________
F.2d 1109, 1113-14 (9th Cir. 1989), cert. denied, 496 U.S. 943
_____ ______
(1990); cf. Easterbrook & Fischel, Corporate Law, supra, at 297
___ _____________ _____
(explaining how unsophisticated investors "take a free ride on
the information impounded by the market").
Thus, a claim that a fraud was perpetrated on the market
______
can draw no sustenance from allegations that defendants made
overly-optimistic statements, if those statements are ones that
any reasonable investor (ergo, the market) would easily
recognize as nothing more than a kind of self-directed
-55-
corporate puffery. The market is not so easily duped, even
granted that individual investors sometimes are. See In re
___ _____
Apple Computer, 886 F.2d at 1114; Wielgos v. Commonwealth
_______________ _______ ____________
Edison Co., 892 F.2d 509, 515 (7th Cir. 1989); see also Raab, 4
__________ ________ ____
F.3d at 289-90 ("[T]he market price of a share is not inflated
by vague statements predicting growth. . . . Analysts and
arbitrageurs rely on facts in determining the value of a
security, not mere expressions of optimism from company
spokesmen." (citations omitted)). This is particularly so with
respect to the securities of an actively traded and closely
followed company like DEC. Cf. LTV, 88 F.R.D. at 144 (citing
___ ___
empirical studies demonstrating that assumptions about market
efficiency are strongest with respect to "[t]the prices of
stocks of larger corporations, such as those listed on the New
York Stock Exchange").
While we have no occasion or intention to adopt here a
per se rule that expressions of optimism uttered by corporate
___ __
managers can never support a claim of securities fraud, we
_____
think that in this case, the statements outside of the
registration statement and prospectus identified by plaintiffs
as actionably misleading are -- with one exception discussed
separately below -- by their nature, too patently immaterial to
support a fraud-on-the-market claim.
We agree with the district court, for example, that a
claim of securities fraud cannot lie on the basis of the
statements made by defendant Steul (DEC's chief financial
-56-
officer) in January 1994, in reaction to the disappointing
earnings results for the quarter just ended. Steul was quoted
as saying that the company's transition to selling its Alpha
chip products was "going reasonably well" and that the company
"should show progress quarter over quarter, year over year."
We hold to be similarly not actionable (because patently
immaterial) Steul's comment of January 19, 1994 that the
company was "basically on track"; his comment of January 20,
1994 that "DEC was a very healthy company"; defendant Robert
Palmer's statement of the same date that he was "confident that
DEC was pursuing the right strategy"; and the February 8, 1994
statement by DEC's head of European operations (not a defendant
here) that he was "pretty optimistic" that the company would
"be able to stabilize [its] revenue" in the first half of
calendar year 1994 and "start to grow revenue" in the second
half. These statements all so obviously fail to pose any
"substantial likelihood" of being "viewed by the reasonable
investor" -- let alone the market -- "as having significantly
altered the total mix of information available," Basic, 485
_____
U.S. at 231-32 (quotation omitted), that they are properly
deemed immaterial as a matter of law.33
____________________
33. Plaintiffs additionally argue that several forward-looking
statements allegedly made by defendants prior to the
_____
commencement of the Class Period (January 19, 1994) gave rise
to a "duty to update," which defendants purportedly violated
during the Class Period. Plaintiffs point to a statement by
Steul in October of 1993 that the company's continuing
restructuring actions over the fiscal year "will probably be
smaller than the last four quarters"; a September 1993
statement that "[s]ervice revenues have continued to grow"; and
-57-
B. Importance of Context: the "Break-Even" Statements
__ __________________________________________________
The Shaw plaintiffs allege that on January 20, February
____
23, and March 29, 1994, DEC made or was responsible for the
following statements to the public, on those respective dates:
"[w]e are operating very close to break-even"; "we're running
very close to break-even"; and "we are very close to break-
even." Plaintiffs assert that given the magnitude of the
losses actually disclosed to the public on April 15, 1994, the
"break-even" statements must have been false when made and
constituted actionable fraud.
Putting aside for the moment whether plaintiffs have
adequately alleged that these statements were made with
fraudulent intent, the statements, when read in isolation,
____________________
a statement by defendant Palmer on November 4, 1993 that the
prospect of turning a profit was a "reasonable expectation" in
fiscal year 1994. Whatever the circumstances in which a
company might be subject to a duty to "update" information
previously disclosed, we do not think that the pre-Class Period
statements identified by plaintiffs are of the kind that could
trigger any such duty. The alleged statement regarding
"service revenues" constitutes a statement of historical fact
not alleged to be false, and as such, does not provide the
basis for a duty to update. See Serabian, 24 F.3d at 361. The
___ ________
other alleged statements are cautiously optimistic comments
that would not be actionable in the first instance. See San
___ ___
Leandro, 75 F.3d at 811. They express, at most, "only the hope
_______
of any company" for a positive future, and "lack the sort of
definite positive projections that might require later
correction." In re Time Warner, Inc. Sec. Litig., 9 F.3d 259,
___________________________________
267 (2d Cir. 1993), cert. denied, 114 S. Ct. 1397 (1994); see
_____ ______ ___
also San Leandro, 75 F.3d at 811 (finding no duty to update
____ ___________
"subdued general comments" of optimism). Moreover, it seems
likely that any "duty to update" DEC's pre-Class Period
statements would have been extinguished by the company's
disclosure of financial information in the negative earnings
announcement of January 19, 1994, the first day of the alleged
Class Period.
-58-
provide reason for pause. The statements cannot accurately be
described as the kind of diffuse expressions of opinion or
optimism that can be deemed, by their nature, obviously
immaterial as a matter of law. Rather, they appear, in
isolation, to be statements quantifying the company's current
operating inflows as more or less approximating outflows, thus
inviting an inference that the end results for the third
quarter might turn out likewise. The rub, however, is the
context surrounding the statements. When evaluated in context,
the "break-even" statements do not give rise to a claim of
securities fraud.
In deciding a motion to dismiss a securities action, a
court may properly consider the relevant entirety of a document
integral to or explicitly relied upon in the complaint, even
though not attached to the complaint, without converting the
motion into one for summary judgment. See Watterson v. Page,
___ _________ ____
987 F.2d 1, 3-4 (1st Cir. 1993) (explaining that the main
problem of looking to documents outside the complaint -- lack
of notice to plaintiff -- is dissipated "[w]here plaintiff has
actual notice . . . and has relied upon these documents in
framing the complaint" (quoting Cortec Indus., Inc. v. Sum
____________________ ___
Holding L.P., 949 F.2d 42, 48 (2d Cir. 1991), cert. denied, 112
____________ _____ ______
S. Ct. 1561 (1992)); see also San Leandro, 75 F.3d at 808-09;
________ ___________
Romani, 929 F.2d at 879 n.3. Were the rule otherwise, a
______
plaintiff could maintain a claim of fraud by excising an
isolated statement from a document and importing it into the
-59-
complaint, even though the surrounding context imparts a
plainly non-fraudulent meaning to the allegedly wrongful
statement. We look to the full context of the "break-even"
statements attributed to defendant Steul.34
The first time the "break-even" statement appeared was
in a Boston Herald article headlined "Digital falls short with
$72.1M loss," published on January 20, 1994, the day after DEC
had announced its disappointing earnings results for the second
quarter of fiscal year 1994. The article attributed the
following statement to Steul:
The $72 million loss represents only 2.2 percent
of revenues, Steul said. "We are operating very
close to break-even. It's a lot of money, but on
the other hand it's small compared to what losses
have been in the past." Steul would not say when
Digital will again be profitable. "I hesitate to
give you an estimate because we just have too
much uncertainty in the immediate future"
[paragraph structure omitted].
It is plain that Steul's "break-even" characterization refers
to the fact that the $72 million loss that had just been
reported for the second quarter of fiscal year 1994 was, in
______
fact, only a small percentage of the company's total revenues.
The statement cannot reasonably be understood as a material
comment on the current status or anticipated results of the
company's third quarter. Since plaintiffs do not allege that
____________________
34. The full text of the news articles in which the "break-
even" statements appeared, and which are cited in the
complaint, have been provided to us in a jointly-prepared
appendix. Plaintiffs have not objected to the district court's
nor the defendants' making reference to the full text of those
articles.
-60-
the characterization of "close to break-even" placed an
actionably fraudulent spin on DEC's second quarter results, the
______
statement in that context can be of no moment.
The second "break-even" statement appeared in a February
23, 1994 Wall Street Journal article. The article's author had
___________________
obtained an "internal" DEC finance review, and divulged its
contents as follows:
"We're running very close to break-even," the
[internal] review says, though "revenue is
uncertain for next two-plus quarters." The
review concludes that Digital "will still be in
turnaround for the next two or three quarters"
and that managers should "focus heavily on cash
conservation." There is a chance, it adds, "if
we keep at Q2 spending levels, that we can make a
profit this fiscal year." While Mr. Palmer
confirmed many of these points in an interview,
he wouldn't make any forecast. "This is a large
organization that was in deep trouble when I
started, and we still have a way to go"
[paragraph structure omitted].
The context of the "break-even" statement in the internal
review, as reported, sufficiently bespeaks caution to render
any forward-looking connotation that could otherwise be taken
from the statement immaterial as a matter of law. Cf. Polin v.
___ _____
Conductron Corp., 552 F.2d 797, 806 n.28 (8th Cir. 1976)
_________________
(holding that statement by company that it "saw a 'possibility'
of a break-even soon" was immaterial as matter of law, since it
was phrased so as to "bespeak caution in outlook"), cert.
_____
denied, 434 U.S. 857 (1977). Given the statements attributed
______
to the internal review that "revenue is uncertain for next two-
plus quarters"; that "[DEC] will still be in turnaround for the
next two or three quarters"; that "we still have a way to go";
-61-
and given Palmer's reported refusal to make any forecast,
coupled with the absence of any specifics regarding the
authoritativeness or timeliness of the "internal" report, no
reasonable investor (nor the market) could have attached
importance to any forward-looking connotation of the "break-
even" statement described in the article.
A similar analysis applies to the "break-even" statement
that appeared in the March 29, 1994 issue of Financial World.
_______________
In that article, defendant Steul was quoted as saying "We are
very close to break-even. If it hadn't been for currencies,
and had we been able to ship everything ordered, we would have
been in the black in the second quarter." As with the Wall
____
Street Journal piece, neither the Financial World piece itself
______________ _______________
nor the Shaw complaint specifies the date on which the
____
statement was actually made.35 But, again, Rule 9(b) issues
aside, the "break-even" comment is most naturally understood as
looking backward to the second quarter of fiscal 1994, not to
the future. Furthermore, to the extent that any other meaning
could be discerned, it is directly negated by other qualifying
comments attributed to Steul in the same article, including the
following:
What Digital needs at this point is time. Says
Steul, "Wall Street always wants quick results,
but it took a couple of years to get where we are
and it will take more than a couple of quarters
to turn it around."
____________________
35. It is unclear whether the statement quoted in Financial
_________
World had been freshly made by Steul, or was recycled from pre-
_____
existing sources. The Shaw complaint does not specify.
____
-62-
This warning that favorable results would be slow to come is a
far cry from a "prediction of a break-even year," which is how
plaintiffs characterize Steul's comments. Additionally,
because plaintiffs allege that a fraud on the market was
committed by statements communicated in this financial
analyst's article, it is only fair to note that the tenor of
the article is one of skepticism about DEC's future
prospects.36 On the facts as alleged, the district court did
not err in concluding that the "break-even" statement in the
Financial World piece was immaterial as a matter of law.
_______________
C. Actionability under Section 10(b) of Omissions
__ ______________________________________________
and Misleading Statements in the Registration
_____________________________________________
Statement and Prospectus
________________________
The remaining statements and omissions alleged by the
Shaw plaintiffs to be fraudulent under Section 10(b) and Rule
____
10b-5 relate to the registration statement and prospectus for
DEC's March 1994 stock offering. These alleged misstatements
and omissions are identical to those that underlie the Wilensky
________
plaintiffs' claims under Sections 11 and 12(2) of the
Securities Act. We conclude that the Shaw plaintiffs may
____
pursue their Section 10(b) claim based on these alleged defects
____________________
36. For example, the article quotes statements by analysts
expressing skepticism about DEC's prospects, and cautions:
"Reasonable as [Steul's comments concerning a turn-around] may
sound, recall that it was only last September [1993] that
Steul's boss boasted that Digital was on its way back after
three years and over 83 billion of red ink." We need not
decide here whether an allegedly misleading statement appearing
in one source can be rendered immaterial as a matter of law, at
the pleading stage, by third-party commentary in that or a
different source.
-63-
in the registration statement and prospectus. Because we hold
that the Shaw complaint survives Rule 12(b)(6) only to that
____
extent, we also conclude that the putative class on whose
behalf the Shaw complaint was brought must be narrowed
____
accordingly.
Material omissions and misleading statements in a
registration statement and prospectus are, in addition to being
actionable under the Securities Act by purchasers in the
offering, also actionable under Section 10(b) and Rule 10b-5 by
contemporaneous purchasers in the aftermarket, provided, of
course, that the additional elements of liability (scienter and
reliance) are established. See In re Ames Dept. Stores Inc.
___ _____________________________
Stock Litig., 991 F.2d 953, 963 (2d Cir. 1993); Fishman v.
_____________ _______
Raytheon Mfg. Co., 188 F.2d 783, 786-87 (2d Cir. 1951); cf.
_________________ ___
Huddleston, 459 U.S. at 383 ("[I]t is hardly a novel
__________
proposition that the 1934 Act and the 1933 Act 'prohibit some
of the same conduct.'" (citation omitted)). In the context of
a fraud-on-the-market claim, this principle has a simple
rationale. The registration statement and prospectus speak not
only to those who purchase in the offering, but to the entire
market. If an issuer's registration statement contains a
misleading statement of fact about the company's financial
condition or omits material information required to be
disclosed, the impact of such statements or omissions, to the
extent material, would not necessarily be limited to the
securities covered by the registration statement. There is no
-64-
logical reason that a registration statement and prospectus
could not serve as a vehicle for an alleged fraud on the
market, affecting all of the company's securities. Thus, even
though the Shaw plaintiffs purchased shares of DEC common stock
____
in the aftermarket, not shares of preferred stock in the
offering, their fraud-on-the-market claims may properly
encompass any material misstatements or omissions in the
registration statement. See In re Ames, 991 F.2d at 963-64.
___ __________
We hold, then, that the same allegations of misleading
statements and omissions in the Wilensky complaint that state a
________
claim under Sections 11 and 12(2) also form the basis of a
cognizable claim under Section 10(b) and Rule 10b-5.37 The
allegations in the Wilensky complaint which we found lacking
________
are similarly without force in the Shaw complaint.
____
D. Limitation of the Shaw Class
__ _________________ _____
____________________
37. In so holding, we do not intend to create a private right
of action under Section 10(b) for violations of any SEC rule.
Our holding is limited to the proposition that, in the context
of a public offering, plaintiffs who (through the market) rely
upon the completeness of a registration statement or prospectus
may sue under Section 10(b) and Rule 10b-5 for nondisclosures
of material facts omitted from those documents in violation of
the applicable SEC rules and regulations. Cf. Backman, 910
___ _______
F.2d at 12-13 (suggesting that SEC regulations and insider
trading may create a duty to disclose under Rule 10b-5);
Roeder, 814 F.2d at 27 (same). But cf. In re Wells Fargo, 12
______ _______ _________________
F.3d at 930 n.6 (declining to reach the issue). A different
rule would lead to the anomalous result of a Rule 10b-5
plaintiff being able to sue an individual insider selling his
company's securities for the nondisclosure of material
nonpublic information, but not being able to sue the issuer
itself for failing to disclose the same information in
connection with an offering.
-65-
Our conclusion that the Shaw complaint states a claim,
____
but only to the extent it is based on the same statements and
omissions that form the basis of the surviving claims in the
Wilensky complaint, requires an important adjustment to be
________
made. The Shaw plaintiffs allege that they were injured when
____
they purchased DEC common stock at prices that were inflated as
a result of misleading statements and omissions by DEC and the
individual defendants. The named plaintiffs purport to
represent a class of persons who purchased DEC stock between
January 19 and April 15, 1994. However, because the only
allegations in the Shaw complaint that state a claim are those
____
that depend upon the purported misstatements and omissions in
the registration statement as of its effective date -- March
21, 1994 -- it follows that only those who purchased their
shares on or after March 21, 1994 (and before April 15, 1994,
___________
when disclosure occurred) could have suffered cognizable
injury.
Of the four plaintiffs named in the Shaw complaint, only
____
Gary Phillips is alleged to have made his purchase within those
two limiting dates; thus only his claim may be reinstated. The
district court's dismissal of the claims of the three other
named plaintiffs is affirmed. On remand, the district court
should require the Shaw plaintiffs to amend their complaint to
____
redefine the "Class Period" accordingly.
V.
Rule 9(b)
_________
-66-
Defendants argue, as an alternative basis for affirming
the district court's dismissals, that both the Wilensky and
________
Shaw complaints fail to meet the requirement of Fed. R. Civ. P.
____
9(b) that claims of fraud be pleaded with "particularity." We
ask first whether the dictates of Rule 9(b) apply to the claims
asserted in the Wilensky complaint, and answer in the negative.
________
We then test the allegations of the Shaw complaint and conclude
____
that it satisfies Rule 9(b).
A. Whether Rule 9(b) Applies to the Wilensky Complaint
__ ________________________________ _________
Rule 9(b) mandates that "[i]n all averments of fraud
. . ., the circumstances constituting fraud . . . shall be
stated with particularity." Fed. R. Civ. P. 9(b). The
threshold question is whether the Wilensky complaint, which
________
sets forth claims under Sections 11 and 12(2) of the Securities
Act, contains any "averments of fraud."
Fraud is not an element of a claim under either Section
11 or 12(2), and a plaintiff asserting such claims may avoid
altogether any allegations of scienter or reliance. See
___
Shapiro, 964 F.2d at 288; Lucia v. Prospect St. High Income
_______ _____ __________________________
Portfolio, Inc., 769 F. Supp. 410, 416 (D. Mass. 1991), aff'd,
________________ _____
36 F.3d 170 (1st Cir. 1994). However, despite the minimal
requirements of Sections 11 and 12(2), a complaint asserting
violations of those statutes may yet "sound[] in fraud." Haft
____
v. Eastland Financial Corp., 755 F. Supp. 1123, 1126 (D.R.I.
_________________________
1991). For example, if a plaintiff were to attempt to
establish violations of Sections 11 and 12(2) as well as the
-67-
anti-fraud provisions of the Exchange Act through allegations
in a single complaint of a unified course of fraudulent
conduct, fraud might be said to "lie[] at the core of the
action." Hayduk v. Lanna, 775 F.2d 441, 443 (1st Cir. 1985).
______ _____
In such a case, the particularity requirements of Rule 9(b)
would probably apply to the Sections 11, 12(2), and Rule 10b-5
claims alike. "It is the allegation of fraud, not the 'title'
of the claim that brings the policy concerns [underlying Rule
9(b)] . . . to the forefront." Haft, 755 F. Supp. at 1133;
____
accord Shapiro, 964 F.2d at 287-88 (applying Rule 9(b) to
______ _______
Section 11 and 12(2) claims "grounded in fraud"); Lucia, 769 F.
_____
Supp. at 416-17 (same).
As the district court noted, the Wilensky complaint
________
avoids grounding its Section 11 and 12(2) claims on any
allegations of fraud. Although the complaint does assert that
defendants actually possessed the information that they failed
to disclose, those allegations cannot be thought to constitute
"averments of fraud," absent any claim of scienter and
reliance. Otherwise, any allegation of nondisclosure of
material information would be transformed into a claim of fraud
for purposes of Rule 9(b). In the circumstances, we hold that
the Wilensky complaint was not subject to the pleading
________
requirements of Rule 9(b).
B. Whether the Shaw Complaint Satisfies Rule 9(b)
__ ___________ _____________________________
The defendants' primary challenge to the sufficiency of
the Shaw complaint under Rule 9(b) is that it fails to allege
____
-68-
specific facts that would permit a reasonable inference that
defendants had knowledge of information foretelling the
financial results for the third quarter of fiscal year 1994
prior to the quarter's end. We limit our analysis to those
allegations in the Shaw complaint that state a cognizable claim
____
for securities fraud. The issue is thus whether the plaintiffs
have sufficiently pleaded that defendants knew facts as of
March 21, 1994 that indicated the third quarter was going to
turn out as it did, and that the company would soon thereafter
announce further restructuring actions necessitating an
additional restructuring charge for the fiscal year. Although
the question is close, we think that the complaint survives
Rule 9(b) scrutiny.
This court has been "especially rigorous" in applying
Rule 9(b) in securities fraud actions "to minimize the chance
'that a plaintiff with a largely groundless claim will bring a
suit and conduct extensive discovery in the hopes of obtaining
an increased settlement, rather than in the hopes that the
process will reveal relevant evidence.'" Romani, 929 F.2d at
______
878 (quoting New England Data Servs., Inc. v. Becher, 829 F.2d
_____________________________ ______
286, 288 (1st Cir. 1987)). We have emphasized that the
particularity requirement cannot be avoided "simply through a
general averment that defendants 'knew' earlier what later
turned out badly." Greenstone v. Cambex Corp., 975 F.2d 22, 25
__________ ____________
(1st Cir. 1992). A securities plaintiff cannot plead "'fraud
by hindsight.'" Id. (quoting Denny v. Barber, 576 F.2d 465,
___ _____ ______
-69-
470 (2d Cir. 1978)). This means that a plaintiff may not
simply contrast a defendant's past optimism with less favorable
actual results, and then "contend[] that the difference must be
attributable to fraud." DiLeo v. Ernst & Young, 901 F.2d 624,
_____ _____________
627 (7th Cir.), cert. denied, 498 U.S. 941 (1990). Rather,
_____ ______
Rule 9(b) requires that the complaint "set[] forth specific
facts that make it reasonable to believe that defendant knew
that a statement was materially false or misleading."
Greenstone, 975 F.2d at 25 (collecting cases); see also
__________ _________
Serabian, 24 F.3d at 361 (quoting Greenstone).
________ __________
Here, the complaint cannot fairly be characterized as
resting on conclusory allegations of the defendants' knowledge.
The plaintiffs provide a series of factual allegations relating
to a combination of developments known to the company (e.g.,
____
failing product pricing strategies, market resistance to new
products, wayward compensation policies, failure to implement
downsizing plans) that could have provided a basis for advance
knowledge of the information disclosed on April 15, 1994.38
____________________
38. In asserting that defendants had direct knowledge of DEC's
third quarter operating results as they developed, plaintiffs
allege that "[m]ore so than the management of most companies,
DEC's management, including the Individual Defendants, was
virtually immediately cognizant of the Company's sales
information" by virtue of the company's use of "a highly-
efficient reporting system which allows the Company to forward
sales and cost information to senior management virtually as
sales are made." The defendants argue that these allegations
should be viewed with skepticism and as the product of nothing
more than "pure speculation." Speculation or not, we think
that the plaintiffs' allegations of a "highly-efficient
reporting system" may speak to the question of how defendants
___
might have known what they allegedly knew, but absent some
indication of the specific factual content of any single report
_______
-70-
These factual allegations, together with other aspects of the
complaint discussed below, provide a basis for a reasonable
inference that defendants knew facts by March 21 indicating
that the third fiscal quarter would be disastrous, and that
accelerated restructuring efforts requiring a further
restructuring charge were likely to follow.39 Cf. Serabian,
___ ________
24 F.3d at 365; In re Wells Fargo, 12 F.3d at 931.
_________________
In additional support of their allegations of
defendants' knowledge, plaintiffs assert that two insiders of
the company, neither of whom is a defendant here, sold DEC
stockholdings during the third fiscal quarter. One, the
company's treasurer, sold 1,625 shares (68% of the officer's
total holdings) on February 11, 1994. The other, the general
manager and vice president of the company's personal computer
business, sold 2,000 shares (20% of his position) on March 22,
1994.
____________________
generated by the alleged reporting system, do not independently
provide a factual basis for inferring any such knowledge. On
balance, we do not think that generalized allegations regarding
the existence of an internal "reporting system" substantially
assist a securities fraud complaint in overcoming the hurdle of
Rule 9(b). See Pitten v. Jacobs, 903 F. Supp. 937, 949-50
___ ______ ______
(D.S.C. 1995); cf. Arazie v. Mullane, 2 F.3d 1456, 1467 (7th
___ ______ _______
Cir. 1993) (refusing to credit "scanty" allegations concerning
internal documents, absent indication of "who prepared the
projected figures, when they were prepared, how firm the
numbers were, or which . . . officers reviewed them").
39. We reject defendants' argument that the complaint fails
adequately to particularize the roles of the individual
defendants in the purported fraud. Cf. Serabian, 24 F.3d at
___ ________
367-68.
-71-
Of course, the mere fact that insider stock sales
occurred does not suffice to establish scienter. See Tapogna
___ _______
v. Egan, 141 F.R.D. 370, 373 (D. Mass. 1992). However,
____
allegations of "insider trading in suspicious amounts or at
suspicious times" may permit an inference that the trader --
and by further inference, the company -- possessed material
nonpublic information at the time. See Greenstone, 975 F.2d at
___ __________
26 (citing In re Apple Computer, 886 F.2d at 1117); see also
____________________ ________
Rubinstein, 20 F.3d at 169-70 (characterizing sufficiently
__________
suspicious trading as "presumptively probative of bad faith and
scienter"). Here, the level of suspicion warranted by the
alleged insider stock sales is marginal: the first sale
occurred more than a month prior to the date of concern here
(March 21, 1994); and the second sale, though made at what
might be considered a "suspicious" time, involved a small
(albeit not insignificant) percentage of the insider's total
holdings of DEC stock. Nonetheless, we think that the
plaintiffs' allegations of insider trading, inasmuch as they
are at least consistent with their theory of fraud, provide
some support against the defendants' motion to dismiss under
Rule 9(b).
Finally, in testing the allegations of the complaint
against Rule 9(b), we need not turn a blind eye to the obvious:
the proximity of the date of the allegedly fraudulent
statements and omissions to both the end of the quarter then in
progress and the date on which disclosure was eventually made.
-72-
While the short time frame between an allegedly fraudulent
statement or omission and a later disclosure of inconsistent
information does not, standing alone, provide a sufficient
factual grounding to satisfy Rule 9(b), see Arazie, 2 F.3d at
___ ______
1467-68, there is nothing in Rule 9(b) that precludes
consideration of such temporal proximity as a circumstance
potentially bolstering the complaint's claims of fraud. See
___
Fecht, 70 F.3d at 1083-84. On the facts as alleged in this
_____
case, we think that the proximity of the date of the allegedly
misleading statements and omissions to the end of the ongoing
quarter (and the date of eventual disclosure) provides some
circumstantial factual support to be taken into account in
determining whether the complaint pleads an adequate basis for
inferring defendants' culpable knowledge.
We have no intention here of diluting the stringent
mandate of Rule 9(b). But in determining the adequacy of a
complaint under that rule, we cannot hold plaintiffs to a
standard that would effectively require them, pre-discovery, to
plead evidence. Rule 9(b) proscribes the pleading of "fraud by
hindsight," Denny, 576 F.2d at 470, but neither can plaintiffs
_____
be expected to plead fraud with complete insight. We conclude
that the portions of the Shaw complaint that survive Rule
____
12(b)(6) scrutiny also satisfy the particularity requirements
of Rule 9(b).
VI.
Conclusion
__________
-73-
The district court erred in dismissing the Wilensky and
________
Shaw complaints in their entirety. Portions of both complaints
____
survive Rule 12(b)(6), but only to the extent that they allege:
____
(i) that the registration statement filed in connection with
the public offering of March 21, 1994, failed to disclose
material information in DEC's possession as of that date that
would have alerted the market to the likelihood of disastrous
quarterly results; and (ii) that the statement in the
prospectus supplement as to the "adequacy" of the restructuring
reserve remaining as of March 21, 1994 was materially false or
misleading.40 We hold, however, that the Wilensky complaint
________
fails to state a claim under Section 12(2) of the Securities
Act as to DEC and the individual defendants. Furthermore, in
light of the limited basis on which we permit the Shaw action
____
to go forward, only the claims of the single named plaintiff
who purchased DEC shares after March 21, 1994 may be
reinstated, and the allegations in the Shaw complaint
____
pertaining to the scope of the putative plaintiff class must be
modified accordingly. Finally, the requirements of Fed. R.
Civ. P. 9(b) do not apply to the Wilensky complaint as
________
currently pleaded, and the surviving portion of the Shaw
____
complaint does satisfy Rule 9(b). On remand, the district
____________________
40. The district court did not state any independent reasons
for dismissing the Wilensky plaintiffs' derivative claims under
________
Section 15 of the Securities Act or the Shaw plaintiffs' claims
____
under Section 20(a) of the Exchange Act and for common law
negligent misrepresentation. Those claims should, therefore,
be reinstated and permitted to proceed to the extent consistent
with this opinion.
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court may choose to require the plaintiffs to amend their
complaints in accordance with these conclusions.
In closing, we note that although the issues of
materiality and knowledge raised by the two complaints preclude
terminating this litigation on the pleadings, nothing we say
here is intended to foreclose the possibility that those and
other issues, after discovery and an opportunity for factual
development, might be susceptible to resolution on motions for
summary judgment. To borrow wise words from one of our prior
decisions: "Despite our conclusion that certain allegations
survive threshold consideration, we note that plaintiffs remain
a great distance from actually proving" any violations of the
federal securities laws. Serabian, 24 F.3d at 365-66.
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Affirmed in part, reversed in part, and remanded. No
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costs are awarded.
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