Federal Securities Laws Principles - Summary Judgment
The “fraud on the market” doctrine.
To prevail in a federal securities fraud action, plaintiffs generally must prove that the defendants knowingly or recklessly made false or misleading statements of material fact to investors, or knowingly or recklessly failed to disclose material facts necessary to make the disclosed information not materially false or misleading. Whereas a federal securities fraud plaintiff normally must prove the element of individual investor reliance on material misstatements of fact, plaintiffs invoking the “fraud on the market” theory are relieved from this burden:
Under the fraud on the market theory, the plaintiff has the benefit of a presumption that he has indirectly relied on the alleged misstatements, by relying on the integrity of the stock price established by the market.
In re Apple Computer Sec. Lit., 886 F.2d 1109, 1113-1114 (9th Cir. 1989). See generally Basic Incorporated v. Levinson, 489 U.S. 224 (1988) (approving “fraud on the market” on the market doctrine).
The materiality standard.
The test of materiality is whether a substantial likelihood exists that a reasonable investor would consider the misrepresented or omitted fact important in making an investment decision. TSC Industries, Inc. v. Northway, 426 U.S. 438, 439 (1976); Basic Incorporated v. Levinson, 485 U.S. 222, 231-232 (1988). Moreover, materiality cannot be viewed in isolation, but must be judged in the context of the “total mix” of information available to the securities markets:
Put another way, there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the “total mix” of information made available.
TSC Industries at 449. The fact that informational details are omitted does not equate to a showing that defendants failed to provide material information to investors. As the Supreme Court has pointedly observed, a business corporation has no duty to communicate an “avalanche of trivial information” to shareholders, so long as material information is disclosed. TSC Industries at 448-449.
The Ninth Circuit has repeatedly affirmed summary judgment rulings on the ground that plaintiffs failed to show materiality of the information allegedly misrepresented or omitted. See, e.g., Hanon v. Data Products Corp., 976 F.2d 497, 504-506 (9th Cir. 1992); McGonigle v. Combs, 968 F.2d 810, 817 (9th Cir. 1992).
The required element of scienter.
Plaintiffs’ federal securities law claims must fail unless plaintiffs are able to show that the defendants acted with the requisite culpable state of mind or scienter. Negligence, whether common or gross, will not suffice. As the Ninth Circuit has ruled:
To establish liability under section 10(b), the plaintiffs must show that the defendants acted with scienter, “a mental state embracing intent to deceive, manipulate, or defraud.” The plaintiffs may establish scienter by proving either actual knowledge or recklessness. ... In this context, “recklessness” is conduct “involving not merely simple or even inexcusable negligence, but an extreme departure from the standards of ordinary care and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it.”
In re Software Toolworks, Inc. Sec. Lit., 50 F.3d 615, 626 (9th Cir. 1994), cert. denied, ___ U.S. ___ (1995), quoting Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1568-1569 (9th Cir. 1990) (en banc).
When a defendant presents declarations or other competent evidence showing lack of scienter, the burden shifts to the plaintiffs to make an affirmative contrary showing. Conclusory allegations of scienter do not suffice, and individual defendants alleged to be “controlling persons” of a business corporation are entitled to summary judgment if they establish that they “acted in good faith and did not directly or indirectly induce the act or other acts constituting the violation or cause of action.” The Ninth Circuit has repeatedly upheld summary judgment orders based on a finding of the absence of the requisite scienter. See, e.g., Kaplan v. Rose, 49 F.3d 1363, 1383 (9th Cir. 1994), cert. denied, ___ U.S. ___ (1995); In re Software Toolworks, Inc. Sec. Lit., supra at 628.
The strict standard governing imputation of liability for reports of third-party securities analysts.
Plaintiffs often allege not only liability based on defendants’ own statements to the securities market, but also on the basis of statements made by third-party securities analysts or news reports. Claims of liability premised on such third-party statements, are subject to a very strict legal standard. A company and its officers cannot be liable for misstatements of material fact made by third-party securities analysts absent proof that the defendants sufficiently “entangled” themselves with the securities analysts such that statements of the analysts fairly can be imputed to the corporate defendants. In other words, to establish liability, it must be demonstrated that a defendant has endorsed, approved or placed his or its “imprimatur” on the analyst’s report or statement. A corporation and its officers have no duty to police reports and statements of third-party securities analysts for their accuracy, or to state publicly any corporate disagreements with the contents of independent analyst reports. See, e.g., In re Syntex Corp. Sec. Lit., 855 F.Supp. 1086, 1097 (N.D. Cal. 1994), aff’d, 95 F.3d 922, 934 (9th Cir. 1996); In re Quarterdeck Office Systems, Inc. Sec. Lit., 854 F.Supp. 1466, 1473 (C.D. Cal. 1994); In re Gupta Corp. Sec. Lit., 900 F.Supp. 1217, 1237 (N.D. Cal. 1994); Raab v. General Physics Corp., 4 F.3d 286, 288-289 (4th Cir. 1993).
The “truth on the market” defense.
The “fraud on the market” theory assumes that the securities market efficiently processes all available material information from all sources. An important corollary to this theory is that defendants cannot be held liable if it can be shown that information which the defendants allegedly failed to disclose, nonetheless was disclosed to the market through other reputable sources. As stated by the Ninth Circuit:
In a “fraud on the market” case, an omission is materially misleading only if the information has not already entered the market. If the market has become aware of the allegedly concealed information, the facts allegedly omitted by the defendant would already be reflected in the stock’s price and the market will not be misled. This principle has been termed by some courts as the “truth-on-the-market” doctrine or corollary.
Provenz v. Miller, 102 F.3d 1478, 1492 (9th Cir. 1996). See also, e.g., In re Apple Computer Sec. Lit., 886 F.2d 1109, 1115 (9th Cir. 1989); Rubin v. Trimble, No. C-95-4353 MMC, 1997 WL 227956 at *7 (N.D. Cal. 1997). Where a “truth on the market” defense is proven, summary judgment may be appropriate. See, e.g., In re Apple Computer Sec. Lit., supra at 1119 (partial affirmance of summary judgment rulings).
Other relevant, established points of law.
a) No duty to disclose internal projections or other forward-looking information.
The obligation to disclose material information does not require corporate defendants to disclose internal earnings, financial or business projections made for corporate planning purposes. See, e.g., In re VeriFone Sec. Lit., 11 F.3d 865, 867, 869-871 (9th Cir. 1993); In re Lyondell Petrochemical Sec. Lit., 984 F.2d 1050, 1052-1053 (9th Cir. 1993); Vaughn v. Teledyne, Inc., 628 F.2d 1214, 1221 (9th Cir. 1980). The rationale for this well-established rule of law is that such internal forecasts or projections are by their nature contingent and uncertain.
b) “Puffing” and general statements of optimism not actionable.
Likewise, no liability can be premised on disclosures of accurate historical data accompanied by general statements of optimism or confidence, absent a particularized showing that no good faith basis existed for such statements. See, e.g., Rintel v. Wathen, 806 F.Supp. 1467, 1470 (C.D. Cal. 1992); In re Gupta Corp. Sec. Lit., 900 F.Supp. 1217, 1236 (N.D. Cal. 1994); In re Syntex Corp. Sec. Lit., 855 F.Supp. 1086, 1093-1096 (N.D. Cal. 1994) (citing numerous examples of non-actionable statements), aff’d 95 F.3d 922 (9th Cir. 1996).
c) Statements which clearly “bespeak caution” not actionable.
Plaintiffs may not base a federal securities fraud cause of action on forward-looking corporate communications or statements which adequately “bespeak caution” concerning risk factors, uncertainties, and potential problems which may impact future events or trends under discussion. See generally In re Worlds of Wonder Sec. Lit., 35 F.3d 1407, 1413-1415 (9th Cir. 1994) (affirming grant of summary judgment based on “bespeaks caution” doctrine).
d) Failure to disclose trade secret or competitively sensitive information not actionable.
Plaintiffs may not ground a federal securities fraud claim upon a defendant’s failure to disclose information which constitutes a trade secret or competitively sensitive information, the disclosure of which would harm a corporation’s competitive position. See, e.g., In re Canadaigua Sec. Lit., 944 F.Supp. 1202, 1210-1211 (S.D.N.Y. 1996) (“courts have been sensitive about forcing a company to damage its own interests as well as those of its shareholders by revealing competitive information.”); In re VeriFone Sec. Lit., 784 F.Supp. 1471, 1483 (N.D. Cal. 1992) (disclosure of competitively sensitive information not required because such a disclosure obligation “simply cannot be in the best interests of investors and shareholders”), aff’d, 11 F.3d 865 (9th Cir. 1993).
e) Negligence not actionable.
Negligence or corporate mismanagement is not actionable under the anti-fraud provisions of the Securities Exchange Act. See Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 479 (1997). Moreover, a plaintiff may not by creative pleading “bootstrap” a claim of negligence into a claim of fraud, i.e., allegations that defendants “failed to disclose” their own alleged mismanagement, negligence or lack of foresight, are insufficient to state a claim for securities fraud. See, e.g., Field v. Trump, 850 F.2d 938, 947 (2d Cir. 1988); Panter v. Marshall Field & Co., 646 F.2d 271, 288 (7th Cir. 1981).
f) No duty to characterize information in language favored by plaintiffs so long as substantive material facts are disclosed.
The appropriate inquiry is whether material information was communicated, not the choice of words selected by the defendants to communicate it. Plaintiffs cannot base a cause of action for securities fraud on allegations which amount to assertions that plaintiffs would have phrased the disclosures in more derogatory, colorful or self-deprecating language. See, e.g., Wright v. IBM, 796 F.Supp. 1120, 1126 (N.D. Ill. 1992); In re Seagate Tech II Sec. Lit., [1989 Transfer Binder] Fed.Sec.L.Rep. (CCH) 94,502 at 93,201 (N.D. Cal. 1989); Kowal v. MCI, 16 F.3d 1271, 1277 (D.C. Cir. 1994).
