Opinion ID: 77664
Heading Depth: 2
Heading Rank: 1

Heading: Projections and omission of performance information

Text: 80 The test for materiality in the securities fraud context is whether a reasonable man would attach importance to the fact misrepresented or omitted in determining his course of action. SEC v. Carriba Air, 681 F.2d 1318, 1323 (11th Cir. 1982) ( citing TSC Indus. v. Northway, 426 U.S. 438, 449, 96 S.Ct. 2126, 2132, 48 L.Ed.2d 757 (1976)). The SEC first claims that Merchant made projections for the performance of the partnerships that were materially misleading. Statements regarding projections of future performance may be actionable under Section 10(b) or Rule 10b-5 if they are worded as guarantees or are supported by specific statements of fact ... or if the speaker does not genuinely or reasonably believe them. Kowal v. IBM Corp. (In re IBM Corp. Sec. Litig.), 163 F.3d 102, 107 (2d Cir.1998); see also Rubinstein v. Collins, 20 F.3d 160, 166, 168 (5th Cir.1994); Kowal v. MCI Communications Corp., 16 F.3d 1271, 1277 (D.C.Cir.1994). The SEC argues that Merchant promised investors a 3.2% quarterly or 16.5% annual return on capital, and that those returns were unreasonable given the high fees charged by Merchant and other service providers. 81 The district court found that these projections were not materially misleading. We divide our analysis, and address first the projections made before June 2002. We conclude that the district court did not clearly err with respect to the partnership interests offered prior to June 2002. First, the defendants did not guarantee a rate of return. The partnership agreement explicitly advised partners that the returns were not guaranteed. The agreement also recognized that the return might be greater or worse: it provided for a 50-50 split of profits left after those distributions, but also disclosed that the return might be less, and that partners might in fact lose their entire capital contribution. 82 Second, the district court also did not clearly err in determining that the projections were initially made in good faith and had a reasonable basis. Evidence in the record supports Merchant's contention that the projections were not unreasonable when made. New Vision provided Merchant with the models it used to calculate the projected return on the investment, and Merchant used those models to calculate its internal projections. Merchant claims that the projected returns failed to materialize in part because the partnerships began operating soon after September 11, 2001. Further, Wyer testified that the projected return was so high precisely because the business was risky, and the fact that the investments underperformed did not necessarily demonstrate that the expected return at the inception was unreasonable. Thus, viewing the evidence as a whole, we do not believe that the district court clearly erred in determining that the projections were not initially made in good faith and with a reasonable basis. 83 The initial projections were also rendered immaterial by the accompanying cautionary language. In this circuit we adhere to the bespeaks caution doctrine in assessing the materiality of forward-looking statements. 18 When an offering document's projections are accompanied by meaningful cautionary statements and specific warnings of the risks involved, that language may be sufficient to render the alleged omissions or misrepresentations immaterial as a matter of law. Saltzberg v. TM Sterling/Austin Assocs., 45 F.3d 399, 399 (11th Cir.1995). The cautionary language must be meaningful: boilerplate will not suffice. Id. A disclaimer does not provide per se immunity, precisely because the disclaimer must be meaningful and tailored to the risks the business faces. The bespeaks caution doctrine is ultimately simply shorthand for the well-established principle that a statement or omission must be considered in context, so that accompanying statements may render it immaterial as a matter of law. Kaufman v. Trump's Castle Funding (In re Donald J. Trump Casino Sec. Litig.), 7 F.3d 357, 364 (3d Cir.1993) ( cited in Saltzberg, 45 F.3d at 399). 84 Here, the offering documents included meaningful cautionary language that informed investors of the risk inherent in the investment and rendered the pre-June 2002 projections immaterial. A bolded section titled Risk Factors warned that becoming a General Partner is only appropriate for those persons capable of withstanding the risk of losing their entire capital contribution. It advised that there are no assurances that any amount of debt can actually be recovered. It noted the riskiness of the market, noting that [t]he debt collection business is intensely competitive and that [a]n economic downturn of any serious proportion or a national crisis could adversely affect the ability to collect debt in [sic] a timely basis. Finally, it observed that Merchant has a limited operating history and that its financial objectives must, therefore, be considered speculative. This cautionary language, specifically tailored to several of the risks faced by the debt purchasing business, rendered the projections immaterial as a matter of law, even if they were misrepresentations. 85 We next address whether the district court clearly erred in finding that the projections made after June 2002 were not materially misleading. The SEC also argues that, after June 2002, Merchant made materially misleading omissions when it knew that the partnerships' business model was not succeeding, yet continued to sell RLLP interests without disclosing the lack of success or the specific reasons why the business was failing. The test for materiality of an omission is whether a reasonable man would attach importance to the fact omitted in determining a course of action. Kennedy v. Tallant, 710 F.2d 711, 719 (11th Cir.1983). It is well established that a materially misleading omission of past performance information occurs when a promoter makes optimistic statements about the prospects of the business but fails to include past performance information that would be useful to a reasonable investor in assessing those statements. See, e.g., Carriba Air, 681 F.2d at 1323-24 (material omission where failed to disclose that highly similar predecessor business had gone bankrupt); No. 84 Employer-Teamster Joint Council Pension Trust Fund v. Am. West Holding Corp., 320 F.3d 920, 935 (9th Cir.2003) (material omission where airline painted rosy picture of financial prospects, while knowing it had undisclosed specific problems, including maintenance issues and an FAA investigation); Rubinstein, 20 F.3d at 170 (optimistic statements that omit known substantial adverse facts are actionable under antifraud provisions). Additionally, general cautionary language does not render omission of specific adverse historical facts immaterial. See, e.g., In re Westinghouse Sec. Litig., 90 F.3d 696, 710 (3d Cir.1996) (general cautionary language did not render misrepresentations immaterial where management knew about specific negative events that had already occurred); Rubinstein, 20 F.3d at 171 ([T]he inclusion of general cautionary language regarding a prediction would not excuse the alleged failure to reveal known material, adverse facts.). 86 The SEC established through unrebutted testimony that the defendants knew their business model was not succeeding as early as June 2002. The SEC's expert showed that the partnerships in the aggregate were operating at 89% of benchmark in June, and 77% three months later. The defendants were also aware of the poor performance. The SEC produced an email in which the defendants discussed the poor performance of RLLP-5 in June, when it was collecting at 55% of benchmark. Beasley also admitted that they knew that the partnerships were performing poorly when they sold the later interests. Yet the defendants continued to sell the interests through November 2002 without disclosing the poor performance of the interests that had already been sold, or the specific reasons for the poor performance. The partnership materials contained only the same general disclosures of risk that had been present from the beginning. These warnings did not include, for example, Merchant's belief that collections had suffered in the wake of September 11, 2001, or that the level of fees Merchant was collecting had prevented the partnerships from being profitable, given the collection rate in the first six to nine months. 87 Instead, alongside the general cautionary language, the materials continued to paint a rosy picture of the business's prospects. The interests were called Evergreen High Yield RLLPs. The partnership agreement promised returns on capital of 3.2% per quarter or 16.5% per year. The risk disclosure implied unwarranted optimism. It said that Merchant is confident that it has done its very best to mitigate these risks. It also represented that there was no assurance Merchant will continue to be successful in the purchase and sale of distressed debt. This implied, contrary to fact, that Merchant had been successful in the purchase and sale of distressed debt. In its description of the debt industry, Merchant said that the projected growth of credit card debt illustrates the potential growth rate of the debt industry, without disclosing that Merchant's operating history contradicted that assessment. 88 In this context, Merchant's omission of the performance history of the existing RLLPs was materially misleading, and not cured by the general cautionary language in the risk disclosure. See Kowal, 16 F.3d at 1277 (no duty to disclose projections, but if do disclose projections, its disclosure must be full and fair). What may once have been a good faith projection became, with experience, a materially misleading omission of material fact. As the Fifth Circuit has recognized, [t]o warn that the untoward may occur when the event is contingent is prudent, to caution that it is only possible for the unfavorable events to happen when they have already occurred is deceit. Rubinstein, 20 F.3d at 171 ( quoting Huddleston v. Herman & MacLean, 640 F.2d 534, 544 (5th Cir. March 9, 1981), 19 aff'd in part, rev'd in part by Herman & MacLean v. Huddleston, 459 U.S. 375, 103 S.Ct. 683, 74 L.Ed.2d 548 (1983)). Here, unfavorable events had already occurred when Merchant made its optimistic statements, which made those statements materially misleading. 89 Merchant's only argument in response (which the district court accepted) is that the SEC's expert testified that Merchant had been truthful and accurate in its disclosures to its partners. This expert, however, had a limited engagement. At trial the expert testified that his assignment was threefold: (1) to determine whether the monthly statements to the partners were consistent with the actual transactions; (2) to determine whether the financial transactions of the partnerships were consistent with the representations in the partnership offering documents; and (3) to assess the overall financial performance of the partnerships, and whether that performance was consistent with Merchant's projections. This assignment included, as the district court put it, determining whether the financial transactions of the partnerships were consistent with the disclosures that were contained in the partnership offering documents. SEC v. Merchant Capital, LLC, 400 F.Supp.2d 1336, 1357 (N.D.Ga.2005). When Merchant asked this expert whether he had uncovered evidence of fraud, the expert replied that he had not, but was careful to emphasize that his investigation was limited to the internal handling of money and the financial reporting, and did not presume to assess whether the offering materials as a whole made fraudulent representations to the partners. 20 He later specifically testified that his assignment did not address whether Merchant accurately disclosed losses or projections to investors in the offering materials. From this testimony, it is clear that the expert analyzed only whether the partnerships' financial transactions were consistent with the offering materials, not whether the offering materials contained sufficient information about past performance so as to make their projections not materially misleading. The fact that this expert did not find fraud therefore did not support the district court's conclusion that the projections made after June 2002 were not materially misleading. Because the expert's testimony does not support the district court's conclusion, and because the other evidence of material omission in the partnership materials is overwhelming, the district court clearly erred in determining that the post-June 2002 omissions were not material.