Opinion ID: 196753
Heading Depth: 2
Heading Rank: 2

Heading: Importance of Context: the Break-Even Statements

Text: 92 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. 93 Putting aside whether plaintiffs have adequately alleged that these statements were made with fraudulent intent, the statements, when read in isolation, 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. 94 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, 503 U.S. 960, 112 S.Ct. 1561, 118 L.Ed.2d 208 (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 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 DEC. 34 95 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: 96 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]. 97 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 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. 98 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: 99 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]. 100 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.) (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, 98 S.Ct. 178, 54 L.Ed.2d 129 (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; 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. 101 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: 102 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. 103 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. 104 C. Actionability under Section 10(b) of Omissions and Misleading Statements in the Registration Statement and Prospectus 105 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 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. 106 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); Fischman v. Raytheon Mfg. Co., 188 F.2d 783, 786-87 (2d Cir.1951); cf. Huddleston, 459 U.S. at 383, 103 S.Ct. at 688 ([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 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. 107 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 108 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. 109 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.