Opinion ID: 2176586
Heading Depth: 1
Heading Rank: 3

Heading: liability of hibbard brown

Text: The Commissioner found that Hibbard Brown acted in violation of 6 Del.C. § 7303(2) in connection with the sales of securities to Krieger and Flynn. The Court of Chancery expressly affirmed the finding that Hibbard Brown had failed to disclose adequately its market maker status in violation of section 7303(2). Nevertheless, the Court of Chancery did not find Hibbard Brown to be directly involved in the other fraudulent conduct committed by Martone and Hart. Section 7303(2) sets forth one of the antifraud provisions of the Delaware Securities Act: It is unlawful for any person, in connection with the offer, sale or purchase of any security, directly or indirectly: . . . . (2) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they are made, not misleading.... 6 Del.C. § 7303(2). The language of section 7303(2) is virtually identical to Securities and Exchange Commission (the SEC) Rule 10b-5 promulgated by the SEC pursuant to Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78a et seq. (the 1934 Act). See Singer v. Magnavox Co., Del.Ch., 367 A.2d 1349, 1360 (1976), aff'd in part and rev'd in part on other grounds, Del.Supr., 380 A.2d 969 (1977) (observing that 6 Del.C. § 7303 is almost identical to, and in fact is identical in the wording of its three subprovisions to, Securities And Exchange Commission Rule 10b-5). While this Court has not had the opportunity to address the elements of a cause of action under section 7303(2), the similarity of that provision with Rule 10b-5 evidences the General Assembly's intent that it be governed by similar principles. The legal nexus between section 7303(2) and Rule 10b-5 is further strengthened by an examination of their respective objectives. The purpose of the Delaware Securities Act is to prevent the public from being victimized by unscrupulous or overreaching broker-dealers, investment advisors or agents in the context of selling securities or giving investment advice.... 6 Del.C. § 7301(b). Similarly, Section 10(b) was designed as a catchall clause to prevent fraudulent practices. Chiarella v. United States, 445 U.S. 222, 226, 100 S.Ct. 1108, 1113, 63 L.Ed.2d 348 (1980). [2] See also Travis v. Anthes Imperial, Ltd., 473 F.2d 515, 522 (8th Cir.1973) (observing that section 10(b) and Rule 10b-5 were designed to protect investors from deceptive schemes); Fox v. Prudent Resources Trust, 382 F.Supp. 81, 86 (E.D.Pa.1974) (stating that the basic purpose of Rule 10b-5 is to safeguard investors by policing devices inimical to `the climate of fair dealing'). Thus, both federal and state antifraud provisions share the goal of protecting investors by preventing deception. It is also significant that securities fraud provisions of other states which are modeled on Rule 10b-5 have been interpreted using federal case law applicable to that Rule. E.g. Commodity Futures Trading Comm'n v. American Metal Exchange Corp., 775 F.Supp. 767, 783 (D.N.J.1991) (analyzing a claim under New Jersey's antifraud provision using federal precedent under Rule 10b-5 because of their similarity), aff'd in part and vacated in part on other grounds, 991 F.2d 71 (3d Cir.1993); Branch-Hess Vending Services Employees' Pension Trust v. Guebert, 751 F.Supp. 1333, 1342 (C.D.Ill.1990) (recognizing that the elements of a violation of the antifraud section of the Illinois Securities Act generally parallel those of Rule 10b-5); Pelletier v. Zweifel, 921 F.2d 1465, 1511 (11th Cir.1991) (holding that the same elements are required for Georgia's securities fraud provision and Rule 10b-5), cert. denied, ___ U.S. ___, 112 S.Ct. 167, 116 L.Ed.2d 131 (1991). Accordingly, in order to establish a violation of section 7303(2), it must be demonstrated that the defendant (1) made a misstatement or omission (2) of material fact (3) with scienter (4) in connection with a purchase or sale of a security (5) upon which the plaintiff (or another person if the action is brought by the Delaware Securities Division) relied and (6) that reliance proximately caused the plaintiff's (or other person's) injury. See, e.g., In re Phillips Petroleum Sec. Litig., 881 F.2d 1236, 1244 (3d Cir.1989).
The Commissioner argues on appeal that the Chancery Court erred by reversing the Commissioner's finding that Hibbard Brown either actively or tacitly encouraged the conduct of its agents. The Commissioner's finding of liability was based on its analysis of Hibbard Brown's Weekly Research Notes. According to the Commissioner, these Notes contained numerous misleading statements and falsehoods evidencing a pattern of dishonesty within the firm. The Court of Chancery, however, found that Hibbard Brown was not intimately implicated in the wrongdoing, and did not affirm any of the Commissioner's findings of direct liability other than the violations based on the market maker nondisclosure. The Court of Chancery reversed the Commissioner's findings of direct involvement in the fraud apparently because there was no material and substantial evidence of such involvement in the record. [3] We agree with this assessment. In the Company Comments section of the Weekly Research Notes, Hibbard Brown favorably describes the prospects of a number of companies. These descriptions normally include a discussion of the company's business, financial results, recent developments, management's views, and Hibbard Brown's assessment (usually positive) of the company's prospects. The comments are therefore a combination of specific facts, predictions and statements of opinion. The Commissioner placed substantial importance on its finding that the Research Notes contained numerous misleading statements and falsehoods. A close scrutiny of the Commissioner's opinion, however, reveals very few actual misrepresentations. Federal courts have recognized that [s]tatements about future events that are plainly expressions of opinion and not guarantees are not actionable under the federal securities laws. Hershfang v. Citicorp, 767 F.Supp. 1251, 1256 (S.D.N.Y.1991). See also Friedman v. Mohasco Corp., 929 F.2d 77, 79 (2d Cir.1991) (holding that Rule 10b-5 claims based on an opinion of financial advisors regarding the expected market value of securities to be issued in a merger did not state a cause of action). An optimistic prediction regarding a company's future prospects is not a falsehood absent evidence that it was not made in good faith (i.e., not genuinely believed to be true) or that there was no reasonable foundation for the prediction. E.g. Eisenberg v. Gagnon, 766 F.2d 770, 776 (3d Cir.), cert. denied sub nom., Weinstein v. Eisenberg, 474 U.S. 946, 106 S.Ct. 342, 88 L.Ed.2d 290 (1985); Ciresi v. Citicorp, 782 F.Supp. 819, 822 (S.D.N.Y.1991), aff'd mem., 956 F.2d 1161 (2d Cir.1992). It is also not per se improper to recommend a company simply because its past history is unimpressive. The fact that a company turns out to be unprofitable does not establish that an earlier prediction of future profitability is fraudulent. See Eisenberg, 766 F.2d at 776 (holding that [i]n establishing scienter with respect to projections and opinions, it is insufficient to show ... that a forecast turned out to be incorrect) (citation omitted) (emphasis in original); Design Time v. Synthetic Diamond Technology, 674 F.Supp. 1564, 1571 (N.D.Ind.1987) (Without more, an allegation of faulty economic prognostication will not support an inference of fraud). Most of the Commissioner's criticism of the Research Notes is based on hindsight and second-guessing. For example, in discussing News Communications, Inc. in the November 6, 1989 issue of Research Notes, Hibbard Brown observes that the growth forecast for this company is reaching fruition and predicts that [w]ithin the next 12-18 months we believe that News Communications can achieve annual revenues in the vicinity of $8 million.... The Commissioner seems to criticize these statements by pointing to the company's $1,249,011 net loss for fiscal 1990. Nevertheless, Hibbard Brown's predictions were made in the context of News Communications' results for the quarter ending August 31, 1989, which were discussed in the Research Notes and indicated a substantial increase in both revenues and profits over the same quarter for the preceding year. The Commissioner has not cited any evidence to show that those predictions were manifestly unreasonable in light of the contemporaneous positive quarterly results. Even though Hibbard Brown's forecasts proved to be incorrect, the Commissioner's second-guessing does not constitute material and substantial evidence of fraudulent conduct. [4] The fact that Hibbard Brown recommended highly speculative companies in its Research Notes is not evidence of fraud since that publication is distributed to a variety of potential customers. Many investors may prefer to buy risky ventures in the hope that the rewards of discovering a future corporate giant will offset the losses from the many companies which fail. Such a strategy may well be appropriate if the investor has a diversified portfolio and is not deceived about the risks. In fact, a number of the securities purchased by Krieger and Flynn were sold at a modest profit, though such gains were reinvested in stocks which suffered substantial losses. The fraud is not what stocks Hibbard Brown recommended, but instead how they were described by the brokers selling them. Martone and Hart, not Hibbard Brown, bear the direct responsibility for concealing the risks associated with the securities they were selling to persons they knew were not well-suited to investing in highly speculative ventures. [5] The only concrete misstatement found by the Commissioner is in the Research Notes dated May 14, 1990, which stated that Children's Creative Workshop, Ltd. was expected to open its first prototype store by the end of that summer. The company's Form 10-Q financial report for the quarter ending January 31, 1990, indicated that the company was not in a position to open the new store until additional financing was obtained. This Form 10-Q was filed with the Securities and Exchange Commission on April 27, 1990, a little over two weeks before the May 14, 1990 issue of Research Notes. We do not find the misstatement in the May 14, 1990 Research Notes to be sufficient to show either a pattern of dishonesty or management approval of fraudulent behavior. Even though Hibbard Brown probably should have been aware sooner of the information in the Form 10-Q, it is certainly plausible that the drafters of the Research Notes were unaware of the statements contained in the Form 10-Q that had been filed only two weeks previously. Moreover, the erroneous information was corrected in the July 16, 1990 Research Notes. Finally, the May 14, 1990 misstatement, as a matter of law, could not support a finding of liability under section 7303(2) in the circumstances presented here. Flynn purchased his shares of Children's Creative Workshop in September and October of 1989, over six months before the misstatement. A violation of section 7303(2) cannot be predicated on after-the-fact statements since neither the in connection with requirement nor the reliance element can be established. Accordingly, we conclude that the Commissioner's finding of direct involvement by the management of Hibbard Brown in the fraud perpetrated by its agents is not supported by material and substantial evidence. The Court of Chancery was therefore correct not to affirm that finding and the violations premised on it. [6]
The Court of Chancery held that Hibbard Brown violated section 7303(2) by failing to make a sufficient disclosure regarding its status as a market maker in the stocks they recommended for purchase. On the purchase confirmation slips sent to Delaware investors, Hibbard Brown stated WE MAKE A MKT IN THIS SECURITY. [7] While observing that such disclosure [may be] sufficient in some cases under Federal Securities laws, and that this statement may suffice for sophisticated investors, the Court of Chancery concluded: However, in the present case, the investors were unsophisticated and relied upon the information provided to them by HB and its agents. A one-line disclosure statement to such clients does not meet the adequacy requirements imposed on HB by 6 Del.C. § 7303(2). Hibbard Brown & Co. v. Hubbard, Del.Ch., C.A. No. 12451, 1992 WL 389927, , slip op. at 12, Chandler, V.C. (Dec. 21, 1992) (emphasis in original). Whether disclosures are adequate is a mixed question of law and fact. Zirn v. VLI Corp., Del.Supr., 621 A.2d 773, 777 (1993). Therefore, the findings of the Court of Chancery with respect to the adequacy of disclosures will be upheld if they are sufficiently supported by the record and are the product of an orderly and logical deductive process. Shell Petroleum, Inc. v. Smith, Del.Supr., 606 A.2d 112, 114 (1992); Levitt v. Bouvier, Del.Supr., 287 A.2d 671, 673 (1972). Nevertheless, this Court's review of the legal standards formulated and applied by the Court of Chancery is de novo. See Zirn, 621 A.2d at 777. The Court of Chancery erred as a matter of law by relying on the lack of sophistication of Messrs. Krieger and Flynn in holding that Hibbard Brown's disclosure was inadequate. The adequacy of disclosure is determined by focusing upon a reasonable investor, and not by considering the attributes of the particular investor at issue. In the context of a director's duty of disclosure, this Court has held that the materiality of omitted information is determined using the standards enunciated in TSC Industries v. Northway, 426 U.S. 438, 96 S.Ct. 2126, 48 L.Ed.2d 757 (1976). [8] Rosenblatt v. Getty Oil Co., Del.Supr., 493 A.2d 929, 944 (1985) (adopting the TSC standard for determining compliance with the duty of disclosure); Stroud v. Grace, Del.Supr., 606 A.2d 75, 84 (1992) (reaffirming Rosenblatt's holding regarding the TSC materiality standard). This Court recently stressed that [t]he TSC materiality standard is an objective one, measured from the point of view of the reasonable investor. Zirn v. VLI Corp., Del. Supr., 621 A.2d 773, 779 (1993) (emphasis in original). The United States Supreme Court has held that the materiality of misrepresentations and omissions in the Rule 10b-5 context is governed by the objective reasonable investor standard set forth in TSC Industries. Basic v. Levinson, 485 U.S. 224, 230-32, 108 S.Ct. 978, 982-84, 99 L.Ed.2d 194 (1988). In light of the fact that section 7303(2) and Rule 10b-5 are identically worded and have a similar purpose in protecting investors from fraudulent conduct in securities transactions, there is no reason why they should have different standards for materiality. Accordingly, the sophistication of the particular investor involved is not an appropriate consideration in assessing the adequacy of disclosure under either Rule 10b-5 or section 7303(2). [9] Furthermore, the Court of Chancery's holding on the adequacy of the phrase WE MAKE A MKT IN THIS SECURITY is inconsistent with federal case law under Rule 10b-5 (as the Vice Chancellor recognized). In Pross v. Baird, Patrick & Co., 585 F.Supp. 1456 (S.D.N.Y.1984), the Southern District of New York held that the identical phrase used by Hibbard Brown was a sufficient disclosure of market maker status for purposes of Rule 10b-5. Id. at 1459. The Court of Chancery's holding that the disclosure used by Hibbard Brown violated section 7303(2), even though the same language satisfies Rule 10b-5, creates the risk of uncertainty and confusion. We therefore reverse the finding of the Commissioner and the Court of Chancery that Hibbard Brown violated section 7303(2) by failing to disclose its status as a market maker. Because the Court of Chancery based its four-month suspension of Hibbard Brown on the four statutory violations it found, our reversal of the two nondisclosure violations reduces the suspension to two months. [10]