GEORGE SEMERENKO v. CENDANT CORP.; WALTER A. FORBES; E. KIRK SHELTON; COSMO CORIGLIANO; CHRISTOPHER K. MCLEOD; ERNST & YOUNG LLP; P. SCHOENFELD ASSET MANAGEMENT LLC v. CENDANT CORP.; WALTER A. FORBES; E. KIRK SHELTON; COSMO CORIGLIANO; CHRISTOPHER K. MCLEOD; ERNST & YOUNG LLP
No. 99-5355, 99-5356
UNITED STATES COURT OF APPEALS FOR THE THIRD CIRCUIT
Filed August 10, 2000
Amended Opinion Filed: August 10, 2000
2000 Decisions. Paper 163.
Honorable William H. Walls, District Judge; MANSMANN and GREENBERG, Circuit Judges and ALARCON, Senior Circuit Judge
Precedential; (Opinion Filed: June 16, 2000)
Jill S. Abrams
Stephen J. Fearon, Jr.
Nancy Kaboolian
Abbey, Gardy & Squitieri, LLP
212 East 39th Street
Allyn Z. Lite
Joseph J. DePalma
Mary Jean Pizza
Lite DePalma Greenberg & Rivas, LLC
Two Gateway Center - 12th Floor
Newark, NJ 07102-5003
Andrew Barroway
David Kessler
Schiffrin & Barroway
Three Bala Plaza East - Suite 400
Bala Cynwyd, PA 19004
Attorneys for Appellants George Semerenko and P. Schoenfeld Management, LLC
Jonathan J. Lerner
Samuel Kadet [Argued]
Skadden, Arps, Slate, Meagher & Flom LLP
Four Times Square
Michael M. Rosenbaum
Carl Greenberg
Budd Larner Gross Rosenbaum Greenberg & Sade, P.C.
150 John F. Kennedy Parkway
CN 1000
Short Hills, NJ 07078-0999
Attorneys for Appellee Cendant Corporation
James M. Hirschhorn
Steven S. Radin
Sills Cummis Radin Tischman Epstein & Gross, P.A.
One Riverfront Plaza
Newark, NJ 07102-5400
Dennis J. Block [Argued]
Howard R. Hawkins, Jr.
Cadwalader, Wickersham & Taft
100 Maiden Lane
New York, NY 10038
Greg A. Danilow
Timothy E. Hoeffner
Weil, Gotshal & Manges LLP
767 Fifth Avenue
New York, NY 10153
Attorney for Appellees Walter Forbes and Christopher McLeod
Richard Schaeffer [Argued]
Bruce Handler
747 Third Avenue
New York, NY 10017
Attorneys for Appellee E. Kirk Shelton
Gary P. Naftalis
Kramer, Levin, Naftalis & Frankel
919 Third Avenue
New York, NY 10022
Attorney for Appellee Cosmo Corigliano
Alan N. Salpeter
Michele Odorizzi
Mayer, Brown & Platt
190 South LaSalle Street
Chicago, IL 60603
William P. Hammer, Jr.
J. Andrew Heaton [Agrued]
Ernst & Young LLP
1225 Connecticut Avenue, NW
Washington, D.C. 20036
Douglas S. Eakeley
Lowenstein Sandler
65 Livingston Avenue
Roseland, NJ 07068
Attorneys for Ernst & Young LLP
Harvey J. Goldschmid
General Counsel
Solicitor
Eric Summergrad
Deputy Solicitor
Hope Hall Augustini
Special Counsel
Securities & Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0606
Attorneys for Amicus-Appellant Securities and Exchange Commission
OPINION OF THE COURT
ALARCON, Senior Circuit Judge.
I
The P. Schoenfeld Asset Management LLC and the class of similarly situated investors (collectively, the“Class“) appeal from the order of the district court dismissing their claims for securities fraud pursuant to
We conclude that the complaint alleges sufficient facts to establish the elements of reliance and loss causation, and that the district court applied the incorrect analysis for determining whether the complaint alleges that the purported misrepresentations were made “in connection with” the purchase or the sale of a security. Because the standard that we have articulated for the “in connection
II
The Class filed this action against the Cendant Corporation (“Cendant“),1 its former officers and directors Walter A. Forbes, E. Kirk Shelton, Christopher K. McLeod, and Cosmo Corigliano (the “individual defendants“), and its accountant Ernst & Young LLP (“Ernst & Young“) (collectively, the “defendants“). The Class alleges that the defendants violated S 10(b) and Rule 10b-5 by making certain misrepresentations about Cendant during a tender offer for shares of American Bankers Insurance Group, Inc. (“ABI“) common stock. The Class consists of persons who purchased shares of ABI common stock during the course of the tender offer. The class period runs from January 27, 1998 to October 13, 1998. The complaint does not allege that any member of the Class purchased securities issued by Cendant, or that any member of the Class tendered shares of ABI common stock to Cendant. Instead, it alleges that the defendants made certain misrepresentations about Cendant that artificially inflated the price at which the Class purchased their shares of ABI common stock, and that the Class suffered a corresponding loss when those misrepresentations were disclosed to the public and the merger agreement was terminated. In light of the procedural posture of this case, we must assume the truth of the facts alleged in the complaint. See In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1420 (3d Cir. 1997).
On December 22, 1997, the American International Group, Inc. (“AIG“) announced that it would acquire one
On March 3, 1998, AIG matched Cendant‘s bid and offered to pay ABI shareholders $58 for each share of outstanding ABI common stock. Cendant eventually raised its bid price to $67 per share. It then executed an agreement to purchase ABI for approximately $3.1 billion, payable in part cash and in part shares of Cendant common stock. Cendant filed an amendment to its Schedule 14D-1 on March 23, 1998 reporting the terms of the merger agreement. Eight days later, Cendantfiled a Form 10-K reporting its financial results for the 1997 fiscal year.
After the close of trading on April 15, 1998, Cendant announced that it had discovered potential accounting irregularities, and that its Audit Committee had engaged Willkie, Farr & Gallagher and Arthur Andersen LLP to perform an independent investigation. Cendant also announced that it had retained Deloitte & Touche LLP to reaudit its financial statements, and that “[i]n accordance with [Statement of Accounting Standards] No. 1, the Company‘s previously issued financial statements and auditors’ reports should not be relied upon.” Nevertheless, the April 15, 1998 announcement reported that the irregularities occurred in a single business unit that “accounted for less than one third” of Cendant‘s net income, and it indicated that Cendant would restate its annual and quarterly earnings for the 1997 fiscal year by $0.11 to $0.13 per share. Immediately after Cendant disclosed the accounting irregularities, the price of ABI common stock dropped from $64-7/8 to $57-3/4, representing an eleven percent decrease from the price at which the shares had been trading.
Following the April 15 announcement, Cendant made several pubic statements in which it represented that it was
We are outraged that the apparent misdeeds of a small number of individuals within a limited part of our company has adversely affected the value of your investment -- and ours -- in Cendant. We are working together diligently to clear this matter up as soon as possible. We fully support the Audit Committee‘s investigation and continue to believe that the strategic rationale and industrial logic of the HFS/CUC merger that created Cendant is as compelling as ever.
Cendant is strong, highly liquid, and extremely profitable. The vast majority of Cendant‘s operating businesses and earnings are unaffected and the prospects for the Company‘s future growth and success are excellent.
We have reaffirmed our commitment to completing all pending acquisitions: American Bankers, National Parking Corporation and Providian Insurance.
In a press release issued on May 5, 1998, Cendant stated that “over eighty percent of the Company‘s net income for the first quarter of 1998 came from Cendant business units not impacted by the potential accounting irregularities.”
On July 14, 1998, Cendant revealed that the April 15, 1998 announcement anticipating the restatement of its financial results for the 1997 fiscal year was inaccurate, and that the actual reduction in income would be twice as much as previously announced. Cendant further acknowledged that its investigation had uncovered several accounting irregularities that had not previously been disclosed, and that those accounting irregularities affected additional Cendant business units and other fiscal years. Cendant estimated that earnings would be reduced by as much as $0.28 per share in 1997. After the July 14, 1998 disclosure, the price of ABI common stock dropped until
On August 13, 1998, Cendant issued a press release announcing that its investigation into the accounting irregularities was complete. The release stated that Cendant would restate its earnings by $0.28 per share in 1997, by $0.19 per share in 1996, and by $0.14 per share in 1995. On August 27, 1998, Cendant issued a statement that the board of directors had adopted the audit report. The audit report was publicly filed with the SEC on August 28, 1998, and a copy was forwarded to the United States Attorney for the District of New Jersey. The report includedfindings that “fraudulent financial reporting” and other“errors” inflated Cendant‘s pretax income by approximately $500 million from 1995 to 1997, and that Forbes and Shelton were “among those who must bear responsibility.” After the audit report was filed with the SEC, the price of ABI common stock closed at $53-1/2 per share on August 28, 1998 and fell further to a closing price of $51-7/8 per share on August 31, 1998, the first day of trading following the disclosure.
On September 29, 1998, Cendant filed an amended Form 10-K for the 1997 fiscal year announcing that Cendant had actually lost $217.2 million in 1997 rather than earning $55.5 million, as previously reported. That announcement caused the price of ABI common stock to drop further to $43 per share by the close of trading. On October 13, 1998, Cendant and ABI announced that they were terminating the merger agreement, and that Cendant would pay ABI a $400 million dollar break up fee, despite the fact that it was not contractually bound to do so. The termination agreement, which was executed the same day, provided that the termination of the merger would not result in liability on the part of Cendant or ABI, or on the part of any of their directors, officers, employees, agents, legal and financial advisors, or shareholders. In response to the disclosure, the price of ABI common stock dropped to $35-1/2 per share by the end of the day.
On October 14, 1998, the day after Cendant and ABI disclosed the termination of the planned merger, the Class filed a complaint in the United States District Court for the District of New Jersey alleging that Cendant and the individual defendants violated S 10(b) and Rule 10b-5 by making fraudulent misrepresentations concerning Cendant‘s financial condition, its willingness to complete the tender offer, and its willingness to complete the proposed merger. The complaint also alleged that the individual defendants were liable for those violations as control persons under S 20(a). The Class subsequently amended its complaint to expand the class period and to name Ernst & Young as an additional defendant in its claims under S 10(b) and Rule 10(b)(5).2
The defendants filed a motion to dismiss the Class‘s complaint pursuant to Rule 12(b)(6) and Rule 9(b) of the Federal Rules of Civil Procedure. The district court granted the motion and entered an order dismissing the complaint under Rule 12(b)(6). In explaining its dismissal order, the district court stated that the complaint failed to establish that the alleged misrepresentations were made “in connection with” the Class‘s purchases of ABI common stock, that the Class reasonably relied on the purported misrepresentations, and that the Class suffered a loss as the proximate result of the purported misrepresentations. The order also dismissed the Class‘s S 20(a) claim against the individual defendants on the basis that a claim for control person liability cannot be maintained in the absence of an underlying violation of the Exchange Act. In light of its decision to dismiss the complaint pursuant to Rule 12(b)(6), the district court declined to consider whether the Class‘s complaint also failed to satisfy the heightened pleading requirements of Rule 9(b).
Before we address the merits of the Class‘s arguments, we must first resolve an important question that concerns our jurisdiction to hear this appeal pursuant to
Plaintiffs have requested leave to amend their complaints if any or all of their claims are dismissed. However, plaintiffs have not detailed the substance of any amendment or presented to the Court a proposed amended complaint. Although plaintiffs no longer have the right to amend their complaints as a matter of course after those complaints have been dismissed, the Court may still permit amendment as a matter of discretion. Kauffman v. Moss, 420 F.2d 1270, 1276 (3d Cir.) cert. denied, 400 U.S. 846, 91 S. Ct. 93, 27 L. Ed. 2d 84 (1970). However, the Court will not consider plaintiffs’ requests until they submit the sought amendment for the Court‘s review. The present complaints lack legal vitality. Without scrutiny of the proposed amendment, the Court cannot determine whether it, the amendment, would be resuscitable or futile. Plaintiffs’ motion for leave to amend is denied.
This court has held that a dismissal without prejudice is not a final and appealable order under S 1291, unless the plaintiff can no longer amend the complaint or unless the plaintiff declares an intention to stand on the complaint as dismissed. See Nyhuis v. Reno, 204 F.3d 65, 68 n.2 (3d Cir. 2000); In re Westinghouse Sec. Litig., 90 F.3d 696, 705 (3d Cir. 1996); Borelli v. City of Reading, 532 F.2d 950, 951-52 (3d Cir. 1976) (per curiam). The Class did not advise the district court that it could no longer amend its pleadings, or that it had elected to stand on the complaint. Instead, it filed a notice of appeal with this court. In its opening brief, the Class represented that “[t]his court has jurisdiction over
On March 1, 2000, this court ordered the parties to submit further briefing on the question whether the district court had entered a final, appealable order. In its supplemental brief, the Class indicated that it intended to stand on its complaint for the purposes of our review of whether the dismissal was proper under Rule 12(b)(6), but not for the purposes of our independent review of whether the complaint complied with Rule 9(b). In effect, the Class took the position that it could stand on its complaint to satisfy the final judgment rule and, at the same time, avoid a de novo review of whether the complaint pleads the element of scienter with sufficient particularity.
Our own research indicates that the Class‘s position is consistent with the law of this circuit. In Shapiro v. UJB Financial Corp., 964 F.2d 272 (3d Cir. 1992), this court recognized that a plaintiff may amend a complaint to comply with the particularity requirements of Rule 9(b) even after the plaintiff stands on the complaint to invoke the court‘s appellate jurisdiction under
In this matter, the district court did not consider the sufficiency of the allegations under Rule 9(b).“[B]ecause we are hesitant to preclude the prosecution of a possibly meritorious claim because of defects in the pleadings,” the Class should be “afforded an additional, albeitfinal opportunity, to conform the pleadings” in the event that its complaint fails to comply with Rule 9(b).3 In re Burlington Coat Factory Sec. Litig., 114 F.3d at 1435 (quoting Ross v. A.H. Robins Co., 607 F.2d 545, 547 (2d Cir. 1979)). We leave it to the district court, however, to determine, in the first instance, whether such an amendment is required. See Shapiro, 964 F.2d at 285 n.14. We hold, consistent with the law of this circuit, that we have jurisdiction to hear the merits of this appeal pursuant to S 1291. See Shapiro, 964 F.2d at 278. Our review is limited to the question whether the dismissal was proper under Rule 12(b)(6).
IV
Our review of a district court‘s decision to grant a motion to dismiss is plenary. See Weiner v. Quaker Oats Co., 129 F.3d 310, 315 (3d Cir. 1997). “A motion to dismiss pursuant to Rule 12(b)(6) may be granted only if, accepting all well pleaded allegations in the complaint as true, and viewing them in the light most favorable to [the] plaintiff, [the] plaintiff is not entitled to relief. The issue is not whether a plaintiff will ultimately prevail but whether the claimant is entitled to offer evidence to support the claims.” In re Burlington Coat Factory Sec. Litig., 114 F.3d at 1420 (quotations and citations omitted). In this case, we may affirm only if it appears that the Class could prove no set of facts that would entitle it to relief. See Weiner, 129 F.3d at 315.
In the present case, the defendants make numerous arguments to support the dismissal of the Class‘s complaint pursuant to Rule 12(b)(6). They contend that the district court correctly concluded that the alleged misrepresentations were not made “in connection with” the purchase or the sale of a security. They also suggest that the Class could not have reasonably relied on any of the alleged misrepresentations, and that the alleged misstatements were not the proximate cause of the Class‘s loss. We address each argument, below, under a separate heading.
A.
We must first decide whether the Class‘s complaint pleads sufficient facts to satisfy the “in connection with” requirement of S 10(b) and Rule 10b-5. The parties have expressed much disagreement over the standard that this court applies in determining whether an alleged misrepresentation was made “in connection with” the purchase or the sale of a security. The defendants, in varying respects, contend that the alleged misrepresentations must speak directly to the investment value of the security that is bought or sold, and that they must have been made with the specific purpose or objective of influencing an investor‘s decision. In contrast, the Class and the SEC, as amicus curiae, argue that the “in connection with” requirement is satisfied whenever a
In Ketchum v. Green, 557 F.2d 1022 (1977), this court considered the question whether certain misrepresentations arising out of an internal contest for the control of a closely held corporation were made “in connection with” the subsequent forced redemption of the losing parties’ stock. There, a group of minority shareholders secretly conspired to remove the two majority shareholders from their respective positions as the chairman of the board of directors and as the president of the corporation. See Ketchum, 557 F.2d at 1023-24. By misrepresenting their intentions concerning the election of corporate officers, the minority shareholders were able to persuade the majority shareholders to elect them to a majority of the seats on the board of directors. See id. After gaining control of the board of directors, the minority shareholders immediately voted to remove the two majority shareholders from their officerships. See id. To entrench themselves, they also passed resolutions terminating the majority shareholders’ employment and authorizing the mandatory repurchase of the majority shareholders’ stock pursuant to a stock retirement agreement. The majority shareholders brought an action pursuant to S 10(b) and Rule 10b-5 to enjoin their ouster from the corporation and to obtain damages. See id. at 1024. On review, this court held that the majority shareholders failed to establish that the complained of misrepresentations were made “in connection with” the purchase or the sale of a security. See id. at 1027-29. In addition to noting that the case fell within an“internal corporate mismanagement” exception to S 10(b) and Rule 10b-5, the court reasoned that the degree of proximity between the claimed fraud and the securities transaction was simply too attenuated for the case to fall within the scope of the federal securities laws. See id. at 1028-29.
This court again considered the contours of the“in connection with” requirement in Angelastro v. Prudential-Bache Sec., Inc., 764 F.2d 939 (3d Cir. 1985), when it addressed the question whether a brokerage firm could be held liable under S 10(b) and Rule 10b-5 for making misrepresentations concerning the terms of its margin accounts. In that case, a class of investors sued a national brokerage firm for misrepresenting both the specific interest rates that it would charge in connection with a margin purchase and the formula that it would apply in calculating those rates. See Angelastro, 764 F.2d at 941. The district court dismissed the investors’ complaint on the basis that the alleged misrepresentations were not made “in connection with” the purchase or the sale of a security. See id. This court reversed, holding that the investors could pursue their claims under S 10(b) and Rule 10b-5. The court reasoned that the requisite causal connection was satisfied by the brokerage firm‘s fraudulent course of dealing, notwithstanding the fact that the alleged misrepresentations did not relate to the merits of a security. See id. at 944-45. In holding in favor of the class, the court specifically noted that “Rule 10b-5 also encompasses misrepresentations beyond those implicating the investment value of a particular security.” Id.
While the decisions in Ketchum and Angelastro are illustrative of the point that the “in connection with” language requires a causal connection between the claimed fraud and the purchase or the sale of a security, and that the misrepresentations need not refer to a particular security, they are not helpful in applying the standard to the facts of this case. This case does not present a claim based on allegations of internal corporate misconduct arising from a contest for the control of a closely held corporation. See Ketchum, 557 F.2d at 1028. Nor does it concern a fraudulent course of dealing by a brokerage firm. See Angelastro, 764 F.2d at 944. Rather, it involves the public dissemination of allegedly misleading information into an efficient securities market. In light of the law of this circuit that the scope of the “in connection with” requirement must be determined on a case-by-case basis, we are compelled to look elsewhere in deciding the standard
In resolving the issue before us, we are persuaded by recent decisions in the Second Circuit and the Ninth Circuit that have addressed the scope of the “in connection with” requirement when the alleged fraud involves the public dissemination of false and misleading information. See In re Ames Dep‘t Stores Inc. Stock Litig., 991 F.2d 953, 956, 965-66 (2d Cir. 1993) (involving the public dissemination of false information in publicly filed offering documents, press releases, and research reports); McGann v. Ernst & Young, 102 F.3d 390, 392-93 (9th Cir. 1996) (involving the public dissemination of false information in a publiclyfiled annual report). Those courts have generally adopted the standard articulated in Securities & Exch. Comm‘n v. Texas Gulf Sulphur Co., 401 F.2d 833, 862 (2d Cir. 1968) (in banc), and applied an objective analysis that considers the alleged misrepresentation in the context in which it was made.5 They have held that, where the fraud alleged involves the public dissemination of information in a medium upon which an investor would presumably rely, the “in connection with” element may be established by proof of
We conclude that the materiality and public dissemination approach should apply in this case. The purpose underlying S 10(b) and Rule 10b-5 is to ensure that investors obtain fair and full disclosure of material facts in connection with their decisions to purchase or sell securities. See Angelastro, 764 F.2d at 942. That purpose is best satisfied by a rule that recognizes the realistic causal effect that material misrepresentations, which raise the public‘s interest in particular securities, tend to have on the investment decisions of market participants who trade in those securities. See In re Ames Dep‘t Stores Inc. Stock Litig., 991 F.2d at 966. We therefore adopt the reasoning of the Second Circuit and the Ninth Circuit and hold that the Class may establish the “in connection with” element simply by showing that the misrepresentations in question were disseminated to the public in a medium upon which a reasonable investor would rely, and that they were material when disseminated. We also point out that, under the standard which we adopt, the Class is not required to establish that the defendants actually envisioned that members of the Class would rely upon the alleged misrepresentations when making their investment decisions. See In re Ames Dep‘t Stores Inc. Stock Litig., 991 F.2d at 965; In re Leslie Fay Cos. Sec. Litig., 871 F. Supp. at 697-98. Rather, it must only show that the alleged misrepresentations were reckless. See In re Advanta Corp. Sec. Litig., 180 F.3d 525, 535 (3d Cir. 1999) (reaffirming that S 10(b) and Rule 10b-5 cover reckless misrepresentations).
In its petition for rehearing, Ernst & Young contends that the alleged misrepresentations contained in thefinancial statements and audit reports that it prepared for Cendant should not be deemed to have been made “in connection with” the purchase of ABI common stock unless it was reasonably foreseeable that they would be incorporated in the tender offer documents. We agree. The Supreme Court has warned that “[a]ny person or entity, including a lawyer, accountant, or bank who employs a manipulative device or makes a material misstatement . . . on which a purchaser relies may be liable as a primary violator under 10b-5, assuming all of the requirements for primary liability are met.” Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 191 (1994) (emphasis in original). Because an accountant is blameless where it could not reasonably have foreseen that its representations would be used in the purchase or the sale of securities, however, the Class must also establish that Ernst & Young knew, or that it had reason to know, that Cendant would use its financial statements and audit reports when making the tender offer for shares of ABI common stock. See McGann, 102 F.3d at 397 (holding that the “in connection with” requirement was satisfied for the purposes of Rule 12(b)(6) where the plaintiffs “squarely alleged that the [auditor] knew that [its client] would include its audit opinion in a Form 10-K“); Frymire-Brinati v. KPMG Peat Marwick, 2 F.3d 183 (7th Cir. 1993) (stating that “[t]o find the `connection’ just because the managers, unbeknownst to the auditors, show the financial statements to some potential investor would abolish the requirement that the defendant‘s acts occur in connection with the purchase or sale of securities“).
We emphasize, though, that it is no defense that the alleged misrepresentations were made in the context of a tender offer and a proposed merger, or that they did not specifically refer to the investment value of the security that was bought or sold. It is well established that information concerning a tender offer or a proposed merger may be material to persons who trade in the securities of the target company, despite the highly contingent nature of both types of transactions. See Basic Inc. v. Levinson, 485 U.S. 224, 238-39 (1988) (holding that preliminary merger
We do not resolve, however, whether the “in connection with” requirement is satisfied in the present case. Because the standard that we have set forth is different from the one applied by the district court, and because the parties have not been afforded a full opportunity to brief the issues of materiality and public dissemination, we will remand this matter to allow the district court to consider, in the first instance, the question whether the Class‘s complaint pleads sufficient facts to satisfy the requirements of
We note, however, that the issue of materiality typically presents a mixed question of law and fact, and that the delicate assessment of inferences is generally best left to the trier of fact. See Shapiro, 964 F.2d at 281 n.11. The district court should decide the issue of materiality as a matter of law only if the alleged misrepresentations are so clearly and obviously unimportant that reasonable minds could not differ in their answers to the question. See Weiner, 129 F.3d at 317; In re Craftmatic Sec. Litig., 890 F.2d 628, 641 (3d Cir. 1990).
B.
We next turn to the question whether the Class‘s complaint alleges sufficient facts to establish the element of reliance. It is axiomatic that a private action for securities fraud must be dismissed when a plaintiff fails to plead that he or she reasonably and justifiably relied on an alleged misrepresentation. See Weiner, 129 F.3d at 315 (setting forth reliance as an element of a private right of action under
Traditionally, purchasers and sellers of securities were required to establish that they were aware of, and directly misled by, an alleged misrepresentation to state a claim for securities fraud under
The fraud on the market theory of reliance is, in essence, a theory of indirect actual reliance under which a plaintiff is entitled to three separate presumptions in attempting to establish the element of direct reliance. See Zlotnick v. Tie Communications, 836 F.2d 818, 822 (3d Cir. 1988). Under the fraud on the market theory of reliance, the court presumes (1) that the market price of the security actually incorporated the alleged misrepresentations, (2) that the plaintiff actually relied on the market price of the security as an indicator of its value, and (3) that the plaintiff acted reasonably in relying on the market price of the security. See id. The fraud on the market theory of reliance, however, creates only a presumption, which a defendant may rebut by raising any defense to actual reliance. See Basic, Inc., 485 U.S. at 248-49. This court has pointed out that the presumption of reliance may be rebutted by showing that the market did not respond to the alleged misrepresentations, or that the plaintiff did not actually
In the present case, we are persuaded that the Class has sufficiently pleaded the element of reliance to withstand a challenge under
We conclude that it was reasonable for the Class members who purchased shares prior to March 3, 1998 to rely on the alleged misrepresentations occurring prior to that date. The defendants have not provided us with a legitimate reason for us to conclude to the contrary. Their arguments concern only the reasonableness of the reliance of the Class members who purchased shares of ABI common stock after March 3, 1998. They have no bearing on the investment decisions of persons who purchased shares of ABI common stock prior to that date, because the reasonableness of reliance is determined at the time of the transaction in question. See Hayes v. Gross, 982 F.2d 104, 107 (3d Cir. 1992) (requiring an investor to rely on an alleged misrepresentation at the time of the purchase or the sale of securities); Zlotnik, 836 F.2d at 823 (same); Gannon v. Continental Ins. Co., 920 F. Supp. 566, 578 (D.N.J. 1996) (holding that an investor cannot rely on statements that are made subsequent to the purchase of securities).
To the extent that the defendant‘s arguments suggest that it is unreasonable as a matter of law to rely on information concerning a tender offer or a merger before the transaction is finalized, we disagree. The Supreme Court has cautioned that “[n]o particular event or factor short of closing the transaction need be either necessary or sufficient by itself to render merger discussions material.” Basic, Inc., 485 U.S. at 239. And, other courts have similarly held that information concerning a tender offer may be material while the transaction is still in the planning stage. Maio, 51 F.3d at 637; Mayhew, 916 F. Supp. at 131. If it may be reasonable for an investor to find information concerning a tentative tender offer or a merger
We are also persuaded that the Class members who purchased shares of ABI common stock between March 3, 1998 and April 15, 1998 alleged sufficient facts to satisfy the element of reliance. With respect to those purchasers, the defendants maintain that AIG‘s $58 tender offer provided an independent valuation of ABI common stock upon which the Class members directly or indirectly relied. In effect, the defendants suggest that the market did not incorporate the alleged misrepresentations into the price of ABI common stock during the competing tender offer, and that the Class members would have purchased shares of ABI common stock to tender to AIG even if they had known the truth about Cendant. See Basic, Inc., 485 U.S. at 249 (noting that the presumption of indirect actual reliance may be rebutted by showing that the plaintiff would have completed the transaction regardless of the alleged misrepresentations); Zlotnik, 836 F.2d at 822 (stating that the presumption of indirect actual reliance may be rebutted by showing that the market price was not affected by the alleged misrepresentations). While those arguments are facially appealing, we do not find them persuasive given the procedural posture of this case.
In reviewing a motion to dismiss under
We agree that the Class has failed to demonstrate that it was reasonable for its members to rely on the defendants’ prior financial statements and auditors’ reports following the April 15, 1998 disclosure of the accounting irregularities. The complaint states that Cendant disclosed on April 15, 1998 that it had uncovered accounting irregularities, and that it warned investors not to rely on its prior financial statements and auditor‘s reports when making an investment decision.10 The complaint further alleges that the common stock of both Cendant and ABI traded in an efficient market, and that the market price of each stock instantly dropped after Cendant issued the warning.11 In light of the curative nature of the warning
Nevertheless, we do not accept the defendants’ contention that the Class could not have reasonably relied on the alleged misrepresentations that were included in the April 15, 1998 announcement. The Class claims that the April 15, 1998 announcement misrepresented Cendant‘s financial condition by stating that the company expected to restate its 1997 earnings by $0.11 to $0.13 per share and to reduce its net income prior to restructuring and unusual charges by approximately $100 to $115 million. The defendants claim that the Class was not entitled to rely on those statements or on any subsequent statements, because the announcement warned that the representations were subject to “known and unknown risks and uncertainties including, but not limited to, the outcome
The parties disagree as to whether the bespeaks caution doctrine applies to the statements made in the April 15, 1998 announcement that predicted the amount by which Cendant would restate its results for the 1997 year. The Class and the SEC maintain that the “bespeaks caution” doctrine is inapplicable, because the statements related to present and historical facts that were capable of verification and, as such, not forward-looking. See Grossman v. Novell, Inc., 120 F.3d 1112, 1123 (10th Cir. 1997) (holding that the bespeaks caution doctrine applies only to forward-looking information). The defendants, in contrast, characterize the statements concerning the restatement as forward-looking, and thus subject to the bespeaks caution doctrine, because Cendant had not completed a reaudit when it disclosed the amount of the anticipated restatement. See Harris v. Ivax Corp., 182 F.3d 799, 802-3 (11th Cir. 1999) (holding that statements made on the last day of a quarter concerning the results for the quarter are forward-looking).
We need not decide whether the alleged misrepresentations in the April 15, 1998 announcement were forward-looking statements, however, because we conclude that the accompanying warnings were not sufficiently cautionary to warn against the danger of relying on the specific numbers identified in the announcement. In
a vague or blanket (boilerplate) disclaimer which merely warns the reader that the investment has risks will ordinarily be inadequate to prevent misinformation. To suffice, the cautionary statements must be substantive and tailored to the specific future projections, estimates or opinions in the prospectus which the plaintiffs challenge.
Id. at 371-72. In Kline v. First Western Gov‘t Sec., Inc., 24 F.3d 480, 489 (3d Cir. 1994), this court clarified that “Trump requires that the language bespeaking caution relate directly to that by which plaintiffs claim to have been misled.”
In the present case, the cautionary language set forth in the April 15, 1998 announcement generally pertains only to the risk that the results of operations could vary in future fiscal years.13 In fact, the only risk factor that is apparently
The Class was not entitled, however, to rely indefinitely upon the April 15, 1998 misrepresentations. Cendant announced on July 14, 1998 that it had revised the restatement of its 1997 income, and it disseminated the formal results of the Audit Committee‘s investigation one
C.
Finally, we must decide whether the Class‘s complaint adequately pleads the element of loss causation. The defendants contend that the complaint failed to allege sufficient facts to support an inference that the alleged misrepresentations were the proximate cause of the Class‘s loss. They maintain that the complaint shows that several intervening events, and not the alleged misrepresentations, led first to the artificial inflation and then to the decline in the market price of ABI common stock. In particular, they assert that the price of ABI common stock was inflated by AIG‘s $58 tender offer and by the approval of the merger agreement by the board of directors of ABI. They also suggest that the Class‘s loss was actually caused by the mutual termination of the merger agreement by the board of directors of both ABI and Cendant. We disagree.
In Scattergood v. Perelman, 945 F.2d 618, 624 (3d Cir. 1991), this court held that a plaintiff may establish the element of loss causation simply by showing that he or she purchased a security at a market price that was artificially inflated due to a fraudulent misrepresentation. Id. In that case, the defendants issued a press release stating that they were considering acquiring the outstanding shares of another company at the prevailing market price. See id. at 623. The press release also warned that the defendants had “not yet determined to proceed with such transaction,” and it cautioned that there could “be no assurance that [the defendants] will ultimately decide to make such an offer or that the [board of directors of the target corporation] would recommend such an offer to the stockholders.” Id. Some of the plaintiffs purchased shares of the target company‘s
This court reached a similar conclusion in Hayes v. Gross, 982 F.2d 104, 107 (3d Cir. 1992). There, an investor filed a class action lawsuit against the directors and officers of a savings and loan association pursuant to
Plaintiff alleges that defendants knowingly or recklessly made material misrepresentations which inflated the market price for Bell stock, and that he relied on the market price as reflecting Bell‘s true value. As a result, plaintiff claims to have suffered injury as a stock purchaser.
We interpret Scattergood and Hayes as holding that, where the claimed loss involves the purchase of a security at a price that is inflated due to an alleged misrepresentation, there is a sufficient causal nexus between the loss and the alleged misrepresentation to satisfy the loss causation requirement. Cf. Sowell v. Butcher & Singer, Inc., 926 F.2d 289, 297 (3d Cir. 1991) (stating that the difference between the purchase price and the “true value” of the security at the time of the purchase is the “proper measure of damages to reflect the loss proximately caused by the defendants’ deceit“) (quoting Huddleston v. Herman & MacLean, 640 F.2d 534, 555 (5th Cir. 1981) modified on other grounds, 459 U.S. 375 (1983)). We note, however, that those decisions assume that the artificial inflation was actually “lost” due to the alleged fraud. Where the value of the security does not actually decline as a result of an alleged misrepresentation, it cannot be said that there is in fact an economic loss attributable to that misrepresentation. In the absence of a correction in the market price, the cost of the alleged misrepresentation is still incorporated into the value of the security and may be recovered at any time simply by reselling the security at the inflated price. See Green v. Occidental Petroleum Corp., 541 F.2d 1335, 1345 (9th Cir. 1976) (Sneed, J., concurring) (stating that an investor‘s proximate losses are limited to those amounts that are attributable to the unrecovered inflation in the purchase price). Because a plaintiff in an action under
We find the Eleventh Circuit‘s decision in Robbins v. Koger Properties, Inc., 116 F.3d 1441, 1448 (11th Cir. 1997), instructive of this point. In that case, a group of investors filed a class action lawsuit against Kroger Properties, Inc. (“KPI“), its officers, and its independent accountant pursuant to
Turning to the complaint at issue in this case, we are persuaded that the Class has alleged sufficient facts to show that the alleged misrepresentations proximately caused the claimed loss. The Class contends that it purchased shares of ABI common stock at a price that was inflated due to the alleged misrepresentations, and that it suffered a loss when the truth was made known and the price of ABI common stock returned to its true value. The complaint states, in relevant part:
94. As a result of the Cendant Defendants’ fraudulent conduct as alleged herein, the prices at which ABI securities traded were artificially inflated throughout the Class Period. When plaintiff and the other members of the Class purchased their ABI securities, the true value of such securities was substantially lower than the prices paid by plaintiff and
the other members of the Class. The market price of ABI common stock declined sharply from its March 23, 1998, $64-7/16 per share closing price, to its September 29, 1998, $43 per share closing price. By October 13, 1998, ABI‘s closing price dropped to $35-1/2. In ignorance of the materially false and misleading nature of the statements and documents complained of herein, as well as of the adverse, undisclosed information known to defendants, plaintiff and the other members of the Class relied, to their detriment on such statements and documents, and/or on the integrity of the market, in purchasing their ABI common stock at artificially inflated prices during the Class Period. Had plaintiff and the other members of the Class known the truth, they would not have taken such action. 95. At all relevant times, the misrepresentations and omissions particularized in this Amended Complaint directly or proximately caused, or were a substantial contributing cause of, the damages sustained by plaintiff and the other members of the Class. The misstatements and omissions complained of herein had the effect of creating in the market an unrealistically positive assessment of Cendant, as well as of its financial condition, causing ABI‘s common stock to be overvalued and artificially inflated at all relevant times. Defendants’ false portrayal, during the Class Period, of the Company‘s operations and prospects, as well as of Cendant‘s financial condition, resulted in purchases of ABI securities by plaintiff and by the other members of the Class at artificially inflated prices measured by the difference between the market prices and the actual value of such securities at the time of purchase, thus causing the damages complained of herein.
* * *
97. As a direct and proximate result of defendants’ aforesaid wrongful conduct during the Class Period, plaintiff and other members of the Class have suffered substantial damages in connection with their purchases of ABI common stock.
Notwithstanding the allegations of the complaint, however, the defendants maintain that the price of ABI common stock was inflated, not by the alleged misrepresentations, but rather by AIG‘s $58 tender offer and by the approval of the merger agreement by the board of directors of ABI. We do not agree. The Class period covers persons who purchased shares of ABI common stock prior to both events. For those purchasers, neither the competing tender offer nor the board approval of the merger agreement could have provided an independent valuation that would have inflated the price of ABI common stock.
Nor can we say, for the Class members who purchased shares of ABI common stock after that time, that the announcement of AIG‘s $58 bid and the approval of the merger agreement were sufficient to destroy the causal connection between the alleged misrepresentations and the artificial inflation in the price of ABI common stock. It is well established that not every intervening event is sufficient to break the chain of causation. See Rankow v. First Chicago Corp., 870 F.2d 356, 367 (7th Cir. 1989) (stating that to allow any intervening change in market conditions not directly caused by the defendant to break the chain of causation and exempt the defendant from liability would eviscerate
We also disagree with the defendants’ contention that the mutual termination of the merger agreement was an intervening event that caused the Class‘s loss. The complaint alleges that the market price of the common stock of both ABI and Cendant declined in response to the alleged fraud. From that allegation, it is reasonable to conclude that the disclosure of the falsity of the alleged misrepresentations played a substantial factor in the termination of the merger agreement. Indeed, it is possible that the board of directors of ABI no longer found it beneficial for its shareholders to exchange shares of ABI common stock for shares of Cendant common stock following the discovery of Cendant‘s true financial condition. In light of the sharp decline in the price of Cendant common stock, it is also reasonable to infer that the board of directors of Cendant sought to cancel the merger to avoid diluting the shares of its existing shareholders. We therefore agree with the contentions of the Class and conclude that the complaint alleges sufficient facts to establish the element of loss causation.
CONCLUSION
In sum, we conclude that the complaint alleges sufficient facts to establish the elements of reliance and loss causation. We do not resolve, however, whether the
A True Copy:
Teste:
Clerk of the United States Court of Appeals
for the Third Circuit
Notes
In accordance with SAS No. 1, the Company‘s previously issued financial statements and auditors’ reports should not be relied upon. Revised financial statements and auditors’ reports will be issued upon completion of the investigations.
Certain matters discussed in the news release are forward-looking statements, as defined in the
Private Securities Litigation Reform Act of 1995 . Such forward-looking statements are subject to a number of known and unknown risks and uncertainties including, but not limited to, the outcome of the Audit Committee‘s investigation; uncertainty as to the Company‘s future profitability; the Company‘s ability to develop and implement operational and financial systems to manage rapidly growing operations; competition in the Company‘s existing and potential future lines of businesses; the Company‘s ability to integrate and operate successfully acquired businesses and the risks associated with such businesses; the Company‘s growth strategy and for the Company to operate within the limitations imposed by financing arrangements; uncertainty as to the future profitability of acquired businesses; and other factors. Other factors and assumptions not identified above were also involved in the derivation of these forward-looking statements, and the failure of such other assumptions to be realized as well as other factors may also cause actual results to differ materially from those projected. (emphasis added).