Opinion ID: 350232
Heading Depth: 1
Heading Rank: 1

Heading: facts

Text: 3 The fortunes of Bausch & Lomb, Inc. (B & L), one of the nation's leading optical manufacturers, changed dramatically in March 1971, when it secured the Food and Drug Administration's approval to market the first hydrophilic 3 soft contact lens in the United States. Because the new product, trade named Soflens, was more comfortable than the conventional hard contact lens, it was eagerly received by ophthalmic practitioners in a nationwide series of introductory symposia sponsored by B & L between May and November 1971. Soflens sales soon significantly increased B & L's profits. Annual earnings grew 50 percent in 1971 compared to the previous year, and earnings in the last quarter of 1971 rose to $1.02 per share, almost triple those of the same quarter in 1970. The increment was almost completely attributable to Soflens. 4 As earnings skyrocketed, the value of B & L's stock soared on the New York and Pacific stock exchanges. The price of a B & L share jumped from $46 in March 1971 to a peak of $194.75 on January 28, 1972, and B & L was dubbed a glamor stock. But, like any infatuation, the investment community's love affair with B & L faded swiftly as Soflens' imperfections became increasingly apparent during the first quarter of 1972. 5
6 Both analysts and B & L itself anticipated a decrease in sales of a 72-Soflens kit for practitioners after the final introductory symposium. Subsequent sales would consist primarily of replacement lenses. But, during the early months of 1972, Soflens faced less predictable, and more serious, difficulties. A primary source of concern among investors and within B & L itself was a spate of adverse publicity (flak) generated by broad coverage accorded medical studies indicating that soft contact lenses were not as safe and effective as conventional vision aids. The financial press reported that medical researchers had discovered substantial bacterial contamination of the Griffin lens, a soft contact lens manufactured by Frigitonics Inc. for the Canadian market, and that the American Optometric Association was questioning the sterility of Soflens itself. Rumors abounded that the FDA was contemplating withdrawal of its approval of Soflens, further prompting many analysts to predict weakened consumer acceptance of the product. 7 The possibility of competition for Soflens proved even more damaging to B & L's stature among investors. On February 23rd and 24th, 1972 the price of B & L shares dropped a total of 191/8 points, 113/8 of these on the 23rd alone, after the Wall Street Journal announced that E. I. du Pont de Nemours & Co. would enter the soft contact lens business. By the end of the month, B & L's prospects had again darkened. On February 29th, Smith Barney & Co. analyst J. Gary Burkhead withdrew his buy recommendation on B & L. The next day, March 1st, B & L issued a press release stating that Soflens shipments had been halted by contamination in the shipping vials, and on that day alone B & L stock prices fell 171/2 points. During the three weeks preceding the week of March 13th, B & L plummeted a precipitous 40 points on the New York Stock Exchange. And, as that week began, reports that the Senate planned to investigate B & L's monopolistic hold on the soft contact lens market circulated in the financial community.
8 Amid mounting investor concern about Soflens, Daniel G. Schuman, Chairman of B & L, embarked upon a series of interviews with financial analysts on March 15th. Although Schuman was reputed among analysts to be a poor source of information because of his extreme caution in discussing financial matters, intense interest in the impact of recent developments on B & L's fate led several analysts to seek appointments with Schuman. Despite misgivings about the proposed meetings which had been arranged without his knowledge while he was vacationing, Schuman determined to proceed rather than appear to evade inquiries concerning the company's declining fortunes. Not surprisingly, Schuman maintained his customary circumspect style during these sessions only three of which need be discussed in detail.
9 On the afternoon of March 15th, Schuman spoke with Lewis A. Sanders, an analyst with Sanford C. Bernstein & Co. Sanders proffered his earnings estimates of $5 for the year, and $.75 for the quarter, seeking Schuman's appraisal. Schuman declined to comment, however, even though B & L's own earnings projection for the first quarter, which he had received on March 13th, was $.74, strikingly close to Sanders's. The conversation turned to the effect of the flak on Soflens sales and Schuman informed Sanders that the number of warranty cards received from customers had ceased to increase in the last two weeks, indicating that sales of Soflens had flattened out. But, he cautioned that reliable forecasting was impossible on the basis of two weeks of data, especially since the flow of returning cards depended on the whims of Soflens customers. Schuman continued that, contrary to earlier hopes, B & L did not expect to introduce the aphakic lens, a hydrophilic lens for cataract patients, and the minikit, a 38-lens package designed to attract the practitioner unwilling to invest in the larger 72-lens kit, in the first quarter. This disclosure conformed with the information B & L's Marketing Division had disseminated to inquiring Soflens customers. Indeed, the SEC does not contend that any liability arises from the Sanders-Schuman interview. The session is noteworthy primarily for the effect it produced following his meeting with Schuman, Sanders reconfirmed his existing buy recommendation on B & L, and Sanford C. Bernstein & Co. purchased 850 B & L shares for its discretionary accounts.
10 Late in the afternoon of March 15 Schuman met with Byron R. Wien and Richard J. Clancy, of the firm of Brokaw, Schaenen, Wien, Clancy & Co. (Brokaw). The day had been inauspicious for B & L stock, which had suffered a decline of 81/8 points on the New York Stock Exchange. The Brokaw analysts entered Schuman's office as Sanders was leaving and began their interview by asking Schuman to reveal Sanders's prediction of B & L's annual earnings. Without commenting on its accuracy, Schuman informed them of Sanders's $5 prediction. He then delivered a lengthy soliloquy indicating he understood analysts disagreed widely in their forecasts of B & L's earnings, and that B & L itself had no idea how Soflens would fare. Schuman further opined that analysts' predictions were placing a great deal of unnecessary pressure on the stock and magnifying the widespread publicity concerning Soflens contamination. He concluded with a heartfelt plea that analysts display more circumspection in their predictions and discussions. 11 After suffering through this gratuitous lecture, Wien and Clancy turned to the primary purpose of their visit to persuade B & L to revise its public relations techniques, which focused only on attracting the practitioner, to directly appeal to the consumer. Believing that the flak was hurting Soflens more than Schuman realized, the analysts were convinced that only a direct advertising campaign could halt the decline in Soflens sales. To bolster their argument, they suggested that B & L's earnings might drop to as little as $3 if the course they proposed were not adopted. Offended by their aggressive tactics and resolute in his determination to continue B & L's existing public relations approach, Schuman responded sarcastically by asking, in substance, why the two men had not chosen an even lower earnings figure, for example $1. 12 While admitting, as he had to Sanders, that Soflens sales, based on the warranty card return rate, appeared to have flattened out, Schuman once again warned that the figures were inherently unreliable and that optical sales were traditionally seasonal, with the peak occurring between Easter and September. Schuman further testified to informing the Brokaw analysts that the aphakic lens and minikit would not be marketed during the first quarter, although Clancy could not remember this disclosure. 13 Wien emerged from the interview disheartened by Schuman's refusal to counter declining sales with an aggressive, consumer-oriented advertising campaign, and believed that Brokaw should sell all of its B & L shares. In contrast, Clancy, who was shortly to depart for a vacation, felt that Soflens was a strong product and was inclined to sell only a third of the firm's 72,000 shares. In Clancy's absence, Wien's advice prevailed; on March 16th the entire block of Brokaw shares was sold.
14 During the Wien-Clancy interview, at 4:11 p. m., the Dow Jones Wire Service reported that Warner-Lambert, parent of the American Optical Company, the largest firm in the ophthalmic industry and B & L's principal competitor, was negotiating with Frigitonics Inc. to acquire its rights to the Griffin lens. This first official pronouncement by Warner-Lambert confirming that discussions were in progress struck one investor, Ronald Labow, like a thunderbolt. On the basis of this information alone, Labow testified he sold 100,000 shares of B & L early in the morning of March 16th. This single transaction accounted for nearly one-third of B & L's total trading volume that day.

15 As Labow divested himself of B & L shares, David MacCallum, an analyst employed by Faulkner, Dawkins & Sullivan (FDS) interviewed Schuman. MacCallum was a specialist in health industry securities, had closely monitored B & L, and had even purchased a pair of Soflens for his own use. MacCallum was originally bullish on B & L following the introduction of Soflens. But after an FDS study indicated that consumer acceptance of the product was less than he had predicted, MacCallum in late February or early March decided to withdraw his buy recommendation. FDS managing partner Dwight Faulkner, however, requested that MacCallum delay announcing the change until he had spoken with the company. Firm in his conviction to withdraw the buy recommendation, MacCallum viewed his meeting with Schuman as merely a matter of form and courtesy. The conversation on March 16 progressed along familiar lines Schuman told MacCallum that warranty card returns had declined, that aphakics and the minikit would not be available in March, and that B & L was in the process of preparing its quarterly earnings forecast, which Schuman described as a routine budgeting practice. 16 The interview ended at 11:00 a. m. with MacCallum and Schuman taking a short automobile drive to Rochester, New York, where Schuman would attend a bank board of directors meeting and MacCallum would depart for New York City. Believing that he had survived his session with MacCallum unscathed, Schuman was ill-prepared to deal with the series of events which flowed in its aftermath. 17
18 Even before leaving Rochester, MacCallum implemented his prior decision by telephoning his firm's trading manager in New York City, Derrick Hoitsma. He advised Hoitsma that he was withdrawing his buy recommendation and also revising his quarterly earnings estimate for B & L down to $.60 to $.70. The Wall Street grapevine quickly transformed this information into a rumor that B & L had leaked an earnings forecast of $.60 for the first quarter to MacCallum. 19 When Schuman emerged from the board meeting at 2:00 p. m., he was apprised that B & L's stock had fallen 7 points on an unprecedented volume of 330,000 shares more than the total amount traded in any of the preceding weeks. Schuman returned to his office, and Jack Harby, B & L's president, repeated the earnings estimate rumor. Concerned that such an inaccuracy should be attributed to him and determined to publicly divulge a correct earnings estimate, at 2:24 p. m. the distressed Schuman telephoned MacCallum, who confirmed that the estimate was his own and not Schuman's. Schuman's extreme agitation was apparent when he blurted in reply that $.70 to $.80 was a more probable range. Consumed with a penchant for accuracy and after a quick consultation with B & L's financial officers, Schuman telephoned MacCallum again a few minutes later to correct the estimate to $.65 to $.75. MacCallum testified that he was astonished by Schuman's revelation, which he found completely uncharacteristic of Schuman's usually cautious dealings with analysts. 20 Schuman, however, also promptly called Dan Dorfman, a columnist for the Wall Street Journal, and released the earnings information for publication, the method he believed would most quickly convey the proper estimate to the public. He also disseminated identical statistics to an ensuing flood of callers. Unhappy with Dorfman's presentation in the March 17 Journal, and under pressure from the New York Stock Exchange, which refused to open trading in B & L stock until the company officially announced the estimate, Schuman caused B & L to issue a press release during the afternoon of March 17th. 21 Ninety-five percent of the B & L stock sold on March 16 had been traded before Schuman's telephone call to MacCallum; the major portion of the stock's 113/4 decline also had occurred prior to that conversation. 22
23 More than a year after the events described above, the SEC brought suit against B & L, Schuman and others, 4 alleging violations of § 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, and seeking a permanent injunction and ancillary relief. After a four-day non-jury trial in March and April of 1976, Judge Ward denied the requested relief. SEC v. Bausch & Lomb, Inc., 420 F.Supp. 1226 (S.D.N.Y.1976). Although he found that the quarterly earnings estimate divulged by Schuman to MacCallum constituted material inside information, Judge Ward held that an injunction was not warranted for two reasons: no past violation of the securities laws had been shown because the SEC had failed to prove that Schuman had acted with the scienter which Judge Ward deemed, under the authority of Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976), to be a necessary element of a § 10(b) and Rule 10b-5 violation; and, even assuming a past violation, the SEC had failed to show that there existed a reasonable likelihood of future wrongdoing by the appellees. This appeal followed.