Opinion ID: 344913
Heading Depth: 2
Heading Rank: 1

Heading: Misrepresentations and Failures to Disclose by Huarisa and SKI

Text: 20 For Huarisa and Sun Chemical to be liable under Rule 10b-5, their statements must have contained material misrepresentations or they must have omitted to state material facts. The most recent test of materiality under the Securities Exchange Act of 1934 is whether there is a substantial likelihood that a reasonable (investor) would consider (the omitted facts or misrepresentations) important in deciding whether to invest. TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449, 96 S.Ct. 2126, 2133, 48 L.Ed.2d 757; S. D. Cohn & Co. v. Woolf, 426 U.S. 944, 96 S.Ct. 3161, 49 L.Ed.2d 1181. Applying this test, we believe the following misrepresentations and omissions were material and that Sundstrand relied thereon. 7 21 As to 1968, Huarisa represented to Sundstrand that SKI would earn $2.6 million or $2.9 million, and $1.16 per share, whereas it lost $367,803, or 15cents per share. Like the court below, we remain unconvinced that these projections were reasonable because Huarisa and Ryan knew of SKI's production and financial difficulties and of the distinct possibility of large write-offs having to be made at the end of that year. 8 22 The projection of $2.13 to $2.50 per share earnings for 1969 was also overstated, for the actual 1969 earnings were only 35cents per share. Defendants have not convinced us that the 1969 projections were reasonable. Again, we agree with the district court that Huarisa and SKI knew, or were reckless in not knowing, that the 1969 earnings were grossly inflated. The pre-merger misrepresentations about SKI's earnings projections for 1968 and 1969 were continued by Huarisa and Ryan at the January 22 meeting when they endeavored to persuade Sundstrand to revoke its decision not to proceed with the merger. However, nothing said by Huarisa and Ryan on January 22 could have influenced Sundstrand to proceed with the February 6 purchase of the Burke shares, for by then Sundstrand had received enough adverse information about SKI to call off the merger and to cause Sundstrand officers to divest themselves of the bulk of their SKI shares. 23 Huarisa and other SKI personnel also failed to disclose to Sundstrand that dissident SKI director James W. Burke filed a May 1968 report with the SKI board of directors questioning its accounting practices for 1967, particularly with respect to continuing to defer certain preproduction costs. Burke filed a supporting report from the accounting firm of Ernst & Ernst. These reports were discussed by the SKI's board at 25 board meetings during 1968, and representatives of Price Waterhouse, SKI's accounting firm, also discussed Burke's questions at several board meetings. Because of Burke's report, commencing in April 1968, the board received monthly financial reports showing the continual increase of deferred preproduction costs on certain SKI programs. In view of Burke's complaints to the SEC, SKI sent a Price Waterhouse partner and one of SKI's lawyers to discuss Burke's charges with the SEC, where it was concluded that the 1967 annual report did not reflect improper accounting practices. However, the Price Waterhouse firm assured the SEC that it would re-evaluate the situation when the 1968 annual report was prepared. The materiality of the nondisclosure of these reports is apparent, for SKI's board and Price Waterhouse representatives devoted major attention to them during 1968, and they certainly were a factor in causing Price Waterhouse to insist that SKI could not continue to defer preproduction costs in 1968. As a reviewing court, we are bound by the district judge's credibility determination that Sundstrand's president Ethington was influenced by the nondisclosure of these critical reports. This was supported by his and Sundstrand's secretary's March 22 flight to New York just after the president of Sun Chemical informed them of the reports. 9 24 On January 27, 1969, Price Waterhouse completed a memorandum stating its preliminary assessment that write-offs ranging from $3 million to.$4.5 million would have to be made on the books of KIC for the year 1968. KIC's vice president-controller Werle admittedly received a copy of this report on January 31, and SKI's financial vice president and treasurer Ryan admittedly received it on February 3. The district court found that Huarisa also must have known of this Price Waterhouse assessment before February 6 when Sundstrand paid the $6,360,915 balance for the 223,190 Burke shares of SKI stock. This memorandum was obviously material, for it resulted in $4.6 million being charged on the KIC books in 1968, causing SKI to lose 15cents per share. The memorandum should have been disclosed to Sundstrand, for it contradicted previous representations made by SKI personnel and certainly would have affected any reasonable investor's decision to proceed with a purchase of the magnitude involved on February 6. 10 But having been prepared so late, it of course could not have influenced Sundstrand to execute or reject the January 9 stock option transfer agreement. Its nondisclosure did not motivate Sundstrand in making its February 6 payment for the Burke shares because we find Sundstrand had sufficient adverse information by then as to SKI. 25 Thus a number of material misstatements and omissions were made by Huarisa and SKI upon which Sundstrand relied. Whether or not this reliance was justified for purposes of damage causation, we defer to a later discussion in this opinion. However, in order to assess damage causation intelligently, it is necessary to study Sundstrand's obligation to purchase the Burke stock in greater detail. 26